CFAI L2 Practice Exam 2017 PM Session
CFAI L2 Practice Exam 2017 PM Session
CFAI L2 Practice Exam 2017 PM Session
The afternoon session of the 2017 Level II Chartered Financial Analyst® Mock
Examination has 60 questions. To best simulate the exam day experience, candidates
are advised to allocate an average of 18 minutes per item set (vignette and 6 multiple
choice questions) for a total of 180 minutes (3 hours) for this session of the exam.
Questions Topic Minutes
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sell-side analyst whom I know to be thorough and competent. I liked her ideas, so
with her permission and acknowledgement, I replicated portions of her report. The
sell-side analyst’s report was so thorough I did not have to add much to my report.
But I did add my own recommendation, risk rating, and a time frame over which I
think her target price will be met. Her report was published just two days after she
visited the company’s management, and I sent my report to our clients only one day
after I received her report, so I know the information was timely.”
1 Austin’s description of the objectives of the CFA Institute ROS is least likely
correct with regard to the impact of:
A policies and procedures.
B self-regulation.
C the firm’s work environment.
2 Does Austin's communication plan for the Independence and Objectivity of
Research Policy and Procedures Manual most likely meet the requirements of
the CFA Institute ROS?
A Yes
B No, with regard to distribution to the analysts and their supervisors
C No, with regard to the availability to clients and prospective clients
3 Which of Austin’s suggestions regarding Standard 6.0 Relationships with
Subject Companies is most likely a CFA Institute ROS requirement rather than
a recommendation?
A Suggestion 1
B Suggestion 2
C Suggestion 3
4 Which of Evergreen’s personal trading polices is most likely stricter than
required or recommended by the CFA Institute ROS Standard 7.0 Personal
Investments and Trading?
A The types of transactions that need to be reported
B Trading contrary to the firm’s recommendation
C Trading restrictions for all employees
5 What is Austin’s most appropriate response to Osram’s question with regard to
the CFA Institute ROS requirements?
A “No, you are required to fully disclose any investments of the firm or what
you own personally only when a direct conflict of interest is present.”
B “You should disclose your spouse’s interests. I will revise the policy to reflect
this requirement.”
C “You need to make a disclosure regarding your spouse’s interests only when
you are actively marketing the company you are discussing.”
6 Which of the CFA Institute ROS did Shera most likely violate by issuing her last
research report?
A Standard 8.0 Timeliness of Research Reports and Recommendations
B Standard 11.0 Rating System
C Standard 3.0 Reasonable and Adequate Basis
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Degrees of
ANOVA Freedom (DF) Sum of Squares (SS) Mean Square (MS)
Garfield presents the regression results to the investment committee with the
following three conclusions:
1 The regression intercept is statistically significant.
2 The model explains more than half of the variation in HighTech’s returns.
3 The NASDAQ index return and the HighTech return are positively correlated.
The committee asks Garfield whether he can use the model to predict the return
on HighTech’s stock. Ram Gupta, a committee member, asks:
“What would HighTech’s return be in a month when the return on the
NASDAQ index is 0.05633?”
Another committee member, Riko Samora, thinks that the simple regression model
omits important factors that might affect HighTech’s performance. Samora believes
that because more than 40% of HighTech’s customers are in Tokyo, the value of the
Japanese currency should influence HighTech’s sales and that the model’s significance
would considerably improve if Garfield considers this fact.
Following Samora’s suggestion, Garfield runs a multiple linear regression adding
the change in the JPY/USD exchange rate as a second independent variable. The results
from this regression are shown in Exhibit 2.
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Garfield presents the new results to Samora, who asks him two questions:
1 Are the results of this second regression significant?
2 Do you suspect that the model has problems with multicollinearity or serial
correlation?
Garfield responds to the Samora’s questions by examining the F-, t-, and DW
statistics in the regression output to see whether they are significant.
7 The standard error of estimate of the regression model shown in Exhibit 1 is
closest to:
A 0.0031.
B 0.1802.
C 0.0557.
8 Which of Garfield’s conclusions to the investment committee about the findings
from his first model (Exhibit 1) is least likely correct? Conclusion:
A 1
B 2
C 3
9 In response to Gupta’s question about predicting HighTech’s return, Garfield’s
prediction (in decimal form) will be closest to:
A 0.06118.
B 0.04333.
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C 0.06297.
10 Using the results shown in Exhibit 2, the value of the F-statistic is closest to:
A 9.63.
B 37.51.
C 16.76.
11 Based on the results of the regression model shown in Exhibit 2, the best
conclusion Garfield can make about a hypothesis that the coefficient JPY/USD
change is zero is to:
A reject the alternative hypothesis.
B reject the null hypothesis.
C fail to reject the null hypothesis.
12 In preparing his response to Samora’s second question, Garfield’s most appro-
priate conclusion is that the model:
A has multicollinearity but not serial correlation.
B has serial correlation but not multicollinearity.
C does not have either multicollinearity or serial correlation.
The discussion of short-term exchange rate forecasting continues with the fol-
lowing comments:
Beauregard: “Technical analysis is not likely to benefit our emerging
market trades because the currencies are thinly traded.”
Thibodeaux: “Utilizing trend following in our carry trade strategy should
protect us from experiencing losses in a market unwind.”
Beauregard: “Monitoring market sentiment by following the trend in
risk reversals should enable us to predict and confirm cur-
rency rate movements on our trades.”
Thibodeaux and Beauregard discuss some of CapFX’s recent trades using the cur-
rency quotes and rates provided in Exhibits 1 and 2. For all currency pairs provided
the notation used is, for example: USD/AUD: US dollars per Australian dollar.
■ Based on the data in Exhibit 1, a European client recently entered into a
one-year JPY/EUR carry trade based on the projected outlook for the two
currencies.
■ A Hong Kong based client producing electronic components, signed a long-
term contract to deliver components to a Canadian aircraft parts manufacturer.
The client wanted to estimate the hedging cost for a sale scheduled to close in
nine months. Based on the data presented in Exhibit 2, the client entered into a
nine-month (270-day) HKD/CAD forward contract.
A Statement 3
B Statement 2
C Statement 1
15 Which of the comments about short-term exchange rate forecasting is the most
accurate? The comment by:
A Beauregard regarding their emerging market trades.
B Beauregard regarding monitoring market sentiment.
C Thibodeaux regarding their carry trade strategy.
16 Based on the data in Exhibit 1, the bid EUR/AUD cross-rate implied by the
interbank market is closest to:
A 0.6497.
B 0.6484.
C 0.7650.
17 Based on the data in Exhibit 1, the expected net investment return on a one-
year carry trade based on the JPY/EUR currency pair, measured in JPY terms, is
closest to:
A 2.86%.
B 3.10%.
C 3.01%.
18 Using Exhibit 2, the mid-market forward premium (discount) for a 270-day
forward contract for HKD/CAD is closest to:
A –0.0686.
B –0.0697.
C –0.0913.
Exhibit 1 (Continued)
Recreational
Total for 3 divisions Children’s Products Products Home Furnishings
2013 2012 2013 2012 2013 2012 2013 2012
Earnings before 136.6 170.0
taxes
Net earnings after 109.9 132.3
tax
Total Assets 2,498.0 2,479.5 1,270.9 1,249.6 961.5 948.5 265.6 281.4
Capital 32.7 42.3 22.1 30.0 6.7 8.6 3.9 3.7
expenditures
Proportion 100% 100% 67.6% 70.9% 20.5% 20.3% 11.9% 8.7%
of Capital
expenditures
Proportion of Total 100% 100% 50.9% 50.4% 38.5% 38.3% 10.6% 11.3%
assets
Worried that the balance-sheet-based and cash-flow based accruals ratios (not
shown) raise some concerns about the possible use of accruals to manage earnings,
Petersen asks Berg, for advice on what further type of analysis he should do as a
follow-up on this issue.
19 Using Petersen's preferred method and 2013 divisional data, the best conclusion
Peterson can make about which division will potentially become less significant
in the future is that it will be:
A home furnishings.
B recreational products.
C children's products.
20 If the children's products division had been able to maintain its 2012 operating
margin in 2013, the company’s overall operating margin in 2013, compared to
2012, would have been:
A higher.
B the same.
C lower.
21 Which of the following is the most appropriate use of Berg’s reminder about the
US versus euro exchange rate in 2013? Peterson should use the information:
A to determine the exchange gains or losses included in net income.
B to confirm that the division's organic growth was less than 11.2%.
C when evaluating management's historical performance.
22 The best conclusion Petersen can make about the geographic mix of Rhine’s
profit in 2013 is that compared with 2012 the mix is:
A more international.
B about the same.
C more domestic.
23 Compared with 2011, the change in which working capital account most likely
had the largest effect on Petersen’s observed deterioration in liquidity?
A Accounts payable
B Accounts receivable
C Inventory
24 Berg’s best answer to Petersen’s question about further analysis is that he should
conduct a:
A Cash flow ratio analysis.
B DuPont analysis.
C Discounted cash flow analysis.
Revenues $6,456
Earnings before interest, taxes, depreciation, and amortization 1,349
(EBITDA)
Depreciation expense 243
Operating income 1,106
Interest expense 186
Pretax income 920
Income tax (32%) 294
Net income $626
Assets
Cash and cash equivalents $32 $21
Accounts receivable 413 417
Inventories 709 638
Other current assets 136 123
Total current assets 1,290 1,199
Yee plans to perform two different valuations of McLaughlin, which she calls the
“base case” valuation and the “alternative” valuation. Critical assumptions for each
are given in the following lists.
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Alternative valuation
28 Using Yee’s alternative valuation assumptions and the FCFE valuation approach,
the year-end 2012 value per share of McLaughlin’s common stock is closest to:
A $24.17.
B $18.00.
C $22.80.
29 The most likely combined effect of the three possible financial actions identified
by Yee will reduce McLaughlin’s 2013 FCFE ($ millions) by:
A $100.
B $270.
C $160.
30 Which of Nicosia’s three statements pertaining to McLaughlin’s valuation is the
most accurate? Statement:
A 2
B 3
C 1
Exhibit 1 Selected Stock Data for XRL and ZTL and Additional Market
Information
XRL ZTL
EPS ($) DPS ($) EPS ($) DPS ($)
(continued)
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Exhibit 1 (Continued)
Additional information:
Note: DPS is dividends per share and EPS is earnings per share
Barton begins her analysis by looking at XRL. After doing some research, she con-
cludes that a reasonable growth estimate for the company is the sustainable growth
rate using the most recent year’s retention ratio, and calculates a price for XRL using
this information. She makes the following note:
■ it will not be possible to use the Gordon growth model for her analysis of XRL.
Barton and Eckhart discuss the impact of a company’s growth rate on its future
stock price. Barton determines XRL’s growth rate of earnings for the period from 2011
to 2015 and compares it to the current nominal growth rate of the US economy. She
concludes that XRL is likely to be in the transition stage of growth.
Next Eckhart asks Barton to calculate the intrinsic value of ZTL shares using the
Gordon model to determine if it meets the fund’s investment objectives. He suggests
that rather than using the sustainable growth rate, she should use the growth rate of
dividends over the past five years.
Eckhart tells Barton that he has heard rumors that ZTL is contemplating selling
one of its major manufacturing facilities. He believes that if that should happen, the
company would pay a series of special dividends in each of the three years following
the sale. Barton asks him how she could best incorporate such a possibility into the
valuation of the shares.
Turning to the private equity fund, Eckhart informs Barton that the fund is
considering buying a controlling interest in a closely held company, H-Tron (HTR),
which pays infrequent dividends that are well below the free cash flow from equity.
HTR has healthy cash flows with significant growth potential and holds patents on a
key innovation in electronics technology. Eckhart believes the value of these patents
is not fully reflected in HTR’s balance sheet. He asks her how HTR’s common equity
should be valued given these circumstances. Barton states that she will assess which
valuation method will be the most suitable.
Finally, Eckhart asks Barton to value HTR’s non-callable perpetual preferred stock
as a potential investment for the fund. The stock, currently privately held, pays a fixed
annual dividend of $7.50. After performing some industry analysis, Barton decides to
use an equity risk premium of 6% in valuing the stock.
31 Using the data in Exhibit 1, Barton’s note about the use of the Gordon growth
model to value XRL is most likely:
A correct because the required return on equity is less than the expected
growth rate.
B incorrect because the sustainable growth rate is greater than the US econo-
my’s growth rate.
C incorrect because the required return on equity is greater than the US econ-
omy’s growth rate.
32 Barton's conclusion that XRL is in the transition phase is best described as:
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A correct.
B incorrect, because the company is in the supernormal growth phase.
C incorrect, because the company is in the mature phase.
33 Using the data in Exhibit 1 and following Eckhart’s suggestions regarding the
valuation of ZTL, the most appropriate conclusion that Barton should make
about the ZTL shares is that the fund should:
A take a long position in ZTL.
B not add ZTL to the portfolio.
C take a short position in ZTL.
34 Eckhart’s best response to Barton’s question about the valuation of ZTL consid-
ering the potential sale of its manufacturing facility would be to use:
A the H-model to reflect the change in dividends.
B the Gordon growth model to incorporate the decrease in firm value after the
sale.
C a spreadsheet model that incorporates the special dividends.
35 Based on the information Eckhart provides to Barton about HTR, the most suit-
able method for her to use in determining the fair value of its common equity is
to discount future:
A forecasted future dividends.
B free cash flow to equity.
C residual income.
36 Barton’s estimate of the fair value for HTR’s preferred stock is closest to:
A $125.
B $84.
C $81.
Maalouf provides Fujioka the zero-coupon yield curve in Exhibit 1 and asks her to
use her current approach to calculate the arbitrage-free value of an option-free, fixed-
rate, 4-year bond with a 3.5% coupon rate, annual payments, and a face value of 100.
1 2.15%
2 3.45%
3 4.01%
4 4.40%
Using a different set of benchmark bond values, Maalouf constructs the calibrated
binomial interest rate tree shown in Exhibit 2. He shows Fujioka how to value a 3-year
option-free, fixed-rate bond with a 2.8% coupon rate, annual payments, and a face
value of 100 using this interest rate tree.
6.76%
4.56%
2.85% 5.11%
1.50% 3.45%
2.16% 3.86%
2.60%
2.92%
Maalouf explains, “An alternative to the calculations I just showed you is path-wise
valuation. In this variation, you would determine all of the possible paths interest
rates could take in our binomial tree and value the bond along each path. The value
of the bond is then calculated as the average of the values across all paths. For the
4-year bond you evaluated earlier, you would need to calculate its value for 24 or 16
different paths.”
Fujioka tells Maalouf that she has been reading about the use of Monte Carlo
forward-rate simulation for fixed income valuation. She asks Maalouf to further
explain this approach to her. Maalouf replies, “The Monte Carlo approach is quite
different from the binomial tree approach I’ve been describing to you. Some of these
differences include:”
Difference 1: The Monte Carlo approach does not require calibration, whereas
the binomial tree approach does.
Difference 2: The Monte Carlo approach is typically employed when cash
flows are path dependent, whereas the binomial tree approach only allows one
expected cash flow per node, regardless of the path of interest rates.
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37 Is Fujioka most likely correct when comparing her approach to valuation with
the binomial interest rate tree framework?
A No, the values estimated by the two approaches will likely be different
B Yes
C No, she is incorrect regarding calibration of interest rate trees
38 Of the three conditions Maalouf claims are necessary for a market to be arbi-
trage free, he is least likely correct regarding:
A Condition 1.
B Condition 3.
C Condition 2.
39 The value Fujioka calculates for the four-year bond is closest to:
A 98.149.
B 96.764.
C 96.931.
40 The value Maalouf estimates for the three-year bond using the binomial tree in
Exhibit 2 is closest to:
A 100.623
B 100.908
C 103.708
41 Is Maalouf most likely correct in his description of path-wise valuation?
A No, the values on each path are weighted by their probability of occurrence
B Yes
C No, he is incorrect regarding the number of paths needed to value the four-
year bond
42 Of the three differences Maalouf describes between the binomial tree approach
to fixed-income valuation and the Monte Carlo simulation approach, he is least
likely correct regarding:
A Difference 3.
B Difference 2.
C Difference 1.
Messer replies, “The binomial valuation model can be applied to the 2-year
European style index call options we purchased one year ago. The applicable underlying
instrument is the German Blue Chip Equity price index, which excludes dividends.
Exhibit 1 shows the option’s characteristics at the time of purchase.”
Messer explains, “Of course, with the index moving down 10% in the last twelve
months, the payoffs with these options could have been replicated without using
options.” Szillat responds, “My understanding is that the payoff would have been the
same as the call option if you had purchased 0.5697 index units and lent EUR 356.79
at the 1-year interest rate.”
Messer continues, “Twelve months ago, I noted that 2-year puts with a strike price
of EUR 750 cost EUR 38.48. Using the information in Exhibit 1 and today’s index value,
the binomial valuation model calculates the current price of the put as EUR 80.15. It
is actually trading now above that price at EUR 92.
Szillat responds, “I am curious whether you also use the Black–Scholes–Merton
(BSM) model for valuation. I understand the BSM and binomial models both have
the following three assumptions in common:
Assumption 1 Trading is possible at every instant.
Assumption 2 Volatility can be predicted with certainty.
Assumption 3 The annualized returns on the underlying follow a normal
distribution.
Szillat then asks, “How do you utilize the BSM model?”
Messer answers, “We use the BSM model to calculate estimates on a wide array
of comparative option variables, such as how much the option value will change for
a change in a particular parameter. For example, we can estimate how the rate of
change of an option price speeds up or slows down for a given change in the price of
the underlying index.”
Messer concludes, “We also use the BSM model to calculate the implied volatility.
The implied volatilities of the index options expiring in one year are shown in Exhibit 2.”
700 18.71
710 17.98
720 17.38
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Exhibit 2 (Continued)
43 Using the binomial valuation method and the data in Exhibit 1, the price
Messer paid one year ago for the call option with a strike price of EUR750 is
closest to:
A EUR 51.54.
B EUR 47.57.
C EUR 102.08.
44 With respect to his assessment of replicating the option payoff, Szillat is least
likely correct about:
A lending EUR 356.79.
B using the one-year interest rate.
C purchasing 0.5697 index units.
45 Does the put option with a strike price of EUR 750 currently offer an arbitrage
opportunity?
A No, because the market has bid up the price of the put.
B No, because the put is deep in the money.
C Yes.
46 Which of Szillat’s assumptions is least consistent with the BSM model?
A Assumption 2
B Assumption 3
C Assumption 1
47 In describing how call option prices change, Messer is most likely referring to:
A delta.
B vega.
C gamma.
48 Which of the following would Messer most likely conclude from the implied
volatility data in Exhibit 2, if he excludes the effects of moneyness and time to
expiration?
A Using out-of-the-money options to hedge is more expensive than establish-
ing a long position with out-of-the-money options.
B Using out-of-the-money options to establish a long position is more expen-
sive than establishing a short position using out-of-the-money options.
C Using out-of-the-money options to establish either long or short positions is
more expensive than using at-the-money options.
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Moreno continues, “One of Wabash’s oldest clients, Fond du Lac, has been in
business for over 100 years and has developed sophisticated pricing models. Currently
their models predict that the price of corn is poised to more than double in the next
six months. Fond du Lac has purchased a large amount of corn in the spot market
and has taken delivery at its storage facilities. When the price increase occurs, they
intend to sell the corn in the spot market.”
Moreno asks Gorski to help her prepare a market overview to include in all client
presentations. Gorski collects the spot and futures prices of three commodities.
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Alexander then asks Jun Lee, a senior risk analyst in the group, to explain to
Woolridge how Citadel employs scenario risk measures. Lee explains, “Scenario anal-
ysis complements VaR because it can better account for market liquidity. However,
a limitation of scenario analysis is that it has a greater reliance on historical market
data than does VaR.”
Lee then explains how the risk exposures of option positions may increase or
decrease overall portfolio risk. Lee and Woolridge discuss delta, gamma, and vega
as option sensitivity measures. Woolridge summarizes what she has learned to make
sure she has understood correctly: “Delta measures the sensitivity of an option to the
price of the underlying security and ranges from –0.5 to +0.5. Gamma is a second-
order effect that measures the sensitivity of delta to price changes in the underlying.
Vega is a first-order effect that measures the change in the volatility of an option to
the change in price of the underlying.”
Alexander receives a call from Sandra Patterson, Citadel’s CEO. Patterson expresses
her concern that the firm’s $500 million multi-asset fund has failed to protect investors
during a recent market decline. Alexander drafts an updated risk management policy
to present to the investment committee. The goal of this policy is to ensure that the
fund limits the likelihood of severe downside losses for investors.
“The multi-asset fund has a 5-day, 1% VaR limit of $10 million, and the fund
will undertake hedging activities, including the purchase of protective put
options, if its cumulative 30-day loss ever exceeds $15 million. In addition,
the magnitude of the hedge shall be designed to increase as losses increase.”
Following the investment committee’s approval, Patterson references the updated
risk management policy in her quarterly letter to investors. She states: “At Citadel, we
take risk management very seriously. In response to recent investor concerns about
volatility in our multi-asset fund, we have implemented a new policy. We limit fund
losses to 2% of assets with a 99% level of confidence, with additional measures to limit
total losses to 3% over a rolling 30-day period.”
55 Woolridge’s comments on the advantages of VaR are most likely correct
regarding:
A downside exposure.
B performance evaluation.
C subjectivity.
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56 Using the inputs in Exhibit 1, Woolridge’s estimate of VaR is most likely closest
to:
A $6.5 million.
B $18.9 million.
C $10.5 million.
57 Are Lee’s comments regarding scenario analysis most likely correct?
A No, with regard to market liquidity
B No, with regard to historical data
C Yes
58 Which option sensitivity measure does Woolridge most accurately describe?
A Vega
B Delta
C Gamma
59 Alexander’s risk management policy for the multi-asset fund is least likely an
example of:
A stop-loss limits.
B risk budgeting.
C scenario limits.
60 Patterson’s comments to Citadel’s investors are least likely accurate with regard
to her:
A use of confidence levels.
B discussion of limiting losses.
C implied percentage declines from dollar VaR limits.