CFA Institute 2020 Mock Exam A - Afternoon Session
CFA Institute 2020 Mock Exam A - Afternoon Session
CFA Institute 2020 Mock Exam A - Afternoon Session
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2 2020 Level II Mock Exam (A) PM
That same day, Colleen Collins, a research analyst, approaches McGuinn, con-
cerned that she may be in possession of insider information. Collins relates that she
was at a party the night before and overheard a conversation between two CEOs of
competing, publicly listed manufacturing companies. The CEOs discussed, but did
not express their opinions on, the validity of a recent article published in an online
industry newsletter, which was speculating on the benefits of a merger between their
two companies. The newsletter is available by subscription only. One of these com-
panies is on Forster’s recommended buy list.
Following this conversation, McGuinn feels it is necessary to enhance Forster’s
rules and procedures when dealing with possible insider information. He recommends
the following changes to the company’s policies and procedures:
Recommendation 1: Stop market-making activities when in possession of mate-
rial nonpublic information.
Recommendation 2: Regularly review employee and proprietary trading.
Recommendation 3: Require all employees to attend an annual refresher course
on how to identify and handle material nonpublic information.
After reviewing how Forster chooses and retains its stockbrokers every year,
McGuinn makes several changes in the policy. The following guidelines are imple-
mented and communicated to clients. Stockbroker selection must be based on the
brokers’ ability to:
Guideline 1: provide accounting software.
Guideline 2: execute client transactions efficiently.
Guideline 3: obtain invitations to investment conferences for loyal clients.
After undertaking investigations based on an anonymous report, McGuinn con-
firms that several Forster fund managers were witnessed being wined and dined over
the past few weeks by large brokerage firms trying to get Forster’s business. The same
employees have not notified him about these dinners, a violation of Forster’s internal
policies. McGuinn notifies the employees in writing that they have been violating the
company policy. In the letter of notification, he requires the employees to abide by
the policy in the future.
1 Is McGuinn’s proposed compliance officer structure most likely consistent with
the CFA Institute Code and Standards?
A No, with regard to authority and responsibility.
B Yes.
C No, with regard to policies and procedures.
2 Which item in the request for proposal (RFP) is leastlikelyconsistent with
Standard I(C)–Misrepresentation?
A Guaranteed investment return
B The firm’s organizational structure
C Use of third-party research providers
3 Did Collins most likely receive insider information as defined by the CFA
Institute Code and Standards?
A No, because the information is considered non-material.
B Yes.
C No, because the information is considered public.
4 Which of McGuinn’s recommendations is least appropriate to implement as
per recommended procedures for compliance of Standard II(A)–Material
Nonpublic Information?
2020 Level II Mock Exam (A) PM 3
A Recommendation 1
B Recommendation 2
C Recommendation 3
5 Which guideline with regard to choosing stockbroking services is most likely
consistent with Standard III(A)–Duty to Clients?
A Guideline 2
B Guideline 3
C Guideline 1
6 With regard to the fund managers under investigation, the most appropriate
additional action McGuinn should take is to:
A monitor their future actions.
B report the misconduct up the chain of command.
C require a statement stating the behavior will cease.
us, we pay them a finder’s fee. One such agent we use is Make-a-Difference
Consultants, an asset consulting firm that has adopted the CFA Institute
Code and Standards.
Finally, I also want to disclose to you the compensation arrangements
for the asset management firm’s six investment analysts, all of whom report
to me directly. Two of the analysts work part-time, because they made
earlier commitments with other asset management firms before I found
them. But they do not work for other social impact funds, so I’m OK with
this arrangement because we consider them independent contractors. We
disclose this and other forms of management compensation to all clients
and potential clients. All the analysts are paid monthly and participate in the
firm’s year-end bonus program. The value of the bonus pool is determined
by how well the company has performed.
Prior to the end of the meeting, O’Connor invites Jensen to join her and one of
her analysts on an upcoming trip to Harare, Zimbabwe, to undertake an annual ESG
assessment for one of their social impact investments. The Fund has invested in a
private university for women that was founded a couple of years ago, with 40% of the
students coming from disadvantaged families. O’Connor adds, “This way, you can see
our investment process in action.” Jensen expresses interest in going to Zimbabwe as
part of her due diligence process and asks, “Who pays for my trip expenses?”
During their trip to Zimbabwe, O’Connor and Jensen meet with the university’s
chief financial officer and learn about the increasing success of the school and the
impact the school programs are having on their students. Jensen expresses her excite-
ment about the potential of the school and cannot wait to return home to present the
school as a potential investment to her clients. After returning home, Jensen makes
her first presentation to her smallest client, with assets totaling EUR20 million. She
makes the following statement:
I just got back from a due diligence trip to Zimbabwe with Fiona O’Connor,
the portfolio manager of the Step Up Fund, which has an ESG investment
mandate. We visited an amazing women’s university that has solicited
donations for a scholarship program for disadvantaged women. The school
is very well run, and with the new scholarship program, investment returns
are expected to increase, because they will no longer need to subsidize
tuition. I’ve been assured the other holdings within the Step Up Fund are
of equal caliber. I got to know O’Connor during the trip and feel she has
a good grasp of ESG issues. I really believe you should invest in the Step
Up Fund, because it meets your investment objectives. I would start with
a EUR5 million investment.
7 Based only on the information given, when providing investment advice to her
clients, Jensen should most likely adhere to which of the following to avoid vio-
lating Standard I(A): Knowledge of the Law?
A Irish legislation
B Swiss regulations
C CFA Institute Standards of Professional Conduct
8 Given O’Connor’s first statement about the asset allocation, expected returns,
and strategy of the Step Up Social Impact Private Equity Fund, does O’Connor
most likely violate the CFA Institute Standards?
A No
B Yes, with regard to Standard III(A): Loyalty, Prudence, and Care
2020 Level II Mock Exam (A) PM 5
(continued)
6 2020 Level II Mock Exam (A) PM
Exhibit 1 (Continued)
Using the data provided in Exhibit 1, Dennehy tests the hypothesis that the coef-
ficients for outside air temperature and assembly line speed are significantly different
from zero, using a significance level of 5%. Dennehy also uses the results given in
Exhibit 1 to evaluate the potential for multicollinearity in the data.
Finally, Dennehy would like to confirm that nonstationarity is not a problem. To
test for this he conducts Dickey–Fuller tests for a unit root on each of the time series.
The results are reported in Exhibit 2.
Current liabilities 33
Long-term debt 224
Common shares 160
Retained earnings 0
Total liabilities and shareholders’ equity 417
Sales 140
Depreciation expense 20
Other expenses 120
Tax expense 0
Net income 0
Nanuk, which prepares its translated statements using the current rate method,
is next on the agenda. Cameron reports that annual translated USD-equivalent sales
are up from 22.3 million last year to 23.7 million this year. Cameron reminds Napier
that one of the performance metrics in the bonus calculation for Nanuk’s president
is Nanuk’s sales growth determined in the local currency. Napier asks Cameron to
calculate that figure for the 2016–17 fiscal year.
Napier also asks Cameron what effect Nanuk’s translated statements will have on
Sunjet’s other comprehensive income for the current year.
19 Under which translation method for non-domestic operations will SunMex’s
fixed asset turnover most likelybe higher?
A The temporal method
B The current rate method
C There will be no difference.
20 On translation, SunMex’s USD-denominated net income most likely includes:
A a re-measurement gain of $2.526 million.
B a re-measurement loss of $1.792 million.
C no re-measurement gains or losses.
21 In the bonus calculation for Nanuk’s president, the sales growth that is to be
used isclosestto:
A 10.3%.
B 6.3%.
C 8.5%.
22 Thebestanswer to Napier’s question about the effect of Nanuk on Sunjet’s other
comprehensive income is that Nanuk’s:
A net asset exposure will generate a re-measurement gain.
B net liability exposure will generate a re-measurement gain.
C net asset exposure will generate a re-measurement loss.
Exhibit 1 (Continued)
Cioffi asks, “Why does NANLife have a much larger portion of its investment
portfolio in equity securities compared with the property and casualty company we
were working on yesterday?”
Yu replies, “NANLife can take greater risks with its investments for two reasons:
First, its claims are relatively more predictable, and second, the claims have a shorter
duration.”
Before moving on Cioffi comments,
“It was interesting to learn about the insurance industry when working on
the NANLife file. Unlike the banking industry, it does not have to follow
international standards for capital adequacy, but as a US-based insurer,
NANLife still has some US requirements to meet. The company also pre-
pares its financial statements using statutory accounting rules that differ
from both US GAAP and IFRS.”
Next, they turn their attention to a commercial bank file that still required some
work on the assessment of earnings quality, using summary earnings information
prepared by Yu (Exhibit 2).
Exhibit 2 (Continued)
Yu states,
“We have to finish the CAMELS (capital adequacy, asset quality, manage-
ment capabilities, earnings sufficiency, liquidity position, and sensitivity
to market risk) analysis on this file. In my preliminary review of the bank’s
earnings information, I assigned a score reflecting high quality of earnings,
based on the following points:
23 The average return on fixed-income assets for NANLife in 2018 is closest to:
A 4.6%.
B 4.8%.
C 5.1%.
24 From 2017 to 2018, the risk related to the investment allocation for NANLife is
bestdescribed as having shown:
A no change.
B a decrease.
C an increase.
25 Yu’s reply to Cioffi’s question concerning the higher portion of equity securities
in NANLife’s investment portfolio is bestdescribed as correct with respect to:
A both reasons.
B only the first reason.
C only the second reason.
26 Cioffi’s comments about the regulatory requirements for NANLife are best
described as:
A correct.
B incorrect with respect to accounting rules.
12 2020 Level II Mock Exam (A) PM
that would have been packaged for shipping and then unpacked and shelved at the
stores will be replaced with larger bulk containers. Malik notes that when announced,
analysts will use this information in their valuation of Ouse.
29 The change in ownership structure that occurred two years ago most likely
addressed which of the following issues associated with family-owned
businesses?
A Poor transparency
B Interlocking directorships
C Ability to attract quality management
30 If Ouse were to go public with the share structure similar to Facebook that
Ferguson asked about, which governance issue would most likely arise?
A Voting cap restrictions
B Principal–agent problem
C Principal–principal problem
31 Which of the following approaches to identifying a company’s ESG factors best-
describes the one used by the private equity fund that Malik mentions?
A ESG data providers
B Proprietary methods
C Not-for-profit initiatives
32 Analysts interested in incorporating ESG factors into their analysis will most
likely adjust for the announcement of the changes arising from Ouse’s new
packaging initiative by:
A increasing the risk premium.
B increasing the company’s fair value.
C modifying only the qualitative ESG analysis.
Exhibit 1 Selected Stock Data for XRL and ZTL and Additional Market
Information
XRL ZTL
EPS ($) DPS ($) EPS ($) DPS ($)
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 the 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 with 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 growth model to determine whether 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. If that should happen, he believes that 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.
33 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.
2020 Level II Mock Exam (A) PM 15
C incorrect because the required return on equity is greater than the US econ-
omy’s growth rate.
34 Barton’s conclusion that XRL is in the transition phase is best described as:
A correct.
B incorrect, because the company is in the supernormal growth phase.
C incorrect, because the company is in the mature phase.
35 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.
36 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.
Exhibit 1 (Continued)
37 Using the information provided in Exhibit 1 and assuming that Bird’s interest
rate expectation materializes, the realized return for an investor who buys and
holds to maturity the US Treasury 7.00% coupon bond would most likely be:
A less than the yield to maturity.
B equal to the yield to maturity.
C greater than the yield to maturity.
38 Using the information provided in Exhibit 1 and assuming that Bird’s interest
rate expectation materializes, the year one holding period return for the Zero
Coupon bond is closest to:
A 5.01%.
2020 Level II Mock Exam (A) PM 17
B 3.00%.
C 7.00%.
39 Using the information provided in Exhibit 1 and assuming that Bird’s interest
rate expectation materializes, the forward rate at which an investor would be
indifferent to purchasing the US Treasury zero coupon note today or one year
from today isclosest to:
A 8.02%.
B 7.02%.
C 11.10%.
40 Using the information provided about the Coores bond and assuming that there
are no unusual factors affecting either the government or corporate debt mar-
kets, is Coores bond likely mispriced?
A Yes, because of the difference between the swap rate and the yield to
maturity.
B Yes, because of the difference between the swap rate and the spot rate.
C No.
41 Which of Bird’s statements regarding measures of credit risk is most likely
correct?
A Statement 2
B Statement 3
C Statement 1
42 Given the sample yield curve change shown in Exhibit 2, Factor 1, Factor 2 and
Factor 3 are most likely:
A steepness, curvature, and level.
B level, steepness, and curvature.
C curvature, level, and steepness.
Comment 3 The two fundamental rules of arbitrage are that one does not use
any of one’s own money in a transaction, and one does not take
any price risk.
Kozorez asks Nils to evaluate a carry arbitrage trade for a S&P 500 Index forward
contract. He believes the contract may be mispriced. The index is currently trading at
1,900, and the forward contract expiring in one year is priced at 1,863. The index has
a continuously compounded dividend yield of 2.50%, and the one-year continuously
compounded interest rate is 0.75%. Kozorez believes that at the time of the contract’s
expiration, the index will be trading at 1903.
Nils sets out to evaluate arbitrage opportunities using forward rate agreements
(FRAs). Kozorez makes the following comments to Nils regarding FRAs: “An FRA
has two counterparties, a fixed-rate receiver that is short Euribor and a floating-rate
receiver that is long Euribor. The party that is long a 3 × 9 FRA must make a Euribor
deposit in three months and earns the Euribor rate for the subsequent six months.”
Nils also analyzes a US Treasury futures contract that he plans to use to hedge
a corporate bond’s interest rate risk. He researches the characteristics of Treasury
futures and observes the following characteristics.
Characteristic 1 The underlying deliverable bond in a US Treasury futures
contract consists of a basket of bonds from which the short
position can deliver the cheapest bond.
Characteristic 2 Eligible deliverable bonds can have various maturities and
coupon rates, and the seller will receive the futures price
adjusted by a conversion factor to account for any accrued
interest.
Characteristic 3 Long and short positions are marked to market each day.
Therefore, the contract’s market value at the end of each day
is zero.
Kozorez has a position in Spanish sovereign bonds that he wants to hold during
the next year because he believes euro rates will rally as the European Central Bank
continues with its quantitative easing program. He is less hopeful, however, about the
EUR currency, which he wants hedged back to USD. Kozorez asks Nils to evaluate
this hedging strategy. The US risk-free rate is 0.27%, and the eurozone risk-free rate
is 0.94%. Nils also uses the data in Exhibit 1 for his analysis.
The endowment’s investment committee has asked Silverman to consider the impli-
cations of direct real estate investments in the endowment portfolio. The committee’s
view is that such investments will likely generate income and capital appreciation but
have no significant impact on portfolio risk because of their high correlations with
the existing investments.
Silverman has asked Dua to carry out some preliminary research on commercial
real estate and to report on his findings. Dua reports that commercial real estate
property types include office properties, industrial and warehouse space, and retail
space. Dua indicates that demand for office space depends on employment growth,
whereas a strong economy drives demand for warehouse space. Demand for retail
space depends on the level of import and export activity.
Silverman and his team are evaluating an investment in an office property. They
propose to use three valuation methods: the discounted cash flow method (DCF), the
cost approach, and the sales comparison approach. There are four years remaining in
the property lease, and annual net operating income (NOI) from lease payments is
$750,000. When the lease rolls over in Year 5, there is expected to be a one-time 15%
increase in NOI. Information about the evaluation is provided in Exhibits 1 and 2.
To adjust for age, the price per square foot (PSF) of the comparable property is
adjusted by 3% per year of age difference. The adjustment for the condition of the
office property is 14% for properties in average condition.
Silverman asks the group to provide some characteristics of the three valuation
methods. Lin responds, “the DCF method takes into account cash flows that are
relevant to investors and incorporates the cyclical nature of the real estate market.
2020 Level II Mock Exam (A) PM 21
The cost approach works best for newer properties, whereas the sales comparison
approach provides reliable value estimates in an active real estate market in which
there are numerous transactions.”
49 The investment committee’s view on direct real estate investment is least likely-
correct with regard to:
A income.
B portfolio risk.
C capital appreciation.
50 Is Dua most likelycorrect with regard to the factors that drive demand for differ-
ent commercial real estate property types?
A No, he is incorrect about retail space.
B Yes.
C No, he is incorrect about industrial and warehouse space.
51 Based on the information provided and Exhibit 1, the value of the office prop-
erty based on the DCF approach is closest to:
A $14,254,549
B $16,265,226
C $18,193,813
52 Using the cost approach, the estimated value of the office property based on
Exhibit 1 and other information provided is closestto:
A $14,800,000.
B $15,300,000.
C $17,300,000.
53 Based on Exhibit 2 and other information provided, the value of the office prop-
erty using the sales comparison approach is closest to:
A $16,834,500.
B $17,023,500.
C $13,875,000.
54 In her response to Silverman regarding the characteristics of the three valuation
approaches, Lin is least likely correct with respect to the:
A DCF approach.
B sales comparison approach.
C cost approach.
Patel is reviewing the daily risk report with Flaherty to discuss why value at risk
(VaR) is an important measure of risk. Flaherty makes the following three statements
regarding VaR:
Statement 1 VaR measures the minimum expected loss, rather than the maxi-
mum expected loss, in a portfolio.
Statement 2 VaR is used to estimate portfolio losses that are likely to occur at
a fixed point in time, rather than over a period of time.
Statement 3 VaR measures portfolio volatility in percentage terms.
Patel replies to Flaherty’s statements by focusing on specific aspects of VaR:
“Applegate’s process begins with a risk decomposition of the portfolio holdings, typ-
ically assumes normal distribution of risk factors, and then uses the expected return
and standard deviation for each risk factor to estimate the VaR. The VaR threshold is
converted to a z-distribution. We then calculate the expected return and volatility of
the portfolio and adjust to the desired time interval. Finally, we can obtain VaR and
convert it into a dollar amount by multiplying by the portfolio value.”
In reviewing the VaR report, Patel would like more insight on the average loss that
would occur if the VaR cutoff is extended and asks Flaherty to contact the risk team to
improve the reporting metrics. After discussing with his colleague on the risk team,
Flaherty responds that going forward they will add conditional VaR, incremental VaR,
and marginal VaR to the report.
In addition to VaR, the risk report includes other measures that assist Patel in
better understanding portfolio sensitivities. Patel uses option strategies within the
fund to manage exposures. Patel asks Flaherty to review sensitivity risk measures
to better understand the option exposure within the fund. Flaherty uses gamma to
understand how sensitive option prices are to an increase in volatility of the underlying
stock and delta to determine how large moves in the value of the fund positions will
affect associated option values.
Marcus Thompson oversees risk management at Applegate on a firm-wide basis.
Because of the use of leverage, Thompson pays particular attention to risk measures
to understand the sources and uses of cash and the risk of hitting leverage limits and
facing margin calls. He uses a number of metrics in his risk dashboard and communi-
cates to managers and firm leadership when actions need to be taken to mitigate risk.
Thompson frequently reviews Applegate’s strategies to identify those with greater-
than-expected tail risk. Doing so helps him understand potential capital allocation
requirements for meeting tail risk losses. He is asked to review the following three
newly proposed fund strategies and to assess potential tail risk and capital requirements:
Strategy 1: Long–short equity fund targeting an equity market beta of 0.2 based
on fundamental long and short equity research
Strategy 2: Long-only option strategy that uses technical analysis and momen-
tum to trade call and put options on a short-term basis
Strategy 3: Alternative income strategy focused on long credit positions com-
bined with selling insurance and writing options to generate premium income
C Parametric
57 Which extension of VaR will most likely meet Patel’s needs?
A Conditional
B Incremental
C Marginal
58 Is Flaherty most likely correct in his use of sensitivity measures to assess the
impact of the option positions in the fund?
A Yes
B No, with regard to delta
C No, with regard to gamma
59 Which risk measure is Thompson least likely to use in his analysis?
A VaR
B Active share
C Gross exposure
60 Which of the strategies Thompson is asked to review is most likely to involve
significant tail risk and potential capital requirements?
A Strategy 1
B Strategy 2
C Strategy 3