Level 2 mock exam question and answers 2009

2009 Level II Mock Exam: Morning Session
The morning session of the 2009 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

1-6

Ethical and Professional Standards

18

7-12

Quantitative Methods

18

13-18

Financial Statement Analysis

18

19-24

Financial Statement Analysis

18

25-30

Corporate Finance

18

31-36

Economics

18

37-42

Equity Investments

18

43-48

Fixed Income Investments

18

49-54

Derivative Investments

18

55-60

Portfolio Management

18

Total:

180

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Questions 1 through 6 relate to Ethical and Professional Standards.

Sang-Gyung Jun Case Scenario
Sang-Gyung Jun is enrolled in an MBA program and serves as an unpaid intern for Portree
Investment Services. During his internship, Jun’s supervisor at Portree, Barbara Fantine, teaches
him several stock valuation techniques. Jun hopes his unpaid internship will eventually result in
full-time employment with Portree, and he enthusiastically recruits a number of wealthy clients,
most of whom are members of Jun’s family. Fantine praises his efforts, remarking that “these
clients are the foundation on which you can build your career at Portree.”

Despite his success, Jun’s internship remains unpaid even after he receives his MBA degree and
passes the CFA® Level III examination. Jun seeks full-time employment with Upsala Financial
Corp. which specializes in serving high net worth individuals.
When interviewing for the position at Upsala, Jun informs his interviewer that “I need to obtain
only one more year of work experience before I will receive the CFA charter. After the
interview, Jun contacts the clients he has recruited at Portree to ask if they would become his
clients at Upsala. None of these clients accept this offer.
When Fantine learns of Jun’s plans to leave Portree, she informs Jun, “You are not permitted to
use any of the valuation techniques I have taught you because they belong to me.”
Jun subsequently accepts the position at Upsala and informs Fantine. On the same day, Fantine
receives news about the departure of another Portree employee, Jasmine Velez, CFA. Velez is
leaving to start an investment firm that will directly compete with Portree. Velez has not
contacted any potential clients, but during non-work hours she has incorporated her new firm and
obtained the necessary licenses.
On Jun’s first day of work at Upsala, he receives and reviews a copy of the firm’s compliance
policy, excerpts of which appear in Exhibit 1.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Exhibit 1
Upsala Financial Corp.
Compliance Policy
Independent Practice
Employees of Upsala may enter into independent practice only in business segments not already
targeted by Upsala, and only in roles clearly leading to improvements in employee skill and
expertise that can be used beneficially by Upsala.

Priority of trades
Transactions for employers must have priority over transactions in securities or other
investments of which a member or candidate is the beneficial owner. The interests of outside
clients must be given priority over accounts registered in the name of Upsala itself. Moreover,
all personal trades by employees of Upsala firm will be pre-cleared in accordance with the firm’s
compliance policies.
Jun also receives new business cards which read “Sang-Gyung Jun, CFA, Investment
Consultant.” Jun mails letters of introduction with the business cards to contacts and potential
clients.
In his first meeting with new colleagues Jun, wanting to create a favorable image states, “I
passed all three CFA examinations on the first try, which places me in an elite category of
exceptional charterholders.”
Jun later impresses his supervisor at Upsala with his knowledge of stock valuation techniques.
He does not inform his supervisor that he learned the techniques from Fantine at Portree.
Several months later, Jun receives an offer of part-time consulting work from a family friend
who needs assistance marketing investment services to high-net-worth individuals in Korea. Jun
reviews the firm’s policy on independent practice and confirms that Upsala does not conduct
business in Korea. Jun is convinced that the consulting work will improve his skills and thus
benefit Upsala.
He accepts the consulting work which requires approximately three hours of late-night work on
Mondays and Wednesdays. Since Jun only requires 4-6 hours of sleep he does not feel that this
night work will interfere with his responsibilities. Jun then sends an email to his supervisor
informing him of the consulting offer, its requirements, duration, compensation, and the skills he
expects to develop from the work.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.

1. Did Jun’s actions immediately following his interview with Upsala most likely violate the
CFA Institute Standards of Professional Conduct?
A. Yes.
B. No, because he no longer owes a duty of loyalty to Portree.
C. No, because the Portree clients have not accepted the offer to move.

2. When using the stock valuation methods at Upsala, does Jun violate any CFA Institute
Standards of Professional Conduct?
A. No.
B. Yes, because he does not have Fantine’s permission.
C. Yes, because he does not inform his supervisor of the source of his knowledge.

3. When preparing to establish an investment firm, does Velez violate the CFA Institute
Standard relating to Duty to Employer?
A. No.
B. Yes, because she plans to compete directly with Portree.
C. Yes, because she incorporated the firm before leaving Portree.

4. To make Upsala’s statement on Priority of Trades consistent with CFA Institute
Standards, Jun’s most appropriate recommendation is to revise it so that:
A. the interests of clients must be given priority over accounts in which Upsala’s
employees are beneficial owners.
B. the interests of clients must be given priority over family accounts and accounts
registered in the name of Upsala itself.
C. transactions for clients and then employers have priority over transactions in
securities or other investments of which a member or candidate is the beneficial
owner.

5. Jun least likely violated CFA Institute Standards of Professional Conduct with his:

A. use of the business card.
B. statement about charterholders.
C. statement about passing exams.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


6. When accepting the part-time consulting position, does Jun most likely violate any CFA
Institute Standards?
A. No, because he does not need consent.
B. Yes, because he does not provide adequate disclosure to Upsala.
C. Yes, because the work requirements will interfere with his duties to Upsala.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Questions 7 through 12 relate to Quantitative Methods

Jacques Nordique Case Scenario
Jacques Nordique is a quantitative analyst at Brimford Investment Management. One of the
firm’s managing partners asks Nordique to collect and analyze data as part of a project to explain
and to forecast the behavior of price/earnings (P/E) ratios. Nordique wants to examine timeseries models of P/E behavior and begins by collecting 15 years of monthly data on market P/E
ratios.
After considering several different time-series models, Nordique estimates a regression equation

of the form:
(P/E) = + (P/E) t–1 +

Equation 1

ε

and obtains the results shown in Exhibit 1. Nordique believes the time series is mean reverting
and given the estimated coefficients, he calculates the mean-reverting level of the market P/E
ratio to be 13.3.
Exhibit 1
Regression Results
Dependent Variable is the Market Price/Earnings (P/E) Ratio
Regression Statistics
R-squared
0.959
F-statistic
4160.885
Standard Error of Estimate
0.988
Number of Observations
179
Durbin-Watson Statistic
2.115
Intercept
(P/E) t–1

Coefficients
0.332
0.975

Standard Error
0.189
0.015

Nordique shares his time-series results with his supervisor, Amy Beloit. She is interested in the
implications for stock-bond allocation, especially given that Brimford’s investment strategists
are neutral on the future direction of interest rates. After reviewing the results, Beloit has two
concerns about the time series estimated in Exhibit 1:
(1) do the error terms exhibit heteroskedasticity; and
(2) does the time series exhibit a unit root?
Exhibit 2 contains critical values of several test statistics that may be relevant to the results that
Nordique and Beloit are interpreting.
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Degrees of freedom
2
120+

7.

Exhibit 2
Critical Values of Selected Test Statistics
t-statistic
Durbin-Watson Statistic
One-tailed Probabilities

α = 0.05, K = 1
p = 0.05
p = 0.025
= 1.65 = 1.69
2.92
4.30
1.66
1.98

Nordique’s most appropriate action to determine if Equation 1 correctly fits the time
series is to examine the:
A. R-squared value and F-statistic.
B. autocorrelation between the error terms.
C. correlation between the squared error terms and the independent variable.

8. To determine whether Beloit’s first concern is valid, Nordique’s most appropriate action
would be to:
A. perform the Dickey-Fuller test.
B. regress the squared residuals from Equation 1 on the squared residuals lagged one
period.
C. test whether the variance of the error in one period depends on the variance of the
error in successive time periods.

9. Which of the following models is most appropriate to determine if Beloit’s second
concern is justified?
A. (P/E) t – (P/E) t–1 = + (P/E) t–1 +
B. (P/E) t – (P/E) t–1 = + [(P/E) t – (P/E) t–1 ] +
C. (P/E) t – (P/E) t–1 = + [(P/E) t–1 – (P/E) t–2 ] +
ε

ε

ε

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


10. If Beloit’s second concern about the time-series results in Exhibit 1 is correct, Nordique’s
most appropriate action is to:
A. do nothing.
B. re-estimate the regression using the form: (P/E) = + (P/E) t-1 + (P/E) t-2 + .
C. re-estimate the regression using the form: [(P/E) – (P/E) t-1 ] = + [(P/E) t-1 – (P/E) t-2 ]
+ .
ε

ε

11. If Nordique’s belief about the behavior of the time series is correct, which of the
following is most appropriate?
A. Underweight stocks if the P/E is above its historical average.
B. Overweight stocks if the P/E is above its mean reversion level.
C. Underweight stocks if the P/E is above its mean reversion level.

12. If Nordique’s model is correctly specified, and the market P/E ratio is 22.50 in June 2008,
the estimate of the market P/E ratio for August 2008 is closest to:
A. 21.39.
B. 22.04.

C. 22.27.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Question 13 through 18 relate to Financial Statement Analysis

Greg Fannerson (ACI) Case Scenario
Greg Fannerson, CFA, is a financial analyst with Alchemy Consolidated Industries, Inc. (ACI).
ACI is a U.S. corporation involved in several industry sectors and, in addition, has a significant
portfolio of intercorporate investments. ACI follows U.S. GAAP when preparing its financial
statements. Fannerson’s supervisor, Charles Wilmington, has requested that Fannerson provide
an update on ACI’s existing equity investments. Fannerson has developed Exhibit 1, containing
information about the companies.
Exhibit 1
ACI Inc. Portfolio A
Equity Investments (amounts in millions)
Investees’
Market
Total
Cost
Value
Reported Dividends
Ownership
Investment
Basis
31

Net
Paid by
Percentage
($U.S.) December Income Investees in
2008
2008
2008
Columbus
60 percent
$200
$200
$65
$10.0
Inc.
De Soto
33 percent
$125
Not
$90
$15.0
Inc.
applicable
Le Vaca
30 percent
$0
$2
($50)
0
Inc.
Marco Inc.

25 percent
$75
$65
$60
$12
Viking Inc.
5 percent
$20
$40
$80
$10

Dividends
Received
by ACI in
2008
$6.0
$5.0
0
$3.0
$0.5

In addition to the equity investments in Exhibit 1, Fannerson was asked to evaluate two recently
acquired debt holdings, which have been classified as held-to-maturity. Information about these
securities is shown in Exhibit 2.

Investment
Cortez Inc.
Da Gama Inc.

Exhibit 2
ACI Inc. Portfolio B
Debt Securities (amounts in millions)
Cost Basis
Market Value
(Purchased at Par Value) 31 December 2008
$50
$46
$35
$30

Interest Received
by ACI in 2008
$3
$2

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Wilmington mentions that the economic circumstances regarding the two debt securities has
deteriorated significantly and asked Fannerson’s opinion on how the way in which these
securities had been classified affected ACI’s performance.
Fannerson has gathered the following additional information:
•
•
•
•

•
•

At time of purchase the market value of the net assets of Columbus were equal to
their book values.
The number of seats that ACI holds on the respective Boards of its’ equity
investments is shown in Exhibit 3.
De Soto is a joint venture between ACI and two other partners.
Marco has a majority holder that exercises control over Marco’s operations.
ACI has been unhappy with the performance of the Le Vaca investment for some
time and has been attempting to divest its holding with no success.
ACI does not classify equity securities as held-for-trading securities.
Exhibit 3
Seats on the Board held by ACI in its Investee Companies
Company Total Number Seats controlled
of Directors
by ACI
Columbus
12
7
De Soto
9
3
Marco
16
0
Le Vaca
12
4
Viking

15
0

13. The incremental effect on ACI’s net income ($ millions) from its investment in
Columbus is closest to:
A. 39.
B. 45.
C. 65.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


14. If ACI were to use the IFRS (International Financial Reporting Standards) recommended
method to account for De Soto instead of U.S. GAAP, which of the following will be the
item most likely to increase for ACI?
A. Net income.
B. Total revenues.
C. Return on assets.

15. The year-end 2008 balance sheet carrying value (in $ millions) of De Soto was closest to:
A. 125.
B. 150.
C. 155.
16. The equity income from investments that should be reported on ACI’s 2008 income
statement (in $-millions) is closest to:
A. 18.
B. 30.

C. 33.

17. ACI’s investment income will include dividends from which of the following
investments?
A. Viking only.
B. Marco and Viking.
C. De Soto, Marco and Viking.

18. If ACI had classified the debt securities in Portfolio B as available-for-sale securities, its
pre-tax income ($-millions) for 2008 would have most likely been:
A. 9 lower.
B. 4 lower.
C. unchanged.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Question 19 through 24 relate to Financial Statement Analysis

Erika Wong Case Scenario
Erika Wong, an analyst with Montreal Investments, is forecasting 2008 results for Garrison Inc.
Garrison has two wholly owned European subsidiaries: Catlette and Heren. Wong has prepared
individual forecasts for the parent company (before consolidating the subsidiaries) in U.S. dollars
and for the two subsidiaries in their local currency (the Euro). She wants to determine how the
translation of subsidiary results will affect the consolidated results of operations, using the
following additional information:
•

•
•

Both Catlette and Heren use the FIFO method for inventory.
Catlette’s results will be translated into dollars using the all-current method.
Heren’s results will be remeasured into dollars using the temporal method.

Wong’s forecasted exchange rates for the U.S. dollar and Euro are shown in Exhibit 1 along with
historical rates. Her forecasted financial data for Catlette Company are presented in Exhibits 2
and 3.
Wong is particularly concerned about whether the choice of translation methods will distort
Garrison’s financial ratios relative to the ratios in local currencies. She plans to translate the
forecasted financial statements for the subsidiaries into U.S. dollars using the methods which
Garrison is expected to use.
Exhibit 1
Exchange Rates
31 December 2007
31 December 2008
2008 average
Rate when Catlette’s fixed assets were acquired
Rate when Catlette acquired
Year-end 2007 inventory
Year-end 2008 inventory

0.80 Euro = 1.00 US dollar
0.75 Euro = 1.00 US dollar
0.78 Euro = 1.00 US dollar
0.85 Euro = 1.00 US dollar
0.82 Euro = 1.00 US dollar
0.75 Euro = 1.00 US dollar

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Exhibit 2
Catlette Company
Forecasted Balance Sheet
31 December 2008
(in millions of Euro)
Cash and receivables
Inventory
Fixed Assets
Total Assets

50
200
1,000
1,250

Liabilities
Capital Stock
Retained Earnings

350
650
250

Total liabilities and stockholders’ equity

1,250

Exhibit 3
Catlette Company
Other Financial Data
(in millions of Euro)
2008 Forecasted Sales
2008 Forecasted Cost of sales
31 December 2007 Inventory

1,000
700
100

19. Considering the translation method chosen, Garrison most likely designated the Euro as
the functional currency for:
A. Heren only.
B. Catlette only.
C. both Heren and Catlette.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


20. When Garrison consolidates Heren’s results, it will ignore exchange rate translation gains
and losses on:

A. monetary items if unrealized.
B. nonmonetary items if realized.
C. nonmonetary items if unrealized.

21. The translation method used by Garrison for Catlette is best justified if:
A. Catlette is a sales outlet for the parent’s products.
B. Catlette is a self-contained independent operating entity.
C. Garrison’s reporting currency is used as the functional currency for Catlette.

22. When Garrison consolidates Catlette’s results, unrealized exchange rate translation gains
or losses on monetary assets will be:
A. unreported.
B. reported in non-operating earnings.
C. reported in equity as a cumulative translation adjustment.
23. When Wong converts her forecasted balance sheet for Catlette into U.S. dollars, total
assets at 31 December 2008 (in $ millions) will be closest to:
A. 1,038.
B. 1,510.
C. 1,667.

24. When Wong converts her forecasted income statement data for Catlette into U.S. dollars,
gross profit margin for 2008 will be closest to:
A. 27.2%.
B. 30.0%.
C. 32.7%.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.

Question 25 through 30 relate to Corporate Finance

MFT Plc Case Scenario
MFT Plc is a money management firm based in the U.K. One of MFT’s funds invests in
companies with effective corporate governance and conservative capital structures. Rollo
Martin, a newly hired analyst, prepares a presentation for the MFT investment committee.
Before screening potential investment opportunities, Martin asks his supervisor Hugh Crabbin
how to identify effective corporate governance structures and systems. Crabbin states that
Martin should look for the following corporate governance attributes:
•
•
•

Transparency in disclosures;
Measurable performance accountabilities;
Directors identifying strongly with managers’ interests.

Martin gathers information on a potential investment, France-based TML S.A. The company’s
website provides details of its corporate governance, some of which is presented in Exhibit 1.
Exhibit 1
Extract from TML S.A.’s Corporate Governance Information
Board Responsibilities
1. Acquire adequate training so that members are able to adequately perform their duties.
2. Hire the chief executive officer, determine the compensation package, and periodically
evaluate the officer’s performance.
3. Establish corporate values and governance structures for the company to ensure that the
business is conducted in an ethical, competent, fair, and professional manner.
After reviewing this information, Martin is concerned about TML management’s ability to

receive excessive compensation.
In addition to TML’s corporate governance, Martin analyzes the company’s capital structure. He
observes that it has a low debt-to-equity ratio relative to its peers. Martin determines the
unlevered value for TML to be €2,000,000,000. He makes the estimates shown in Exhibit 2 to
assess the impact of leverage on TML’s capital structure.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Exhibit 2
Selected Leverage Scenarios for TML S.A.
Scenario
Present Value of Costs of Financial
Distress in € thousand
Weighted Average Cost of Capital
Cost of Equity

Low

Current

Medium

High

0

100

1,000

25,000

11.00%
11.00%

10.50%
13.00%

10.00%
16.00%

11.00%
19.00%

Carol Reed, MFT’s chief investment officer, is interested in TML’s dividend policy. TML uses
a longer-term residual dividend approach and currently earnings are near the cyclical high.
Martin explains that in the past the company has kept its cash dividend stable despite rising
earnings. Moreover, he believes that the recent increase in earnings is only temporary. In
addition to paying cash dividends, the company has a share repurchase program.
Reed does not agree that much of the increase in TML’s earnings is temporary. She wants to
know from Martin what the expected dividend of TML would be if the company used a 5-year
period to adjust the dividend towards a target payout ratio of 40 percent. Martin uses TML’s
regular dividend per share of €0.50, last year’s earnings of €2.50 per share, and current year’s
anticipated earnings of €3.0 per share to calculate the expected dividend.

25. Crabbin’s list of corporate governance attributes, given in response to Martin’s question,

is least appropriate with regard to:
A. transparency.
B. identification.
C. measurability.

26. Is each of the responsibilities of the board of directors listed in Exhibit 1 a component of
an effective corporate governance system?
A. Yes.
B. No, because item 1 is not a component.
C. No, because item 2 is not a component.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


27. Martin’s concern about management most accurately reflects:
A. asset risk.
B. accounting risk.
C. strategic policy risk.

28. Assuming static trade-off theory holds and using the information in Exhibit 2, TML’s
value is:
A. unaffected by capital structure.
B. highest under the low leverage scenario.
C. highest under the medium leverage scenario.
29. Given TML’s dividend policy and Martin’s assessment of its earnings, TML’s most likely
course of action would be to:
A. reduce share repurchases.

B. increase the cash dividend.
C. maintain the current cash dividend.

30. If TML were applying the proposed target payout ratio its expected dividend would be
closest to:
A. €0.54.
B. €0.70.
C. €0.74.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Question 31 through 36 relate to Economics

Faye Kennant Case Scenario
Faye Kennant, an equity analyst, is preparing a research report on Svensoft Oyj, which sells
application software to large financial services firms and is based in Helsinki, Finland. Kennant
plans to conduct an industry analysis, consider several valuation alternatives, and select an
appropriate valuation tool for stock selection.
Her first step is to consider whether Svensoft is in an attractive industry and to gauge whether
Svensoft has a strong position within the industry. She prepares the following industry analysis:
•

•

•
•

•
•
•

Industry structure and rivalry: The application software industry is dominated by two
companies: Waldoware and Meteor. The founders of Waldoware and Meteor are longterm rivals and the two firms compete brutally for every customer. Svensoft has
historically avoided competition with the two by focusing on the needs of large financial
services providers and segmenting its offerings. Waldoware recently acquired a small
financial services software firm and has committed significant resources to it for
competing more effectively. Meteor, on the other hand, has developed its own offering,
which many customers consider superior to Svensoft’s offering.
Threat of new entry: The dominant positions enjoyed by existing players have resulted in
significant barriers to entry into the software industry which in turn enabled the existing
players to maintain high profitability. Prominent features of barriers to entry in this
industry are: low customer switching costs, high supply-side economies of scale,
incumbency advantages, and high capital requirements.
Threat of substitutes: substitute products are not currently available.
Customer power: Since most financial services firms already have some sort of
application software, the recent increase in available offerings is allowing them to
negotiate much better deals for renewals or new licenses.
Supplier power: Labor is the primary input to application software. The increased
rivalry has created a high demand for programmers and elevated salaries, particularly for
experienced programmers.
Demand: Application software has largely penetrated its target customer base and
industry revenue growth has slowed. However, the growth of unit sales in this industry
has been closely tracking the overall economic growth.
Supply: There are few limitations to the quantity of application software that can be
provided.

Svensoft has decided to respond to these pressures by further focusing on the reliability of its

applications. Financial services customers have cited reliability as their key consideration in
purchase decisions. Svensoft currently lags Waldoware in this regard but intends to become the
most reliable.
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Given the consolidation that has already taken place in the industry, Kennant believes Svensoft
could be acquired. She considers several potential valuation models to determine Svensoft’s
potential takeover value. Further, in regard to the process of valuing stocks, Kennant believes
the following:
1. Apply appropriate valuation models well grounded in traditional intrinsic value and
discounting concepts; the most important factor in determining a security’s intrinsic
value is a forecast of “earning power” and it should be determined independent of
market price.
2. As Graham and Dodd stipulated, growth stocks should be purchased at bargain prices,
whereas cyclical stocks should be purchased at prices within a range of their intrinsic
value.

31. According to Kennant’s industry analysis, which of the following is the least attractive
competitive force for the software industry?
A. Customer power.
B. Threat of new entry.
C. Threat of substitutes.

32. In regard to the prominent threat of new entry factors that Kennant has included in her
industry analysis, she is least accurate with respect to:
A. incumbency advantages.

B. customer switching costs.
C. supply-side economies of scale.

33. The industry analysis model for Svensoft pays least attention to:
A. demand.
B. profitability.
C. external factors.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


34. Which life cycle phase best describes the application software industry?
A. Mature.
B. Growth.
C. Declining.

35. Which of the following is the least attractive factor with regard to the pricing power in
the applications software industry?
A. Key supply inputs.
B. Product segmentation.
C. Industry concentration.

36. Kennant’s beliefs are most accurate with respect to her belief:
A. 1 but not 2.
B. 2 but not 1.
C. both 1 and 2.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Question 37 through 42 relate to Equity Investments

Robert Davenport case Scenario
Robert Davenport, CFA, is reviewing the report on Fashion Wire that his firm issued last year.
Fashion Wire is a U.S. company operating in the appliance industry.
Selected data from the 31 December 2008 balance sheet and the 2008 income statement are
shown in Exhibits 1 and 2. The data from the financial statements were adjusted as follows:
•
•
•
•

Assets and liabilities are at fair value.
Depreciation expense reflects the economic obsolescence of assets.
Non-recurring items have been removed.
Clean surplus accounting applies.
Exhibit 1
Fashion Wire
Adjusted Selected Data from Balance Sheet
as of 31 December 2008
(U.S. $ millions)
Total Current Assets
Fixed Assets (net of depreciation)
Total Assets

8,665
4,584
13,249

Current Liabilities (non interest bearing)
Long-term Debt
Shareholders’ Equity
Total Liabilities and Shareholders’ Equity

7,936
3,188
8,125
13,249

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Exhibit 2
Fashion Wire
Adjusted Selected Data from Statement of Income
Year Ended 31 December 2008
(U.S. $ millions except for dividends and share data)
Operating Income (EBIT)
Interest Expense
Income before Taxes
Taxes (30%)

Net Income

1,633
240
1,393
418
975

Dividends per share
Number of shares outstanding (millions)

$0.60
812

Davenport also gathers the following information:
• The current stock price is $10.00 per share.
• The required return on equity capital ( ) is 12.0 percent.
• The company’s before-tax and after-tax weighted average cost of capital (WACC)
respectively are 11.8 percent and 10.1 percent.
Davenport is deciding whether the next report on Fashion Wire should include residual income
and related measures of valuation. He first wants to support his belief that shareholders are
better informed with the economic value added (EVA) measure than with traditional net income
measure. He also wants to show how residual income is calculated.
Fashion Wire has already announced several new projects that will greatly increase the size of
the company. Davenport has decided to use value-based measures, specifically EVA, to
illustrate his concern that shareholder value for Fashion Wire may decrease despite the new
projects and larger company size.
Dev Raj, Davenport’s supervisor, presents the following scenario for Rajasthan Appliances, a
Fashion Wire competitor, and asks him to provide a valuation of the competitor’s stock using a
residual income valuation model:

•
•
•
•

Return on equity (ROE) is 14 percent and the growth rate of earnings is 7 percent;
both figures are assumed to remain constant indefinitely.
The book value per share is $12.00.
The cost of equity capital ( ) is 12.5 percent. The before-tax and after-tax weighted
average cost of capital (WACC) are 11.3 percent and 10.6 percent, respectively.
The market value per share is $14.00.

Further, Raj states that residual income models are appropriate even for valuing firms with the
following characteristics:
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


(1) Firms where cash flows are unpredictable.
(2) Firms that do not pay dividends or when dividends are not predictable.
In responding to Raj, Davenport expresses his concern regarding the differences in accounting
practices that could result in misleading valuations when using residual income models.
Specifically, Davenport makes the following two statements:
1. The residual income model will underestimate the value of the company if it chooses to
capitalize an expenditure rather than expensing it.
2. Accounting for changes in the value of investments considered to be “available-for-sale”
biases the valuation by incorrectly stating both book value of equity and ROE.
In closing, Raj asks Davenport to take the above accounting issues into consideration when

valuing companies using residual income models.

37. The best support for Davenport’s belief about the economic value added (EVA) measure
and the traditional net income measure is that EVA:
A. uses cash flow data while net income uses accounting data.
B. deducts the dollar cost of capital from the net operating profit after taxes while net
income does not.
C. deducts the interest charge on debt from the net operating profit after taxes while net
income does not.

38. Fashion Wire’s residual income in 2008 is closest to:
A. -$168.
B. $ 0.
C. $154.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


39. Which of the following results from value-based metrics would best support Davenport’s
concern about Fashion Wire’s shareholder value, new projects, and larger company size?
A. Dollar cost of total capital > Net operating profit after taxes.
B. Return on equity (ROE) > return on equity capital required by investors ( ).
C. Strategic investments that are not expected to generate a return immediately.

40. Based on the scenario provided to Davenport by his supervisor, the intrinsic value of
Rajasthan Appliances’ stock using the residual income valuation model is closest to:
A. $15.27.

B. $19.53.
C. $23.33.

41. In regard to the appropriateness of firm characteristics for using residual income models,
Raj is most accurate with respect to:
A. dividends only.
B. cash flows only.
C. both cash flows and dividends.

42. In regard to Davenport’s response to Raj, it is most accurate to state that he is correct with
respect to:
A. statement 1 but not 2.
B. statement 2 but not 1.
C. neither statement 1 nor 2.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.


Questions 43 through 48 relate to Fixed Income Investments.
Madden Roarke Case Scenario
Madden Roarke, CFA, is a fixed income analyst for Goldrick & Kildow PLC (GK), an
investment management firm. Roarke has been asked to provide an analysis of Windmiller, Ltd.,
a manufacturer of automobile components. GK’s bond portfolio has a large holding of
Windmiller bonds and its manager, Elizabeth Ferguson, is worried that the rating agencies may
lower their ratings on the debt.
In order to learn more about Windmiller, Roarke reviews recent news reports. From these, he
learns that the firm’s CEO is 83 years old and in poor health. The reports note that the CEO is

widely credited for Windmiller’s recent turnaround, but that industry insiders are surprised that
there is no evidence of succession planning in place.
Roarke gathers balance sheet information from Windmiller’s most recent financial reports, which
he summarizes in Exhibit 1.
Exhibit 1
Windmiller Balance Sheet Information
(in billions)
2008
2007
Cash & marketable securities
10.1
9.2
Inventories
5.2
2.8
Accounts receivable
7.8
6.8
Other receivables
3.4
4.6
Current Assets
26.5
23.4
Plant & equipment
43.8
36.7
Other fixed assets
12.7
10.0

Total Assets
83.0
70.1
Short-term debt
12.4
10.3
Current long-term debt
2.4
4.1
Accounts payable
3.7
3.0
Other payables
1.2
0.8
Current liabilities
19.7
18.2
Long-term bonds
34.1
23.7
Long-term bank loans
0.0
5.9
Total liabilities
53.8
47.8
Common par value
0.8
0.8

Retained earnings
28.4
21.5
Total liabilities + equity
83.0
70.1
The Windmiller bonds held in the GK portfolio are currently rated A by the major rating
agencies. Using information from Windmiller’s balance sheets and income statements for the
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currentlyregistered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The
following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting
access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing,
distributing and/or reprinting the mock exam for any purpose.