Level 2 Mock Exam Question and Answers 2014

Mock Exam – AM Answers

Block 1: LaCompte

Question
1 of 6
Even if LeCompte discloses the cost of her attendance she may still not be permitted to take the
trip depending upon her company's policies. In addition, the disclosure in this case is not enough
to avoid a potential violation of Standard I(B) relating to independence and objectivity. By
allowing the corporate issuer to pay for her travel expenses her judgment could be compromised.
It is more appropriate for LeCompte to decline the invitation or have her company pay all costs
for the trip in order to avoid any conflict or appearance of conflict.
2014 CFA Level II
“Guidance for Standards I–VII,” CFA Institute
Standard I(B)

Question
2 of 6
LeCompte violated Requirement 6, Relationships with Subject Companies, by sharing the full
research report with NanoMem. Sharing any section of a research report that might communicate
the analyst's proposed recommendation, rating, or price target is prohibited by the Research
Objectivity Standards. Sharing historical factual information on the other hand is not a violation.

2014 CFA Level II
“CFA Institute Research Objectivity Standards,” CFA Institute
Section 4

Question
3 of 6
Research Objectivity Requirement 5, Research Analyst Compensation, recommends analyst's
compensation be based on the accuracy of recommendations over time. In addition,

compensation should not be directly linked to investment banking or other finance activities,
which it is not in this case. LeCompte's bonus is based on the group's overall performance and is
not specific to the research support she provides to various divisions.

2014 CFA Level II
“CFA Institute Research Objectivity Standards,” CFA Institute
Section 4


Mock Exam – AM Answers

Question
4 of 6
LeCompte provided all the recommended disclosures relating to potential conflicts of interest
with respect to UniFlash. She should have disclosed the "benefit received" from NanoMem
concerning the trip she took, as well as her small equity position in NanoMem as required by
Research Objectivity Requirement 2, Public Appearances.

2014 CFA Level II
“CFA Institute Research Objectivity Standards,” CFA Institute
Section 2.0

Question
5 of 6
The recommended procedures for compliance with the Research Objectivity Requirement 11, Rating
System, states that firms should prohibit covered employees from communicating a rating or
recommendation different from the current published rating or recommendation.
2014 CFA Level II
“CFA Institute Research Objectivity Standards,” CFA Institute
Section 4

Question
6 of 6
According to the CFA Institute Standards I(B), and V(A), members and candidates must exercise
diligence, independence, objectivity, and thoroughness in analyzing investments, making
investment recommendations, and taking investment actions. Changing a written
recommendation to what a subject company desires is not acting diligently, independently,
objectively, and/or thoroughly and the analyst should immediately revise her recommendation to
express her stated opinion of the company.

2014 CFA Level II
“Guidance for Standards I-VII,” CFA Institute
Standard I(B), Standard V(A)


Mock Exam – AM Answers

Block 2: Scott

Question
1 of 6
Economic income = Change in market value plus the after-tax cash flow.
Market value = Present value of future expected after-tax cash flows
Beginning market value, at beginning of Year 3 (assuming end-of-year cash flows):

Ending market value at the end of Year 3:

Economic profit = (292,939 – 382,712) + 147,180 = 57,407
2014 CFA Level II
"Capital Budgeting," by John D. Stowe and Jacques R. Gagne

Section 8.2

Question
2 of 6
Operating income before tax– Interest = Taxable income:
$102,750 – ($300,000 × 0.12) = $66,750
Accounting income or net income = Taxable income × (1 – Tax rate)
$66,750 × (1 – 0.40) = $40,050
2014 CFA Level II
"Capital Budgeting," by John D. Stowe and Jacques R. Gagne
Section 8.2


Mock Exam – AM Answers

Question
3 of 6
Ludlow's suggestion of considering alternate economic environments is an example of scenario
analysis.
2014 CFA Level II
"Capital Budgeting," by John D. Stowe and Jacques R. Gagne
Section 7.3.2

Question
4 of 6
Because the schedule for the first year is equivalent to straight-line depreciation (1/5 = 20%), the
after-tax operating cash flow does not change under straight line or MACRS accelerated
depreciation.
2014 CFA Level II
"Capital Budgeting," by John D. Stowe and Jacques R. Gagne

Section 6.1

Question
5 of 6
Ludlow's suggestion is an example of economic profit: EBIT × (1 – tax rate) – $WACC. EBIT is
earnings before interest and taxes.
2014 CFA Level II
"Capital Budgeting," by John D. Stowe and Jacques R. Gagne
Section 8.3.1

Question
6 of 6
The competing projects are mutually exclusive, which means that only one of the two positive
NPV projects can be accepted. The choice of which project to accept is based on choosing the
project with either (1) the highest equivalent annual annuity (EAA) or (2) the highest value based
on the least common multiple of lives (LCML) approach. The three-year project should be
chosen using either approach as shown in the following.
EAA for three-year project:


Mock Exam – AM Answers
NPV × Present Value Annuity Factor (three years at 15%)

EAA = 128,146/2.2832 = 56,126

EAA for five-year project:
NPV × Present Value Annuity Factor (five years at 15%)

EAA = 183,109/3.3522=54,624
The three-year project is preferred because it has a higher EAA.

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

NPV (five-year project, 15 years):

The three-year project is preferred because the NPV over 15 years is higher.
2014 CFA Level II
"Capital Budgeting," by John D. Stowe and Jacques R. Gagne
Sections 7.1.1– 7.1.2


Mock Exam – AM Answers

Block 3: Daltonia

Question
1 of 6
The components of growth can be determined using Solow’s growth accounting equation: ΔY/Y
= ΔA/A + αΔK/K + (1 − α)ΔL/L
where:
ΔY/Y = GDP percentage growth
ΔA/A = percentage growth from total factor productivity (TFP)
ΔK/K = percentage growth in capital
ΔL/L = percentage growth in labor
α = share of income paid to capital factor
1 – α = share of income paid to labor factor, also the elasticity of output with respect to labor
TFP = Labor productivity growth – Growth in capital deepening = 1.7 – 2.3 = –0.6, which is
given in Exhibit 1. Also given, 1 – α = 0.65 and α = 0.35
GDP growth = ΔY/Y = 3.75

ΔA/A = growth due to TFP
αΔK/K = growth due to capital
(1 − α)ΔL/L = growth due to labor

Arising from the total of components below:
−0.6
+ 2.13 = (0.35) × 6.1
+ 2.21 = (0.65) × 3.4
3.75 GDP growth
Growth due to labor of 2.21% is greater than the growth due to capital or TFP.

2014 CFA Level II
“Economic Growth and the Investment Decision,” by Paul Kutasovic
Sections 4.2-4.3

Question
2 of 6
Pamuk’s conclusion is consistent with the endogenous growth model. In the endogenous growth
model, the economy does not reach a steady growth rate equal to the growth of labor plus an
exogenous rate of labor productivity growth. Instead, saving and investment decisions can
generate self-sustaining growth at a permanently higher rate. This situation is in sharp contrast to
the neoclassical model, in which only a transitory increase in growth above the steady state is
possible. The reason for this difference is because of the externalities on R&D, diminishing
marginal returns to capital do not set in.
2014 CFA Level II
“Economic Growth and the Investment Decision,” by Paul Kutasovic
Section 5.3


Mock Exam – AM Answers

Question
3 of 6
Birol’s statement based on Mundell–Fleming model is inaccurate because restrictive (not
expansionary) fiscal policy, along with expansionary monetary policy, would lead to capital
outflows and cause the currency to depreciate assuming high capital mobility.
2014 CFA Level II
“Currency Exchange Rates: Determination and Forecasting,” by Michael R. Rosenberg and
William A. Barker
Sections 6.1, 6.2.2, 6.3

Question
4 of 6
Suggestion 1 is an accurate description of a sterilized currency intervention. If the currency is
overvalued and inflation is a concern, a sterilized intervention is necessary. Emerging market
authorities would sell domestic securities to the private sector to mop up any excess liquidity
created by its foreign exchange intervention activities. The end result would be that the monetary
base and the level of short-term interest rates would not be altered by the intervention operation.
2014 CFA Level II
“Currency Exchange Rates: Determination and Forecasting,” Michael R. Rosenberg and
William A. Barker
Section 7

Question
5 of 6
Calculate the interbank implied cross rate for (DRN/EUR).
Invert the (EUR/USD) quotes. The 0.8045 bid becomes 1/0.8045 = 1.243 offer for (USD/EUR).
The 0.8065 offer becomes 1/0.8065 = 1.240 bid for (USD/EUR).
Determine the interbank implied cross currency quotes for (DRN/EUR) as follows:
Bid: 1.205(DRN/USD) ᵡ 1.24 (USD/EUR) = 1.4942 (DRN/EUR)

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


Mock Exam – AM Answers

2014 CFA Level II
“Currency Exchange Rates: Determination and Forecasting,” by Michael R. Rosenberg and
William A. Barker
Section 2.1

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

Sell

Sell
Invest at 2.1% DRN LIBOR:

Convert to EUR at projected spot:
Minus borrowing cost: 100,000×0.8%=EUR800
Ending balance = EUR101,065
Minus 100,000 beginning value = EUR1,065 profit
2014 CFA Level II
“Currency Exchange Rates: Determination and Forecasting,” by Michael R. Rosenberg and
William A. Barker
Section 4.1

Mock Exam – AM Answers

Block 4: Tremblay

Question
1 of 6
The mid-market for CAD/USD is (1.2138 + 1.2259)/2 = 1.21985. The mid-market forward
premium (discount) is calculated as:

In this problem, we have:

2014 CFA Level II
"Currency Exchange Rates: Determination and Forecasting," by Michael R. Rosenberg and
William A. Barker
Section 2.2

Question
2 of 6
The relative version of PPP states that the percentage change in the spot exchange rate will be
completely determined by the difference between the foreign and domestic inflation rates. In this
case, the difference in the inflation rates is 1.90%–2.30% =–0.4%. Subtracting 0.4% from the
current bid gives the answer 1.2089. The calculation is 1.2138 – (0.004 × 1.2138) = 1.2089.
2014 CFA Level II
"Currency Exchange Rates: Determination and Forecasting," by Michael R. Rosenberg and
William A. Barker
Section 3.1.4


Mock Exam – AM Answers

Question
3 of 6
It is cheaper to buy Canadian dollars indirectly through Brazilian reals than directly with U.S.
dollars. This creates a triangular arbitrage opportunity:
US$1,000,000 × 2.3844 = BRL2,384,400
2,384,400 × 0.5250 = C$1,251,810
C$1,251,810/1.2259 = US$1,021,135
US$1,021,135 – US$1,000,000 = US$21,135 profit
2014 CFA Level II
"Currency Exchange Rates: Determination and Forecasting," by Michael R. Rosenberg and
William A. Barker
Section 2.1

Question
4 of 6
Baroque's comments describe the international Fisher effect. The international Fisher effect
states that the foreign-domestic nominal yield spread will be solely determined by the foreigndomestic expected inflation differential.
2014 CFA Level II
"Currency Exchange Rates: Determination and Forecasting," by Michael R. Rosenberg and
William A. Barker
Section 3.1.5

Question
5 of 6
Tremblay's first justification describes "club convergence." Her second justification describes a
second source of convergence–imitating or adopting technology already widely used in the
advanced countries. Convergence is consistent with the neoclassical growth model.
2014 CFA Level II
"Economic Growth and the Investment Decision," by Paul Kutasovic

Sections 5, 5.2.2, 5.4


Mock Exam – AM Answers

Question
6 of 6
The possibility for permanent higher growth in per capita output exists within endogenous
growth theories but not in neoclassical growth theory nor in classical growth theory.
2014 CFA Level II
"Economic Growth and the Investment Decision," by Paul Kutasovic
Sections 5, 5.3

Block 5: Galaxy

Question
1 of 6
The change in revenue recognition to an earlier point, before the product has been produced or
delivered, is an aggressive accounting policy that would lower the company's quality of earnings.
2014 CFA Level II
"Evaluating Financial Reporting Quality," by Scott Richardson and Irem Tuna
Sections 2.2, 4.1.2, 4.5

Question
2 of 6
Actual experience has shown that the amount expensed in prior years was too large. The
adjustment would be a reversal of the reserve in 2013: a decrease in the warrant provision and an
increase in net income in 2013. The decrease in the provision (lower current liabilities) would
result in increase in the current ratio.
2014 CFA Level II

"Evaluating Financial Reporting Quality," by Scott Richardson and Irem Tuna
Section 4.1


Mock Exam – AM Answers

Question
3 of 6
Deposits received
Deposit as percentage of order
Revenue recognized on receipt of order
Gross profit margin

$3 million
25%
$3 million/0.25 = $12 million

Increment to gross profit from early recognition policy

53% × $12 million = $6.36 million

2014 CFA Level II
“The Lessons We Learn,” by Pamela Peterson Drake and Frank J. Fabozzi
Lesson 1
“Evaluating Financial Reporting Quality,” by Scott Richardson and Irem Tuna
Sections 4.2.3 and 4.3
“Integration of Financial Statement Analysis Techniques,” by Jack T. Ciesielski, Jr.
Section 1

Question

4 of 6
Total assets
Cash and investments
Operating assets (A)
Total liabilities
Long-term debt
Current portion of long-term debt
Operating liabilities (B)
Net operating assets (A – B)
Balance sheet–based aggregate
accruals: change in net operating
assets

2013
($ thousands)
131,122
–21,122
110,000

2012
($ thousands)
127,000
–25,000
102,000

57,000
–35,000
–5,000
17,000

64,000
–40,000
–5,000
19,000

93,000

83,000
$10,000

2014 CFA Level II
“Evaluating Financial Reporting Quality,” by Scott Richardson and Irem Tuna
Sections 3.2 and 3.3
“Integration of Financial Statement Analysis Techniques,” by Jack T. Ciesielski, Jr.
Section 2


Mock Exam – AM Answers

Question
5 of 6
The compensation expense for restricted stock grants is the fair market value of the shares on the
grant date, and this amount is allocated over the service period: $4.2 million/3 = $1.4 million
2014 CFA Level II
“Employee Compensation: Post-Employment and Share-Based,” by Elaine Henry and Elizabeth
A. Gordon
Section 3.1

Question
6 of 6

Only the executive stock option plan is affected by volatility of the company’s stock. The
volatility affects the initial valuation of the stock options granted (e.g., through use of the Black–
Scholes model to determine the fair value of the options). The initial valuation of the options
determines the expense recognized. Compensation expense for stock grants is based on the fair
market value of the stock on the day of the grant and is not affected by the stock’s volatility.
2014 CFA Level II
“Employee Compensation: Post-Employment and Share-Based,” by Elaine Henry and Elizabeth
A. Gordon
Sections 3.1 and 3.2

Block 6: Piazo

Question
1 of 6
Days of inventory on hand
Inventory turnover ratio
= 365/Inventory turnover ratio
= COGS/Inventory
Piezo uses LIFO under U.S. GAAP, whereas the European firms use FIFO under IFRS. With
rising prices, under LIFO, cost of goods sold (COGS) will be higher and the inventory carrying
amount will be lower. The result is that the inventory turnover ratio will be higher under LIFO
than FIFO. The higher inventory turnover will lead to fewer days of inventory on hand under
LIFO.
2014 CFA Level II
“Inventories: Implications for Financial Statements and Ratios,” by Michael A. Broihahn Section
3


Mock Exam – AM Answers

Question
2 of 6
To be comparable with the European firms, it is necessary to adjust the net income and total asset from
LIFO to FIFO. Under FIFO, total assets increase by the LIFO reserve but decrease by the cash paid for
the cumulative amount of additional income taxes that would arise. Net income will be higher under FIFO
because of lower COGS (i.e., the increase in the LIFO reserve, but it will be reduced by the taxes paid on
the increase in operating profit).
(US$ thousands)
Net Income (LIFO)
+ Reduction in COGS
– Tax on increased operating profit
Net Income (FIFO)
Total assets (LIFO)
+Increase in inventory (FIFO)
– Tax paid on higher cumulative profits
Total assets (FIFO)

$178
+ 320
– 106.6
$391.4
$5,570
+ 867
– 281.6
$6,155.4

Increase in LIFO reserve: 867 – 547
33.3% × 320 (use 2013 tax rate)

Add LIFO reserve: 867

a
33.3% × 320 + 32% × 547

a

Cumulative tax savings: 2013 tax rate for the increase in LIFO reserve; 32% on remainder

2014 CFA Level II
“Inventories: Implications for Financial Statements and Ratios,” by Michael A. Broihahn
Section 3.1

Question
3 of 6

Gross profit under LIFO in 2013 = 11,159 – 9,898 = $1,261
But this arose in part because of the LIFO liquidation, which decreased cost of goods sold by 263 (Exhibit 2, Note 5)
Adjusted gross profit = $1,261 – 263 = $998
Adjusted gross profit margin in 2013 = 998 / 1,159 x 100 = 8.9%
Gross profit margin in 2012 = (8,895 – 7,901)/8,895 x 100 = 11.2%
After adjusting for the LIFO liquidation, gross profit margin is lower by 2.30% (8.9% - 11.2%)
2014 CFA Level II
“Inventories: Implications for Financial Statements and Ratios,” by Michael A. Broihahn
Sections 3.1 and 3.2


Mock Exam – AM Answers

Question
4 of 6
The interest coverage ratio is calculated excluding the effects of capitalized interest. Capitalized interest

affects interest expense and depreciation expense.
(US$ thousands)

$389
a

EBIT
Add back capitalized interest included in depreciation expense (Note 11)
Adjusted EBIT

34
$423

Interest expense from income statement
Capitalized interest (Note 11)
Total interest

$122
66
$188

The interest coverage ratio requirement has been exactly achieved.
a

EBIT = Sales – COGS – S&A expenses = 11,159 – 9,898 – 872 = $389

2014 CFA Level II
“Long-Lived Assets: Implications for Financial Statements and Ratios,” by Elaine Henry and Elizabeth A.
Gordon
Section 2.1

Question
5 of 6
The expensing of the previously capitalised interest is a non-cash amount (the cash outflow was
in a previous period when the expense was incurred) and therefore does not affect operating cash
flow. Net income is lower as a result of the previously capitalized amount being expensed, but as
it is a non-cash expense it is added back to determine cash from operations. (Lower net income
but higher add back = no change in CFO).
2014 CFA Level II
"Long-Lived Assets: Implications for Financial Statements and Ratios," by Elaine Henry and
Elizabeth A. Gordon
Section 2.1


Mock Exam – AM Answers

Question
6 of 6
At the end of 2013, a test of impairment is required because “events or changes in circumstances indicate
that its carrying amount may not be recoverable.”
Carrying amount of asset at 31 December 2013: 2,800 × (1 – 0.13)4 = 1,604
U.S. GAAP Impairment Test
Step 1: Assess recoverability: Compare carrying amount with undiscounted future net cash flows.
Carrying amount 1,604 > 1,350 Expected future cash flows
The recoverability test is not satisfied, so an impairment loss is required.
Step 2: Write the asset down to its fair value.
New carrying value: $1,225 (Exhibit 3)
Estimated depreciation in 2014

2014 CFA Level II

“Long-Lived Assets: Implications for Financial Statements and Ratios,” by Elaine Henry and
Elizabeth A. Gordon
Sections 3 and 4

Block 7: Rhine

Question
1 of 6
Petersen prefers to use the relationship between capital expenditures and total assets by operating
division and thus would use the ratio of capital expenditure proportion to total asset proportion for each
division. This ratio for the recreational products division is less than 1 (see the following table), indicating
that Rhine is allocating a lower proportion of capital expenditures to that division relative to asset
proportions. If this trend continues, the recreational products division will become less significant over
time.


Mock Exam – AM Answers

Proportion of capital
expenditures (Exhibit 1)
Proportion of total assets
(Exhibit 1)
Ratio: Proportion of capital
expenditures to proportion of
total assets

Children’s
Products

Recreational

Products

Home
Furnishings

67.6%

20.5%

11.9%

Total for the
Three
Divisions
100.0%

50.9%

38.5%

10.6%

100.0%

1.3

0.5

1.1

1.0

2014 CFA Level II
“Integration of Financial Analysis Techniques,” by Jack T. Ciesielski, Jr.
Section 2

Question
2 of 6
Apply the 2012 operating margin for the children’s products division to the 2013 revenues for the division
to determine what the 2013 overall operating profit margin would have been if the margin had been
maintained, and then compare it with the 2012 overall operating profit margin.
Operating margin in children’s products in 2012
= Operating profit/revenues
Apply the 9.4% margin to 2013 revenues for division
Increase in 2013 operating profit for division, had the
margin been maintained
Revised 2013 company operating profit with increase in
children’s products operating profit
Revised 2013 company operating margin
2012 company operating margin

115.7/1,236.2
0.094 × 1,176.2
110.6 – 64.7

9.4%
110.6
45.9

172.7 + 45.9

218.6/2,837.1
219.4/2,775.5

218.6
7.7%
7.9%

Even if the children’s products division had maintained its operating margin in 2013, the overall company
operating margin would still have decreased slightly (7.7% versus 7.9%).
2014 CFA Level II
“Integration of Financial Analysis Techniques,” by Jack T. Ciesielski, Jr.
Section 2

Question
3 of 6
Analysts should consider the foreign currency effect on sales growth for evaluating
management's historical performance. Foreign currency fluctuations are out of management's
control, so management should not be held accountable for the fluctuations when evaluating their
performance.
2014 CFA Level II
"Multinational Operations," by Timothy S. Doupnik and Elaine Henry
Section 5.1


Mock Exam – AM Answers

Question
4 of 6
The 2013 effective tax rate on earnings is lower than in 2012 (see the following table), implying that more
profits were earned in a lower tax jurisdiction. The foreign operations are in lower tax regimes, therefore,

it is reasonable to conclude that more of the profits were earned internationally.
(€ millions)
Earnings before taxes
Net earnings after tax
Income taxes
Effective tax rate
(Income taxes/EBT)

2013
136.6
109.9
26.7

2012
170.0
132.3
37.7

19.6%

22.2%

2014 CFA Level II
“Multinational Operations,” by Timothy S. Doupnik and Elaine Henry
Section 4

Question
5 of 6
Petersen interprets that the changes in the cash conversion cycle (CCC) indicate a deterioration in
liquidity. The CCC has increased since 2011, from 84 days to 95 days (see the following table). The

working capital account that had the largest effect on the increase was inventory because the holding
period has increased 6.4 days.
2013
Days
(365/Turnover)
Accounts receivable
5.82
62.7
Inventory
3.78
96.6
Accounts payable
5.71
63.9
a
Cash conversion cycle
95.4
a
CCC = Days in sales + Days in inventory – Days in payables.
Working Capital Account

Turnover

2011
Turnover

Days

6.11
4.09

5.60

59.8
89.2
65.2
83.8

2014 CFA Level II
“Integration of Financial Analysis Techniques,” by Jack T. Ciesielski, Jr.
Section 2

Question
6 of 6
Concerns about earnings manipulation are best addressed by cash flow ratios, such as operating
cash flow before interest and taxes to operating income.
2014 CFA Level II
"Integration of Financial Analysis Techniques," by Jack T. Ciesielski Jr.
Section 2


Mock Exam – AM Answers

Block 8: Turner

Question
1 of 6
For fair value through profit or loss investments, the dividends plus the change in fair value are accounted
for in net income. For the investments that are available for sale only, dividends received affect net
income. For associate companies, the equity method recognizes the share of the investee’s net income.
Investment

Alton
Barker
Cosmic
Darnell

Classification
Fair value through profit or loss
Available for sale
Available for sale
Equity method

Income effect
Dividends
+ Unrealized gain (loss)
Dividends
Dividends
% of investees’ net income

Total

C$
(thousands)
1,000
(3,000)
2,000
3,000
15,000
18,000

2014 CFA Level II

“Intercorporate Investments,” by Susan Perry Williams
Sections 3.2.1, 3.3, 5.1

Question
2 of 6
Only the equity securities that were designated as available for sale (Barker and Cosmic) could have
been designated at fair value, and the unrecognized gains from those securities would then be included in
income. Because Foster is a manufacturing company and not a venture capital or mutual fund company,
it cannot account for its significant influence in Darnell using fair value.
Income would be equal to the dividends from Alton, Barker, and Cosmic plus the changes in market value
for those same three securities plus the income from Darnell using the equity method.
Investment
Alton
Barker
Cosmic
Darnell
Total

Dividends
(C$ thousands)
1,000
2,000
3,000
Equity method

Unrecognized gains (losses)
(C$ thousands)
(3,000)
1,000
7,000

% of investees’ net income

2014 CFA Level II
“Intercorporate Investments,” by Susan Perry Williams
Section 3.2.2, 5.1

C$ Total
(thousands)
(2,000)
3,000
10,000
15,000
26,000


Mock Exam – AM Answers

Question
3 of 6
Associated companies are ones in which the investor (Foster) can exercise significant influence. In
addition to ownership between 20–50% (Foster owns 40%), significant influence may be evidenced by
representation on the board of directors (Foster has representation on Darnell’s board) or by material
transactions between the two companies.
There were transactions between Darnell and Foster, but they were not a material portion of Darnell’s net
income.
Net income reported on the sales = $187.5 thousand.
Darnell’s total income for the year = $15,000/40% = $37,500 thousand.
Share of net income from intercompany sales = 187.5/37,500 = 0.005%, which is not material. Thus, the
extent of intercompany transactions least supports the classification of Darnell as an associated
company.

2014 CFA Level II
“Intercorporate Investments,” by Susan Perry Williams
Section 5

Question
4 of 6
The fair value through profit or loss (Eldon) and available-for-sale (Fizz) securities are carried at market
value on the balance sheet. The two held-to-maturity securities (Gilt and Harp) were purchased at par
value, thus their carrying value will not change during the life of the investment (there is no premium or
discount to amortize).
Investment

Eldon
Fizz
Gilt
Harp
Total

Classification

Fair value through profit or loss
Available for sale
Held to maturity
Held to maturity

Year-End Carrying
Value
(C$ thousands)
$23,000
45,000

50,000
60,000
$178,000

2014 CFA Level II
“Intercorporate Investments,” by Susan Perry Williams
Sections 3.1, 3.2.1, 3.3

Question
5 of 6
For fair value through profit or loss investments, the interest income earned plus the change in fair value
are accounted for in net income. For the investment that is available for sale, only the interest income
earned affects net income because the unrealized gain goes to other comprehensive income. For the two
held-to-maturity securities, only the interest income earned affects net income.


Mock Exam – AM Answers
Investment
Eldon
Fizz
Gilt
Harp
Total

Classification
Fair value through
profit or loss
Available for sale
Held to maturity
Held to maturity

Income effect
Interest income
+ Unrealized gain
Interest income
Interest income
Interest income

C$
(thousands)
1,000
3,000
2,000
2,000
5,000
13,000

2014 CFA Level II
“Intercorporate Investments,” by Susan Perry Williams
Sections 3.1, 3.2.1, 3.3

Question
6 of 6
Reason 3, that Gilt has suspended the most recent (see "note b" of Exhibit 2) and expected future
interest payments until it restructures, is the best reason to consider the investment in Gilt is
permanently impaired.
2014 CFA Level II
"Intercorporate Investments," by Susan Perry Williams
Section 3.6

Block 9: Hamilton

Question
1 of 6
Hamilton’s test confirmed the presence of conditional heteroskedasticity, which means that the
variance of the error term is correlated with the values of the independent variables.
2014 CFA Level II
“Multiple Regression and Issues in Regression Analysis,” by Richard A. DeFusco, Dennis W.
McLeavey, Jerald E. Pinto, and David E. Runkle
Section 4.1.1


Mock Exam – AM Answers

Question
2 of 6
Substituting the assumed values into the estimated model results from Exhibit 1 to determine the
predicted monthly return:
Monthly return = –0.0069% + (1.0264 × 1.5%) + (0.3625 × –1.0%) = 1.17%.
2014 CFA Level II
“Multiple Regression and Issues in Regression Analysis,” by Richard A. DeFusco, Dennis W.
McLeavey, Jerald E. Pinto, and David E. Runkle
Section 2

Question
3 of 6
The null hypothesis is H0: bspread = 1.
The calculated value of the t-statistic is t = (1.0264 – 1.0)/standard error.
The standard error is 1.0264/4.28 = 0.24.
The calculated value for t = (1.0264 – 1.0)/0.24 = 0.11.

2014 CFA Level II
“Correlation and Regression,” by Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto,
and David E. Runkle
Section 2.6
“Multiple Regression and Issues in Regression Analysis,” by Richard A. DeFusco, Dennis W.
McLeavey, Jerald E. Pinto, and David E. Runkle
Section 2

Question
4 of 6
The two-tailed critical t-value (1.972) is taken from the table with p = 0.025.
The confidence interval is 0.3625 (1.972 0.055), or 0.25 to 0.47.
2014 CFA Level II
“Correlation and Regression,” by Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto,
and David E. Runkle
Section 3.5
“Multiple Regression and Issues in Regression Analysis,” by Richard A. DeFusco, Dennis W.
McLeavey, Jerald E. Pinto, and David E. Runkle Practice Problems


Mock Exam – AM Answers

Question
5 of 6
Multicollinearity occurs when two or more independent variables (or combinations of
independent variables) are highly (but not perfectly) correlated. Correlation between independent
variables may be a reasonable indication of multicollinearity in cases in which the regression
contains only two independent variables. In Hamilton’s regression model, the correlation
between the SPREAD and the S&P 500 variables is only 0.30.
2014 CFA Level II

“Multiple Regression and Issues in Regression Analysis,” by Richard A. DeFusco, Dennis W.
McLeavey, Jerald E. Pinto, and David E. Runkle
Section 4.3.2

Question
6 of 6
If errors are not serially correlated, the Durbin-Watson statistic will be close to 2. If the
regression residuals are positively correlated, the Durbin-Watson statistic will be less than 2, as it
is here. A Durbin-Watson statistic greater than 2 suggests negative serial correlation.
2014 CFA Level II
“Multiple Regression and Issues in Regression Analysis,” by Richard A. DeFusco, Dennis W.
McLeavey, Jerald E. Pinto, and David E. Runkle
Section 4.2.2

Block 10: Mitchell

Question
1 of 6
The value of the apartment building = net operating income / (discount rate – growth rate)
Value = $540,000 / (8% - 3%) = $10,800,000.
2014 CFA Level II
"Private Real Estate Investments," by Jeffrey D. Fisher and Bryan D. MacGregor
Section 6.2


Mock Exam – AM Answers

Question
2 of 6
The cash flow is the difference between the net operating income and the debt service. The

equity is the difference between the market value of the property and the mortgage on the
property. ($700,000 – $600,000) / ($10,000,000 – $9,000,000) = 10%
2014 CFA Level II
"Private Real Estate Investments," by Jeffrey D. Fisher and Bryan D. MacGregor
Section 12

Question
3 of 6
Applying a multiple to FFO and AFFO may not capture the intrinsic value of real estate assets
held by the REIT or REOC. Some properties do not produce income and thus would not
contribute to FFO but still have value.
2014 CFA Level II
"Publicly Traded Real Estate Securities," by Anthony Paolone, Ian Rossa O'Reilly, and David
Kruth
Section 6.3

Question
4 of 6
Although buyout investments typically have steady and predictable cash flows, venture capital
investments do not.
2014 CFA Level II
"Private Equity Valuation," by Yves Courtois and Tim Jenkinson
Section 2.3

Question
5 of 6
Post-money valuation = $20,000,00 / (1 + 0.40)3 = $7,288,630
Pre-money valuation = $7,288,630–$5,000,000 = $2,288,630
Ownership fraction = $5,000,000 / $7,288,630 = 68.6%
2014 CFA Level II

"Private Equity Valuation," by Yves Courtois and Tim Jenkinson
Appendix


Mock Exam – AM Answers

Question
6 of 6
A funds of funds tends to have lower survivor bias.
Statement 1 is incorrect because funds of funds tend to have average performance because of
diversification among strategies and managers.
Statement 3 is incorrect because funds of funds tend to have lower backfill bias.
2014 Modular Level 2, Vol. 3, Reading 26, Section 3.2
“Investing in Hedge Funds: A Survey,” Keith H. Black
Section 11