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Thread: Sample CFA Level 2 question bank for June 2013 exam

  1. #71
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    Answer for 26th March :-

    1. b
    2. c
    3. a
    4. b
    5. c
    6. a

    The questions level are very good..!!

    Cheers,
    Nidhi

  2. #72
    Solutions to Item set for 26-March:

    1. Correct Answer is B: Rebecca is incorrect about the usage of options. Covered call won’t protect the downside movement. Protective put is needed to protect the downside movement.
    2. Correct Answer is B: Price of futures contract = 12*(1.06)2/12 = $12.117. Total value of the futures contract = $12.117*100,000 = $1,211,711. Total initial margin needed = 0.2*1,211,711 = $242,342.
    3. Correct Answer is C: Covered call and condor will limit the upside potential. Protective put wouldn’t limit the upside potential and also protects from the downside movement.
    4. Correct Answer is C: Total return swap takes care of both credit risk and market risk. No credit event is required for it to receive the payments.
    5. Correct Answer is B: The counter party has defaulted leading to the replacement risk. Now she has to buy CDS in the market at a higher price.
    6. Correct Answer is A: As the market price at the expiry is greater than the futures price, Glori suffered a loss in her short position. Total loss = (14.50-12.117)*100,000 = $238,289.

  3. #73
    Item set for 27-March (Equity):

    Bernard Sande Case Scenario

    Bernard Sande is an analyst at LLC Inc. He is a valuation analyst and values the private companies.

    LLC Inc. is into manufacturing of high end printing machines. The company has grown considerably inorganically in recent past. The company is planning to acquire one more company REC Conductors. REC Conductors is a private company and is into development of semi-conductors for electronic devices. LLC Inc. is going to acquire 40% of the equity of REC Conductors. The data for REC Conductors are given in Exhibit 1.

    Exhibit 1
    Free cash flow to firm for next 12 months $2 million
    WACC of REC Conductors 15.6%
    WACC of LLC Inc. 13.8%
    Book value of debt $5 million
    Sustainable growth rate of free cash flow to the firm 5.8%
    Sustainable growth rate of earnings of the firm 7.8%

    Bernard uses the capitalized cash flow model to value the equity value of REC Conductors. The market value of debt is 8% more than the current book value of debt for REC Conductors.

    Arevik Khachatryan, another analyst, asks Bernard about the calculation of WACC for the company. She asks her the following questions regarding the discount rates to be used for valuing an acquisition party:

    Arevik Khachatryan: The private company has lesser access to debt as compared to a public company. So, the current capital structure may not be optimal. How should an analyst do an adjustment for this if the transaction has a control perspective?

    Bernand Sande: An analyst should use the debt proportion of the similar public trading company and then calculate the WACC for the company using those proportions.

    Arevik Khachatryan: How should an analyst adjust the discount rate for the projection risk?

    Bernand Sande: An analyst should be concerned about the projection ability of the company. It would be highly subjective to adjust the discount rate. Projections may reflect excessive optimism or pessimism. Analyst should take all that into consideration while adjusting the discount rate for projection risk.

    Arevik Khachatryan has evaluated the value of a private company. The company is valued on the basis of control but her position would be that of a minority. The DLOC for the company is 25% and the DLOM of the company is 10%. After adjusting both the discount factors, she calculated the value of the company to be $120 million.

    LLC Inc. is looking at acquiring another company, Beta Horizons. The valuation of Beta Horizons has been done using the GPCM model (Guideline Public Company Method) where the valuation is done using as per the minority perspective. The value of the equity of the company comes out to be $60 million. LLC Inc. is going to acquire 80% of the company. The discount for lack of control (DLOC) is 20%.

    1. What is the approximate value of the firm (REC Conductors) calculated by Bernand Sande?
    a) $20.41 million
    b) $25.00 million
    c) $25.64 million

    2. How much approximate money is LLC Inc. willing to pay for acquiring 40% stake in REC Conductors?
    a) $6.00 million
    b) $6.16 million
    c) $8.10 million

    3. Is the answer given by Bernard to the question of Arevik regarding the usage of capital structure weights while computing the WACC correct?
    a) Yes
    b) No, the weights should be based on the current capital structure weights
    c) No, the weights should be based on the optimal capital structure weights of the target company

    4. The value of the 80% of the Beta Horizons to be acquired by LLC Inc. is closest to:
    a) $38.4 million
    b) $57.6 million
    c) $60.0 million

    5. Assuming that LLC Inc. will have control on acquiring 40% stake of REC Conductors and the WACC according to optimal structure weight is 1.8% less than the WACC according to current capital structure. What would be the rise in value of firm because of using the WACC with optimal structure weights?
    a) $7.69 million
    b) $7.26 million
    c) $4.59 million

    6. What is the value of the company without discount for control and marketability as done by Arevik Khachatryan?
    a) $184.62 million
    b) $177.78 million
    c) $81.00 million
    Last edited by Konvexity Institute; 28-04-2013 at 09:43 PM.

  4. #74
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    Answer for 27th March :-

    1. a
    2. c
    3. b
    4. c
    5. a
    6. b

  5. #75
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    Quote Originally Posted by Konvexity Institute View Post
    Solutions to Item set for 26-March:

    1. Correct Answer is B: Rebecca is incorrect about the usage of options. Covered call won’t protect the downside movement. Protective put is needed to protect the downside movement.
    2. Correct Answer is B: Price of futures contract = 12*(1.06)2/12 = $12.117. Total value of the futures contract = $12.117*100,000 = $1,211,711. Total initial margin needed = 0.2*1,211,711 = $242,342.
    3. Correct Answer is C: Covered call and condor will limit the upside potential. Protective put wouldn’t limit the upside potential and also protects from the downside movement.
    4. Correct Answer is C: Total return swap takes care of both credit risk and market risk. No credit event is required for it to receive the payments.
    5. Correct Answer is B: The counter party has defaulted leading to the replacement risk. Now she has to buy CDS in the market at a higher price.
    6. Correct Answer is A: As the market price at the expiry is greater than the futures price, Glori suffered a loss in her short position. Total loss = (14.50-12.117)*100,000 = $238,289.

    I scored 33.33 %

  6. #76
    Solutions to Item set for 27-March:

    1. Correct Answer is A: Value of the firm using CCM = FCFF1/ (WACC – gf) = $2 million/ (0.156-0.058) = $20.408 million.
    2. Correct Answer is A: Value of equity = Value of firm – Market value of debt = 20.408 million – 5*1.08 million = $15.008 million. Value of 40% stake = 0.40*15.008 = $6.003 million.
    3. Correct Answer is C: No. The weights should be based on the optimal structure weights of the target company which is generally lesser than the weights of the public company for debt. The cost of debt for a private company is generally higher than an established public company. Thus, the optimal debt weight would be lesser than the debt proportion of the publicly trading company.
    4. Correct Answer is C: DLOC = 1- 1/ (1+control premium) = 0.20. Thus, control premium = 25%. The value of company with control = 60*(1+0.25) = $75 million. The value of 80% stake = 75*0.8= $60 million.
    5. Correct Answer is C: The WACC according to optimal capital structure = 15.6 – 1.8 = 13.8%. The value of firm using optimal WACC = 2 million/ (0.138-0.058) = $25 million. Change in the value of firm = 25 – 20.408 = $4.592 million.
    6. Correct Answer is B: Total discount = 1 – (1-DLOC)*(1-DLOM) = 1 – 0.75*0.90= 32.5%. The value of company without discount = 120/ (1-0.325) = $177.78 million.
    Last edited by Konvexity Institute; 28-04-2013 at 09:43 PM.

  7. #77
    Item set for 28-March (Equity):

    Hemanta Veksler Case Scenario

    Hemanta Veksler, CFA, is an equity analyst in Inaam Securities. He values securities using relative valuation models. He calculates the justified price multiples and compares those with the actual multiple to make investment decisions. He is looking at two securities. The data for the securities has been provided in Exhibit 1.

    Exhibit 1

    Xyre Limited Sonoco Inc.
    Current earnings per share $12.00 GBP 8.00
    Required return on equity 14.50% 12.50%
    Rate of inflation 5% 2%
    Percentage of cost passed through to revenue 60% 50%

    While calculating the justified P/E ratios for Xyre Limited and Sonoco Inc. Hemanta assumed that the growth rate in earnings is due to inflation only and all the earnings have been paid as dividends.

    The share price of Xyre Limited is trading at $95 and that of Sonoco Inc. is trading at GBP 60.

    Dhruv Richman, CFA level II candidate, has just joined the firm. He is going through training. Hemanta is guiding him through his training. Dhruv asks Hemanta about the P/E ratio that whether in an industry a firm with a higher P/E ratio is always overvalued as compared to a firm with a lower P/E ratio.

    Hemanta replies that it is not necessary that a higher P/E ratio means that the company is overvalued. If a firm has a higher P/E ratio than the other company, it could be because of following reasons:

    Reason 1: The firm is overvalued
    Reason 2: The firm has a higher required rate of return
    Reason 3: The firm has a higher growth rate in earnings

    Hemanta also tells that because P/E ratio doesn’t take care of growth in the earnings, another ratio PEG can be calculated to compare the firms. PEG ratio is calculated by dividing the P/E ratio by the growth rate of the company. However, there are some limitations with PEG ratio as well.

    Limitation 1: It assumes a non-linear relationship between P/E and growth
    Limitation 2: It does not factor in differences in risk
    Limitation 3: It does not account for the difference in the duration of growth

    Dhruv is studying the historical pattern of P/E values for cyclical companies. He finds out that the P/E value is high at the bottom of the cycle when the EPS is low and is low at the top of the cycle when the EPS is high.

    Hemanta explains that this is due to the Molodovsky effect which is the cause of this counter cyclical property of P/Es. He states that the high P/E at the bottom of the cycle can also be explained in this way: P/Es may be positively related to recent earnings growth rate but negatively related to the anticipated future growth rate because of expected drop in the earnings.
    After explaining many other things to Dhruv, Hemanta asks him a question. He asks him to calculate the justified P/B ratio for a company for which data is given in Exhibit 2.

    Exhibit 2

    Justified forward P/E ratio 10.0
    Dividend payout ratio 40.0%
    Return on equity 16.0%
    Required return on equity 12.0%

    1. Which of the following securities is/are overvalued according to P/E ratio?
    a) Xyre Limited
    b) Sonoco Inc.
    c) Both the securities are undervalued

    2. Which of the following stock is justified a higher P/E ratio?
    a) Sonoco Inc.
    b) Xyre Limited
    c) Both the stocks have same justified P/E ratio

    3. Which of the following reasons given by Hemanta regarding the interpretation of P/E ratio is least likely to be correct?
    a) Reason 1
    b) Reason 3
    c) Reason 2

    4. Which of the following limitations is least likely to be accurate for PEG ratio as stated by Hemanta?
    a) Limitation 2
    b) Limitation 1
    c) Limitation 3

    5. What is the justified P/B ratio for the company whose data is given in Exhibit 2?
    a) 2.0
    b) 3.0
    c) 4.0

    6. Is Hemanta correct about the explanation of Molodovsky effect?
    a) Yes
    b) No, he is explaining the cause of lower P/E at the top of the cycle
    c) No, because high P/E ratio has nothing to do with the recent growth rate

  8. #78
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    28th March:-

    1. c
    2. a
    3. b
    4. a
    5. a
    6. b

  9. #79
    Solutions to Item set for 28-March:

    1. Correct Answer is C: Justified P/E ratio for Xyre Limited = 1/ {(r-I) + (1-λ)*I} = 1/ {(0.145-0.05) + (1-0.60)*0.05)} = 1/ {0.095 + 0.4*0.05} = 1/0.115 = 8.70. Justified P/E ratio for Sonoco Inc. = 1/ {(0.125-0.02) + (1-0.5)*0.02} = 1/0.115 = 8.70. Actual P/E ratio for Xyre Limited = 95/12 = 7.92. Actual P/E ratio for Sonoco Inc. = 60/8 = 7.5. Both the stocks have higher justified P/E ratios than the actual market P/E ratios. So, both stocks are undervalued.
    2. Correct Answer is C: Both stocks have the same justified P/E ratio as computed in the previous question.
    3. Correct Answer is C: Reason 2 is inaccurate. The high P/E ratio can be due to the lower required rate of return and not due to the higher required rate of return.
    4. Correct Answer is B: Limitation 1 is inaccurate. PEG ratio assumes a linear relationship between P/E and growth while in actuality it is non-linear.
    5. Correct Answer is A: Justified P/B ratio = (ROE – g)/(r-g). From forward P/E ratio, (1-b)/(r-g) = 18 => r-g = 0.4/10 = 0.04. g = 0.12 -0.04 = 0.08. Justified P/B ratio = (0.16 – 0.08)/0.04 = 2.0.
    6. Correct Answer is B: He is explaining the cause of lower P/E ratio at the top of the cycle rather than the cause of higher P/E ratio at the bottom of the cycle.

  10. #80
    Item set for 29-March (Equity):

    Devin Barras Case Scenario

    Devin Barras is valuing a company named Fumbler. Fumbler has been growing at a faster growth rate than the other companies in the similar industry. The company has not paid any dividends so far. The earnings are stable and growing. The income statement for the recent year for the company is given in Exhibit 1.

    Exhibit 1
    Fumbler: Income Statement (in thousands dollars) 2012

    Revenue 350
    Cost of goods sold 120
    Gross profit 230
    SG&A 60
    EBITDA 170
    Depreciation and amortization 55
    Earnings before interest and taxes 115
    Interest expense 35
    Earnings before taxes 80
    Taxes (@40%) 32
    Net income 48

    In the footnotes of the company, the company has provided the details that it has sold a long-term asset for $300,000. The book value for that asset was $280,000. The gain in the asset has been recognized as a part of revenue. The balance sheet at the end of last year has been given in Exhibit 2.

    Exhibit 2
    Fumbler: End of year Balance Sheet (in thousands dollars)

    Year 2011 2012
    Cash 75 103
    Accounts Receivable 40 55
    Inventory 120 145
    Current Assets 235 303
    Net PP&E 450 440
    Total Assets 685 743
    Accounts payable 105 95
    Current portion of long-term debt 45 55
    Current liabilities 150 150
    Long-term debt 250 260
    Common stock 200 200
    Retained earnings 85 133
    Total liability and equity 685 743

    The free cash flow to firm is expected to grow at a rate of 10% for next 3 years and after that it would stabilize to a long term growth rate of 4%. The financing details and capital structure for the company are given in Exhibit 3.

    Exhibit 3

    Target D/E ratio 0.8
    Before-tax cost of debt 8.
    Marginal tax rate 40.0%
    Cost of equity 12.50%

    In management and discussion it is given that company would start dividend payments after 5 years. Devin is contemplating the impact of dividend payments on the free cash flow to the firm.

    Kevin Spacey, a friend of Devin, asks him about the impact of dividend payments, stock issuance, and debt issuance on free cash flow to the firm. Devin makes the following statements:

    Statement 1: There is no impact of dividend payment on the free cash flow of the firm for a particular year
    Statement 2: There is no impact of stock issuance on the free cash flow to the firm for a particular year
    Statement 3: The free cash flow to the firm will increase on debt issuance for a particular year

    1. What is the change in working capital for the company for calculation of FCFF in year 2012 from year 2011?
    a) $88,000
    b) $78,000
    c) $50,000

    2. What is the change in fixed capital investment for the company in year 2012?
    a) -$30,000
    b) $25,000
    c) $65,000

    3. What is the free cash flow to the firm for year 2012?
    a) $29,000
    b) $49,000
    c) $84,000

    4. What is the value of the firm?
    a) $1,178,759
    b) $732,776
    c) $697,633

    5. Which of the following statements made by Devin is least accurate about the impact on FCFF of dividend payments, stock issuance, and debt issuance?
    a) Statement 1
    b) Statement 2
    c) Statement 3

    6. What is the least likely impact of free cash flow to the firm on the payment of dividends in the future years?
    a) Decrease in free cash flow to the firm
    b) No impact in the free cash flow to the firm
    c) Increase in free cash flow to the firm

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