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Free CFA Institute CFA-Level-II Exam Questions

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  • CFA Institute CFA-Level-II Exam Questions
  • Provided By: CFA Institute
  • Exam: CFA Level II Chartered Financial Analyst
  • Certification: CFA Level II
  • Total Questions: 713
  • Updated On: Apr 23, 2025
  • Rated: 4.9 |
  • Online Users: 1426
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  • Question 1
    • Susan Foley, CFA, is Chief Investment Officer of Federated Investment Management Co. (FIMCO), a large investment management firm that includes a family of mutual funds as well as individually managed accounts. The individually managed accounts include individuals, personal trusts, and employee benefit plans. In the past few months, Foley has encountered a couple of problems.
      The Tasty IPO
      Most portfolio managers of FIMCO have not participated in the initial public offering (IPO) market in recent years. However, recent changes to the compensation calculation at FIMCO have tied manager bonuses to portfolio performance. The changes were outlined in a letter that was sent out to clients and prospects shortly before the new bonus structure took effect. Carl Lee, CFA, is one portfolio manager who believes that investing in IPOs may add to his client's equity performance and, in turn, increase his bonus. While Lee's individual clients have done quite well this year, his employee benefit plans have suffered as a result of limited exposure to the strongest performing sector of the market. Lee has placed an order for all employee benefit plans to receive an allocation of the Tasty Doughnut IPO. Tasty is an over-subscribed IPO that Lee knew would make money for his clients. When he placed the order, Lee's assistant reminded him that one pension plan. Ultra Airlines, was explicitly prohibited from investing in IPOs in its investment policy statement, due to the under-funded status of the pension plan. Lee responded that the Tasty IPO would never actually be owned in Ultra's account, because he would sell the IPO stock before the end of the day and realize a profit before the position ever hit the books.
      Another manager, Franz Mason, CFA, who manages accounts for about 150 individuals, is also interested in the Tasty IPO. Mason visits Lee's portfolio assistant and quizzes him about Lee's participation in the Tasty deal. Mason is sure that Lee would not have bought into Tasty unless he had done his homework. Mason places an order for 10,000 shares of the IPO. Mason returns to his desk and begins to allocate the IPO shares among his clients. Mason divides his client base into two groups: clients who are income-oriented and clients who arc capital gains-oriented. Mason believes those clients that are income-oriented are fairly risk averse and could not replace lost capital if the Tasty Doughnut deal lost money. Mason believes the capital gains-oriented accounts arc better able to withstand the potential loss associated with the Tasty IPO. Accordingly, Mason allocates his 10,000 share order of the Tasty IPO strictly to his capital appreciation clients using a pro rata allocation based on the size of the assets under management in each account.
      FIMCO Income Fund (FIF)
      Over the past three years, the FIF, with $5 billion in assets, has been the company's best performing mutual fund. Jane Ryan, CFA, managed the FIF for seven years, but resigned one year ago to start her own hedge fund. Under Ryan, the FIF invested in large cap stocks with reliable dividends. The fund's prospectus specifies that FIF will invest only in stocks that have paid a dividend for at least two quarters, and have a market capitalization in excess of $2.5 billion. Foley appointed FIMCO's next best manager (based on 5-year performance numbers) Steve Parsons, CFA, to replace Ryan. Parsons had been a very successful manager of the FIMCO Opportunity Fund, which specialized in small capitalization stocks. Six months after Parsons took over the helm at FIF. the portfolio had changed. The average market capitalization of FIF's holdings was $12.8 billion, as opposed to $21 billion a year ago. Over the same period, the average dividend yield on the portfolio had fallen from 3.8% to 3.1%. The performance of the FIF lagged its peer group for the first time in three years. In response to the lagging performance, Parsons purchased five stocks six months ago. Parsons bought all five stocks, none of which paid a dividend at the time of purchase, in anticipation that each company was likely to initiate dividends in the near future. So far, four of the stocks have initiated dividend payments, and their performance has benefited as a result. The fifth stock did not initiate a dividend, and Parsons sold the position last week. Largely due to the addition of the five new stocks, the FIF's performance has led its peer group over the past six months.
      Before leaving FIMCO, Ryan had told Foley that above-average returns from both the management and client side could be gained from entering into the risk-arbitrage hedge fund market. Ryan had tried to convince FIMCO management to enter the risk-arbitrage market, but the firm determined that no one had the experience or research capability to run a risk-arbitrage operation. As a result, Ryan started the Plasma Fund LLC one month after leaving FIMCO. Foley remembers seeing Ryan at the annual FIMCO client dinner parly (before she left the firm) discussing the profits to be made from risk-arbitrage investing with several large FIF shareholders. Ryan mentioned that she would be opening the Plasma Fund to these FIMCO clients, several of whom made substantial investments in the first months of Plasma Fund's life. After Ryan resigned and left her office, Foley performed an inventory of firm assets signed out to Ryan. One of the copies of the proprietary stock selection software packages, FIMCO-SelectStock, assigned to Ryan was missing along with several of the SelectStock operating manuals. When Foley contacts Ryan about the missing software and manuals, Ryan states that the reason she took the SelectStock software was that it was an out of date version that FIMCO's information technology staff had urged all managers to discard.
      Has there been any violation of CFA Institute Standards of Professional Conduct relating to either the change in the average holdings of the FIF during the first six months of Parsons's leadership, or in Parsons's subsequent investment in the non-dividend paying stocks?

      Answer: C
  • Question 2
    • Sampson Aerospace is a publicly-traded U .S . manufacturer. Sampson supplies communication and navigation control systems to manufacturers of airplanes for commercial and government use. The company operates two divisions: Commercial Operations and Government Operations. Revenues from the Government Operations division comprise 80% of Sampson's total company revenues. Revenues for other companies in the industry are also driven primarily by sales to the U .S . government.
      Sampson has gained a reputation for offering unique products and services. Sampson's market share has been increasing, and its net profit margin is among the highest in its industry.
      As part of its business strategy, Sampson seeks out opportunities to enhance internal growth by acquiring smaller companies that possess new technologies that would allow Sampson to offer unique products and services. To this end, Sampson CEO, Drew Smith, recently asked his acquisitions team to consider the purchase of a controlling interest in either NavTech or Aerospace Communications, both software applications firms. Smith provides his acquisitions team with an aerospace analyst's industry report that addresses many key issues within the industry. Selected passages from the report are reproduced below:
      Sales in the aerospace electronics industry depend primarily on government military spending, which, in turn, depends on defense budgets. Sales depend on commercial travel to a much lesser extent. The government defense spending budget outlook is fairly bleak as the current administration is looking for ways to reduce the budget deficit. We feel the commercial airline segment has more upside than downside, especially as the global economy improves, so we might see a gradual shift in industry focus toward the commercial airline sector. Companies that already have a foothold in the commercial sector are well-positioned to grow during the global recovery. Even so, companies in this industry will remain highly sensitive to government spending for their revenues. Research and development costs are high and the industry is highly capital intense. While there are only a few companies in this industry, good opportunities exist, especially for companies that have developed sustainable profits through wise acquisitions, cost containment, and the ability to secure long-term government contracts.
      Sampson Aerospace recently announced that it is reducing its investment return assumption on its pension assets from 6% to 5%, and that it has entered negotiations to possibly acquire controlling equity interests in communications software firms, NavTech and Aerospace Communications. NavTech recently has decided to capitalize a significant portion of its research and development expense, and Aerospace Communications has restructured and reclassified many of its leases from operating to financial leases. Sampson CEO Drew Smith recently announced that Sampson had dropped out of negotiations with Knowledge Technologies, claiming it was likely not a sustainable business model.
      Consensus forecasts for NavTech and Aerospace Communications are presented in Exhibit 1.

      1

      Assuring that NavTech is valued according to the constant growth dividend model, the market expectation of dividend growth implied by NavTech's current stock price is closest to:

      Answer: B
  • Question 3
    • GigaTech Inc. is a large U .S .-based technology conglomerate. The firm has business units in three primary categories: hardware manufacturing, software development, and consulting services. Because of the rapid pace of technological innovation, GigaTech must make capital investments every two to four years. The company has identified several potential investment opportunities for its hardware manufacturing division. The first of these opportunities, Tera Project, would replace a portion of GigaTech's microprocessor assembly equipment with new machinery expected to last three years. The current machinery has a book value of $120,000 and a market value of $195,000. Tcra Project would require purchasing machinery for $332,000, increasing current assets by 5190,000, and increasing current liabilities by $80,000. GigaTech has a tax rate of 40%. Additional pro forma information related to the Tera Project is provided in the following table:

      89

      Analysts at GigaTech have noted that investment in the Tera Project can be delayed for up to nine months if managers at the company decide this is necessary. However, once the capital investment is made, the project will be necessary to maintain continuing operations. Tera Project can be scaled up with more equipment requiring less capital than the original investment if results are meeting expectations. In addition, the equipment used in Tera Project can be used in shift work if brief excess demand is expected.
      GigaTech is also considering expanding its software development operations in India. Software development equipment must be continually replaced to maintain efficiency as newer and faster technology is developed. The company has identified two mutually exclusive potential expansion projects, Zeta and Sigma. Zeta requires investing in equipment with a 3-year life, while Sigma requires investing in equipment with a 2-year life. GigaTech has estimated real capital costs for the two projects at 10.58%. GigaTech expects inflation to be approximately 4.0% for the foreseeable future. Nominal cash flows and net present values for the Zeta and Sigma projects are provided in the following table

      90

      Recently, GigaTechs board of directors has become concerned with the firm's capital budgeting decisions and has asked management to provide a detailed explanation of the capital budgeting process. After reviewing the report from management, the board makes the following comments in a memo:
      * The capital rationing system being utilized is fundamentally flawed since, in some instances, projects that do not increase earnings per share are selected over projects that do increase earnings per share.
      * The cash flow projections are flawed since they fail to include costs incurred in the search for projects or the economic consequences of increased competition resulting from highly profitable projects.
      * We are making inappropriate investment decisions since the discount rate used to evaluate all potential projects is the firm's weighted average cost of capital.
      Using the least common multiple of lives approach, determine whether the Zeta Project or the Sigma Project will increase the value of GigaTech by a greater amount.

      Answer: B
  • Question 4
    • Chris Darin, CFA, works as a sell-side senior analyst and vice president for a large Toronto brokerage firm researching mainly hedge funds and alternative investments. Darin recently hired Simon Nielsen for the position of junior analyst at the firm. Although Nielsen does not have experience evaluating hedge funds, Darin hired him mainly for his previous experience at a discount brokerage firm and for his passion for the industry. Darin frequently mentors Nielsen on market trends, investment styles, and on risks inherent in alternative investment vehicles. In a recent conversation, Darin makes the following statements:
      Statement 1: One way to measure hedge fund investment performance is through Jensen's alpha. A portfolio with negative Jensen's alpha would plot above the Security Market Line (SML).
      Statement 2: Both the Sharpe ratio and Jensen's alpha can be used to measure risk-adjusted hedge fund returns. Oneof the advantages is comparability between the two methods since both calculate return relative to systematic risk.
      Their conversation later shifts to discussing hedge fund classifications and how derivatives affect hedge fund performance measurement. Nielsen mentions that put options are often more advantageous than short selling in a market neutral strategy because of their asymmetric returns.
      The following week Darin asks Nielsen to research potential problems and biases in hedge fund indexes and general risks inherent in investing in hedge funds. Nielsen compiles the information and presents the following findings:
      1. One of the data problems in hedge fund indexes is that managers often do not disclose negative fund performance.
      2. The historical performance of hedge funds that are recently added to an index is often added to the past performance of the index.
      3. Long/short equity hedge funds are subject to equity market risk. This risk is typically greater than with equity market neutral or risk arbitrage funds due to the higher standard deviations and market correlations inherent in long/short funds.
      4. Fixed income arbitrage funds are also subject to equity market risk. These funds are short Treasuries and long high-credit-risk bonds. In an economic downturn the short position in Treasuries provides a buffer against the long position and provides a net gain.
      Finally, the two discuss the risk-free rate and various risk measures in hedge fund performance evaluation. Darin explains that even in market neutral strategies, the risk-free rate may not be an appropriate measure of fund performance. Nielsen does not understand and asks him to clarify. Darin further states that risk measures such as Value at Risk have several limitations as a risk measurement tool.
      Nielsen's findings on long/short equity funds and fixed income arbitrage strategies, respectively, are:

      Answer: C
  • Question 5
    • William Bow, CFA, is a risk manager for GlobeCorp, an international conglomerate with operations in the technology, consumer products, and medical devices industries. Exactly one year ago, GlobeCorp, under Bow's advice, entered into a 3-year payer interest rate swap with semiannual floating rate payments based on the London interbank offered rate (LIBOR) and semiannual fixed rate payments based on an annual rate of 2.75%. At the time of initiation, the swap had a value of zero and the notional principal was set equal to $150 million. The counterparty to GlobeCorp's swap is NVS Bank, a commercial bank that also serves as a swap dealer. Exhibit 1 below summarizes the current LIBOR term structure.

      19

      Upper management at GlobeCorp feels that the original swap has served its intended purpose but that circumstances have changed and it is now time to offset the firm's exposure to the swap. Because they cannot find a counterparty to an offsetting swap transaction, management has asked Bow to come up with alternative measures to offset the swap exposure. Bow created a report for the management team which outlines several strategies to neutralize the swap exposure. Two of his strategies are included in Exhibit 2.

      26

      After examining its long-term liabilities, NVS Bank has decided that it currently needs to borrow $100 million over the next two years to finance its operations. For this type of funding need, NVS generally issues quarterly coupon short-term floating rate notes based on 90-day LIBOR. NVS is concerned, however, that interest rates may shift upward and the LIBOR curve may become upward sloping. To manage this risk, NVS is considering utilizing interest rate derivatives. Managers at the bank have collected quotes on over-the-counter interest rate caps and floors from a well known securities dealer. The quotes, which are based on a notional principal of $100 million, are provided in Exhibit 3.

      27

      One of the managers at NVS Bank, Lois Green, has expressed her distrust of the securities dealer quoting prices on the caps and floors. In a memo to the CFO, Green suggested that NVS use an alternative but equivalent approach to manage the interest rate risk associated with its two-year funding plan. Following is an excerpt from Green's memo:
      'Rather than using a cap or floor, NVS Bank can effectively manage its exposure to interest rates resulting from the 2-year funding requirement by taking long positions in a series of put options on fixed-income instruments with expiration dates that coincide with the payment dates on the floating rate note.'
      'As a cheaper alternative, NVS can effectively manage its exposure to interest rates resulting from the 2-ycar funding requirement by creating a collar using long positions in a series of call options on interest rates and long positions in a series of call options on fixed income instruments all of which would have expiration dates that coincide with the payment dates on the floating rate note.'
      GlobeCorp is concerned with its exposure to the interest rate swap initiated one year ago. Evaluate the strategies recommended by Bow in Exhibit 2.

      Answer: A
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