CFA Institute CFA-Level-II Exam Dumps

Erich Reichmann, CFA, is a fixed-income portfolio manager with Global Investment Management. A recent increase in interest rate volatility has caused Reichmann and his assistant, Mel O'Shea, to begin investigating methods of hedging interest rate risk in his fixed income portfolio.

Reichmann would like to hedge the interest rate risk of one of his bonds, a floating-rate bond (indexed to LIBOR). O'Shea recommends taking a short position in a Eurodollar futures contract because the Eurodollar contract is a more effective hedging instrument than a Treasury bill futures contract.

Reichmann is also analyzing the possibility of using interest rate caps and floors, as well as interest rate options and options on fixed income securities, to hedge the interest rate risk of his overall portfolio.

Reichmann uses a binomial interest rate model to value 1-year and 2-year 6% floors on 1-year LIBOR, both based on $30 million principal value with annual payments. He values the 1-year floor at $90,000 and the 2-year floor at $285,000.

Reichmann has also heard about using interest rate collars to hedge interest rate risk, but is unsure how to construct a collar.

Finally, Reichmann is interested in using swaptions to hedge certain investments. He evaluates the following comments about swaptions.

* If a firm anticipates floating rate exposure from issuing floating rate bonds at some future date, a payer swaption would lock in a fixed rate and provide floating-rate payments for the loan. It would be exercised if the yield curve shifted down.

* Swaptions can be used to speculate on changes in interest rates. The investor would buy a receiver swaption if he expects rates to fall.

To most effectively hedge his long position in the floating rate bond against declining rates, Reichmann should:

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Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investment merits of the developing hospice industry. The hospice industry has a short history in the public market, as several companies have recently completed their initial public offering. Hospice services are provided to patients diagnosed with terminal illness as an alternative to aggressive medical management. The use of hospice services at skilled nursing facilities and assisted-living facilities is forecasted to continue its recent growth. Medicare is the primary payer for hospice services, accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offer symptom and pain management to patients diagnosed with a terminal illness by their physician. The program was added to the Medicare benefit package in the early 1980s. Growth in the sector has only recently. accelerated due to the emergence of a number of for-profit companies. The caregiver provides a plan for each admitted patient and care is given in any number of healthcare environments, including the patient's home.

Grass's analysis of the hospice industry has uncovered several facts that are outlined below:

* The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in 2008.

* The average length of stay at facilities for hospice patients is increasing.

* Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies 10%.

* More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.

* Based on the U .S . Census Bureau's statistics, over the next six years (2009-2015), the number of people in the 65 and older age group will increase annually by 1.4%.

* The Medicare hospice benefit is still underutilized by the terminally ill population, according to MedPac (an independent advisory committee for the U .S . Congress on healthcare issues).

* Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.

* In recent years, the U .S . government has approved rate increases for the sector compared to flat or declining rate trends for other healthcare services.

* The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000 annually per person.

* The top six for-profit providers account for about half of the segment's sales.

* The overall hospice provider market is roughly divided into 55% non-profit, 10% U .S . government, and 35% for-profit.

Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the total hospice service market or 20% of the for-profit market. The company has the only regulator approved for-profit certificate for the state of Florida, one of the most attractive markets in the United States. In addition to a strong market share in Florida, Hope has a strong presence in urban markets like Dallas and San Francisco. Hope has a more diversified revenue base than other publicly traded for-profit providers.

Grass is concerned about potential risks that would change his view of the investment merits for the hospice industry. Based on the facts presented, identify the greatest risk for the hospice industry, relying on your understanding of Porter analysis.

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Michelle Norris, CFA, manages assets for individual investors in the United States as well as in other countries. Norris limits the scope of her practice to equity securities traded on U .S . stock exchanges. Her partner, John Witkowski, handles any requests for international securities. Recently, one of Norris's wealthiest clients suffered a substantial decline in the value of his international portfolio. Worried that his U .S . allocation might suffer the same fate, he has asked Norris to implement a hedge on his portfolio. Norris has agreed to her client's request and is currently in the process of evaluating several futures contracts. Her primary interest is in a futures contract on a broad equity index that will expire 240 days from today. The closing price as of yesterday, January 17, for the equity index was 1,050. The expected dividends from the index yield 2% (continuously compounded annual rate). The effective annual risk-free rate is 4.0811%, and the term structure is flat. Norris decides that this equity index futures contract is the appropriate hedge for her client's portfolio and enters into the contract.

Upon entering into the contract, Norris makes the following comment to her client:

"You should note that since we have taken a short position in the futures contract, the price we will receive for selling the equity index in 240 days will be reduced by the convenience yield associated with having a long position in the underlying asset. If there were no cash flows associated with the underlying asset, the price would be higher. Additionally, you should note that if we had entered into a forward contract with the same terms, the contract price would most likely have been lower but we would have increased the credit risk exposure of the portfolio."

Sixty days after entering into the futures contract, the equity index reached a level of 1,015. The futures contract that Norris purchased is now trading on the Chicago Mercantile Exchange for a price of 1,035. Interest rates have not changed. After performing some calculations, Norris calls her client to let him know of an arbitrage opportunity related to his futures position. Over the phone, Norris makes the following comments to her client:

"We have an excellent opportunity to earn a riskless profit by engaging in arbitrage using the equity index, risk-free assets, and futures contracts. My recommended strategy is as follows: We should sell the equity index short, buy the futures contract, and pay any dividends occurring over the life of the contract. By pursuing this strategy, we can generate profits for your portfolio without incurring any risk."

Which of the following types of futures markets best characterizes the observed market for the 240-day equity index futures contract?

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Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investment research firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following two statements about defined contribution plans.

Statement I: Employers often face onerous disclosure requirements.

Statement 2: Employers often bear all the investment risk.

Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm that produces motorcycles and other mechanical parts. It operates exclusively in the United States. At the end of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO) of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assets was $316 million, and the unrecognized actuarial gain was $21 million.

Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year, and the discount rate will be 7% as opposed to 8% in the previous year.

This past year, Samilski began using special purpose entities (SPEs) for various reasons. In preparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carson prepares a memo on SPEs. In the memo, he correctly concludes that the company will be required under new accounting rules to classify them as variable interest entities (VIE) and consolidate the entities on the balance sheet rather than report them using the equity method as in the past.

What are the likely effects of the required change in accounting for SPEs on Samilski's:

Return on assets? Return on equity?

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Pat Wilson, CFA, is the chief compliance officer for Excess Investments, a global asset management and investment banking services company. Wilson is reviewing two investment reports written by Peter Holly, CFA, an analyst and portfolio manager who has worked for Excess for four years. Holly's first report under compliance review is a strong buy recommendation for BlueNote Inc., a musical instrument manufacturer. The report states that the buy recommendation is applicable for the next 6 to 12 months with an average level of risk and a sustainable price target of $24 for the entire time period. At the bottom of the report, an e-mail address is given for investors who wish to obtain a complete description of the firm's rating system. Among other reasons supporting the recommendation, Holly's report states that expected increases in profitability as well as increased supply chain efficiency provide compelling support for purchasing BlueNote.

Holly informs Wilson that he determined his conclusions primarily from an intensive review of BlueNote's filings with the SEC but also from a call to one of BlueNote's suppliers who informed Holly that their new inventory processing system would allow for more efficiency in supplying BlueNote with raw materials. Holly explains to Wilson that he is the only analyst covering BlueNote who is aware of this information and that he believes the new inventory processing system will allow BlueNote to reduce costs and increase overall profitability for several years to come.

Wilson must also review Holly's report on BigTirae Inc., a musical promotions and distribution company. In the report, Holly provides a very optimistic analysis of BigTime's fundamentals. The analysis supports a buy recommendation for the company. Wilson finds one problem with Holly's report on BigTime related to Holly's former business relationship with BigTime Inc. Two years before joining Excess, Holly worked as an investment banker and received 1,000 restricted shares of BigTime as a result of his participation in taking the company public. These facts are not disclosed in the report but are disclosed on Excess Investment's Web site. Wilson decides, however, that the timeliness of the information in the report warrants overlooking this issue so that the report can be distributed.

Just before the report is issued. Holly mentions to Wilson that BigTime unknowingly disclosed to him and a few other analysts who were wailing for a conference call to begin that the company is planning to restructure both its sales staff and sales strategy and may sell one of its poorly performing business units next year.

Three days after issuing his report on BigTime, which caused a substantial rise in the price of BigTime shares, Holly sells all of the BigTirne shares out of both his performance fee-based accounts and asset-based accounts and then proceeds to sell all of the BigTime shares out of his own account on the following day. Holly obtained approval from Wilson before making the trades.

Just after selling his shares in BigTime, Holly receives a call from the CEO of BlueNote who wants to see if Holly received the desk pen engraved with the BlueNote company logo that he sent last week and also to offer two front row tickets plus limousine service to a sold-out concert for a popular band that uses BlueNote's instruments. Holly confirms that the desk pen arrived and thanks the CEO for the gift and tells him that before he accepts the concert tickets, he will have to check his calendar to see if he will be able to attend. Holly declines the use of the limousine service should he decide to attend the concert.

After speaking with the CEO of BlucNote, Holly constructs a letter that he plans to send by e-mail to all of his clients and prospects with e-mail addresses and by regular mail to all of his clients and prospects without e-mail addresses. The letter details changes to an equity valuation model that Holly and several other analysts at Excess use to analyze potential investment recommendations. Holly's letter explains that the new model, which will be put into use next month, will utilize Monte Carlo simulations to create a distribution of stock values, a sharp contrast to the existing model which uses static valuations combined with sensitivity analysis. Relevant details of the new model are included in the letter, but similar details about the existing model are not included. The letter also explains that management at Excess has decided to exclude alcohol and tobacco company securities from the research coverage universe. Holly's letter concludes by stating that no other significant changes that would affect the investment recommendation process have occurred or are expected to occur in the near future.

According to CFA Institute Research Objectivity Standards (ROS), which of the following statements is most accurate with regard to the rating system used by Holly in his investment report on BlueNote Inc.? The rating system:

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