CFA-Institute CFA-Level-II Dumps

Question # 1

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Which of the following statements regarding free cash flow models is least likely correct?

A. Sensitivity analysis indicates that the FCFE model's valuation of BioTLab's common stock is most sensitive to the company's growth rate.
B. FCFE is net income plus depreciation minus net capital expenditures minus the increase in working capital plus net new debt financing.  
C. FCFF can be inflated by increasing capital expenditures relative to depreciation. 

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Question # 2

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Which model would be most appropriate in valuing the Groh Group?

A. FCFF model. 
B. FCFE model. 
C. Dividend Discount model. 

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Question # 3

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.If BioTLabs establishes a dividend and issues additional debt, the most likely effect on FCFF will be;

A. no effect. 
B. a decrease in FCFF. 
C. an increase in FCFF. 

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Question # 4

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Using a two-stage, free cash flow to the firm model, determine which of the following is closest tothe value of BioTLab.

A. $419 million. 
B. $436 million. 
C. $477 million. 

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Question # 5

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Johnson prefers to use free cash flow analysis to value investments. Which of the statements belowis least accurate in describing the advantages of free cash flow valuation models?

A. Accounting issues limit the usefulness of reported earnings, while free cash flow is adjusted for these issues.
B. Determining free cash flow is easier than dividends. 
C. A company must generate free cash flow to grow in the long run. 

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Question # 6

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted 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 offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, 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% in2008.• 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 supplies10%.• 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 ofpeople 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 toMedPac (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 ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually 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 totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass is forecasting Hope Company's revenues and profits for the next year. Which of the followingstatements is least likely a risk Grass should consider in developing his forecast? FurmonInvestment's economist is forecasting a:

A. reduction in Medicare's benefit package. 
B. recession for the U.S. economy. 
C. larger than expected increase for healthcare labor expenditures. 

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Question # 7

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits 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 servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted 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 offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, 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% in2008.• 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 supplies10%.• 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 ofpeople 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 toMedPac (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 ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually 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 totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass is reviewing Hope Company's pricing policy. Which of the following factors is least likely tocontribute to the company's pricing policy?

A. Hope Company relies on many different medical suppliers. 
B. Hope Company provides a unique service for its customer. 
C. Competitors are having difficulty entering many of Hope's key markets. 

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Question # 8

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted 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 offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly 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 healthcareenvironments, 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% in2008.• 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 supplies10%.• 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 ofpeople 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 toMedPac (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 ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually 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 totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass's research report on Hope Company is positive on its investment merits. Grass's report states,"Hope is uniquely positioned in the hospice industry" Which of the following best supports hiscomment?

A. Hope Company's strong presence in the Florida market. 
B. Hope Company relies on the Medicare program for a majority of its revenues. 
C. Hope Company's diversified revenue base has allowed the company to expand beyond the hospice sector.

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Question # 9

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted 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 offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, 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% in2008.• 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 supplies10%.• 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 ofpeople 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 toMedPac (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 ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000• 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 ofpeople 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 toMedPac (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 ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually 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 totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.The market share of the top six for-profit providers, together with the presence of non-profit andgovernment providers, most likely indicates that the:

A. threat of new entrants is low in the hospice industry. 
B. power of suppliers is low in the hospice industry. 
C. threat of substitutes is high in the hospice industry. 

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Question # 10

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted 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 offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, 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% in2008.• 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 supplies10%.• 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 ofpeople 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 toMedPac (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 ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually 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 totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass is a firm believer in the industry life cycle. Which of the following statements is most accurateregarding the hospice industry's position in the industry life cycle? The hospice industry is in the:

A. growth stage, as indicated by recent growth in sales. 
B. pioneer stage, as indicated by recent growth in sales and labor costs. 
C. mature stage, as indicated by high labor costs and slow growth in the number of people aged 65 and older

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Question # 11

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Which of the following statements regarding the models used to estimate the required return is mostaccurate?

A. A strength of the capital asset pricing model (CAPM) is that it usually has high explanatory power. 
B. A strength of multifactor models is their relative simplicity and ease of calculation. 
C. A weakness of build-up models is that they typically use historical values as estimates that may not be relevant to current market conditions.  

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Question # 12

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Which of the following statements regarding the models used to estimate the required return is mostaccurate?

A. A strength of the capital asset pricing model (CAPM) is that it usually has high explanatory power. 
B. A strength of multifactor models is their relative simplicity and ease of calculation. 
C. A weakness of build-up models is that they typically use historical values as estimates that may not be relevant to current market conditions.  

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Question # 13

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.Which of the following pairs correctly identifies the two external credit enhancements in Leighton's list?

A. Letters of credit and excess servicing spread funds.
B. Excess servicing spread funds and bond insurance.
C. Letters of credit and bond insurance.

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Question # 14

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Are Saunders' statements regarding the macroeconomic multifactor models correct?

A. Both statements are incorrect. 
B. Only Statement I is correct. 
C. Only Statement 2 is correct. 

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Question # 15

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Which of the following approaches/methods is most appropriate for Lear to consider in determiningthe required return for Densmore?

A. Build-up method. 
B. Risk premium approach. 
C. Bond-yield plus risk premium method. 

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Question # 16

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM multifactor models, and build-up models.Lear's choice of the Gordon growth model is an example of which of the following types of estimatesof the equity risk premium?

A. Historical estimate. 
B. Forward-looking estimate. 
C. Macroeconomic model estimate. 

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Question # 17

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.According to the FFM, the estimate of the required return for Devon is closest to:

A. 9.4%. 
B. 11.8%. 
C. 13.4%. 

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Question # 18

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.Which of the following statements about interest-only (10) and principal-only (PO)stripsisleastaccurate?

A. The 10 price is positively related to interest rates, and at low current rates, POs exhibit some negative convexity
B. IO cash flowsstart out large and diminish overtime. As a result, 10 investors are most concerned with extension risk
C. In general, the volatility of the combined 10 and PO strips equals the price volatility of the source passthrough. 

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Question # 19

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. In applying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Based on Lear's analysis, Taylor's stock is most likely to be:

A. correctly valued. 
B. overvalued. 
C. undervalued. 

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Question # 20

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.How many of the three statements on appropriate spread measures and valuation models arecorrect?

A. Only two statements are correct.
B. Only one statement is correct.
C. None of the three statements are correct.

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