Subject FinTree

 -­‐  Subject-­‐wise  Alpha Question Answer Explanation

Since  the  consensus  opinion  has  a  reasonable  and  adequate  basis  and  is
1 A
independent  and  objective,  Liew  need  not  decline  to  be  identified  with  the  report.
Total  firm  assets  must  be  the  aggregate  fair  value  of  all  discretionary  and  nondiscretionary  
2 C
assets  managed  by  the  firm.  This  includes  both  fee-­‐paying  and  nonfee  paying  portfolios.
Rafael  should  remove  his  name  from  the  written  report  since  he  disagrees  with  the  
3 A report’s  conclusions.  Reporting  to  supervisory  authorities  may  not  be  necessary  since  it  is  
not  evident  that  the  rest  of  the  research  team  is  engaging  in  any  illegal  conduct.
In  cases  in  which  laws  and/or  regulations  conflict  with  the  GIPS  standards,  firms  are  
4 C required  to  comply  with  the  laws  and  regulations  and  make  full  disclosure  of  the  conflict  in  
the  compliant  presentation.
The  firm  is  only  using  the  surviving  accounts’  returns  in  the  composite,  which
will  inflate  the  performance  figure.  Disclosing  it  to  clients  does  not  absolve  the  firm  from  
5 C inappropriately  representing  firm  performance  (many  clients  may  not  fully  understand  the  
implications  of  the  calculation  methodology).  Hence,  Chao  should  not  use  the  marketing  
material  and  bring  the  situation  to  the  attention  of  the  supervisor.
6 B CFA  Institute  recommends  maintaining  records  for  at  least  seven  years.
Even  though  his  intentions  were  good,  Li  has  violated  Standard  lll  (E)  by
7 A
revealing  confidential  information  about  his  client.
Such  statements  are  strictly  prohibited,  unless  the  firm  is  GIPS-­‐compliant  already  and  it  
8 A
reports  the  performance  of  an  individual  client’s  portfolio  to  that  client.
The  broad  distribution  of  a  restricted  list  often  triggers  the  sort  of  trading  the  list  was  
developed  to  avoid.  Therefore,  a  watch  list  shown  to  only  the  few  people  responsible  for  
9 A
compliance  should  be  used  to  monitor  transactions  in  specified  securities.  Restricting  all  
trading  is  also  counterproductive.
Sen  has  custody  of  the  client  assets  so  her  level  of  responsibility  is  heightened.
Sen  is  obligated  to  manage  the  funds  in  accordance  with  the  terms  of  the
10 C governing  documents  of  the  trust.  In  this  case,  the  trust  documents  clearly  prohibit  
investing  in  non-­‐U.S.  stocks  and  bonds.  Hence,  by  investing  in  high-­‐yield  emerging  market  
Ethical  &  Professional  Standards %
stocks,  Sen  has  violated  Standard  III-­‐A  loyalty,  prudence,  and  care.
11 A The  IPS  should  be  reviewed  at  least  annually.
Best  practice  is  for  independent  analysts  to  negotiate  only  a  flat  fee  for  their  work  that  is  
not  linked  to  their  conclusions  or  recommendations.  A  stock  option  will  increase  in  value  if  
12 B
Lama  issues  a  positive  report.  Hence,  the  compensation  arrangement  does  not  follow  best  
practice.
Because  Wright  did  not  knowingly  makes  this  mistake  he  did  not  violate  Standard  I(C)-­‐  
Misrepresentation.  However,  if  he  does  not  inform  those  who  have  received  the  material  
13 C
about  the  mistake  and  does  not  cease  distribution  until  the  mistake  is  rectified,  he  would  
be  violating  the  Standard.
Hart  has  violated  her  duty  of  loyalty  to  the  firm.  She  made  the  recommendationsand  
prepared  the  presentations  using  GGIN’s  resources  while  being  employed  at  the  firm.  
14 A
Hence,  such  documents  are  the  property  of  GGIN  and  Hart  will  be  in  violation  of  her  duty  
of  loyalty  to  the  firm  if  she  plans  to  take  them  with  her  without  permission.
Since  the  client  specifically  instructed  Blank  to  trade  through  a  particular  broker,  Blank  is  
15 A obligated  to  do  so.  However,  Blank  should  disclose  to  the  client  that  the  broker  does  not  
help  him  in  achieving  best  execution.
Standard  l(C)-­‐Misrepresentation,  does  not  allow  a  member  or  candidate  to  reissue  a  
16 B previously  released  report  solely  under  his  or  her  name  (even  if  his  independent  and  
objective  research  supports  it).
 The  duty  to  clients  imposed  by  Standard  III(B)-­‐Fair  Dealing  may  be  more  critical  when  
changing  recommendations.  The  member  or  candidate  must  make  sure  that  the  change  is  
17 A
communicated  in  a  fair  manner  especially  to  those  who  have  been  affected  by  the  earlier  
advice.
MEIN  has  misrepresented  performance  information,  since  the  20%-­‐28%  return  was  only  in  
a  single  year  and  is  not  representative  of  what  investors  could  earn  every  year.  It  is  not  
18 C
apparent  from  the  information  provided  that  the  firm  can  earn  such  high  returns  for  the  
years  to  come.  Hence,  the  brochure  is  in  violation  of  the  Standards.
The  variance  of  the  distribution  of  the  sample  mean  equals  the  variance  of  the  population  
19 A
divided  by  sample  size.  Hence,  as  sample  size  increases,  the  variance  decreases.
Statement  1  is  correct.
20 A Statement  2  is  incorrect,  Un-­‐biasedness  and  efficiency  are  properties  of  an
estimator’s  sampling  distribution  that  hold  for  any  size  sample.
A  distribution  that  involves  binary  outcome  is  referred  to  as  binomial  distribution.
It  has  following  properties.
i.  A  binomial  distribution  has  fixed  number  of  trials.
21 C ii.  Each  trial  in  a  binomial  distribution  has  two  possible  outcomes.
iii.  Probability  of  success  is  denoted  as  P  (success)  =  p  and  probability  of
failure  is  denoted  as  P  (failure)  =  1-­‐p.
iv.  The  trials  are  independent.
n  =35,  L10  =  (35+1)(10/100)  =  3.6
22 A The  estimate  of  the  10th  percentile  is:
1.10  +(3.6-­‐3)(1.47-­‐1.10)  =  1.322
Here,  z0.005  =  2.58
23 A The  confidence  interval  will  be:
1.56-­‐2.58(0.40/√200)  to  1.56+2.58(0.40/√200)
1.487%  to  1.633%
•  A  stated  annual  interest  rate  is  the  quoted  interest  rate  that  does  not
account  for  compounding  within  the  year.
•  An  effective  annual  rate  is  the  amount  by  which  a  unit  of  currency  will
24 A grow  in  a  year  with  interest  on  interest  included.
•  A  periodic  rate  is  the  quoted  interest  rate  per  period  and  it  equals  the
stated  annual  interest  rate  divided  by  the  number  of  compounding  periods
per  year.
Quantitative  Methods % The  inequality  holds  for  samples  and  populations  and  for  discrete  and  continuous  data  
25 C
regardless  of  the  shape  of  the  distribution.
z  =  22-­‐14/26  =  0.307692
26 A Rounding  off  N(0.31)  =  0.6217  (from  the  table),  Thus  1-­‐0.6217  =  0.3783  or
37.83%.
A  long  time  series  has  the  potential  for  a  structural  change  occurring  during  the  time  frame  
27 B that  would  result  in  two  different  return  distributions.  This  relates  to  time-­‐period  bias.

In  a  comparison  of  portfolios  with  negative  Sharpe  ratios,  we  cannot  generally  interpret  
the  larger  Sharpe  ratio  to  mean  better  risk-­‐adjusted  performance.  Hence,  either  the  
28 C
evaluation  period  needs  to  be  increased  so  that  one  or  more  of  the  Sharpe  ratios  become  
positive,  or  a  different  performance  evaluation  metric  should  be  used.
Investment  C  is  most  appropriate.  This  is  because  it  has  a  positive,  relatively  high  Sharpe  
ratio  and  the  lowest  target  semi-­‐deviation.  Since  Brook  needs  to  cover  the  cash  outflow  
29 C with  his  portfolio’s  returns,  a  target  return  needs  to  be  specified.  The  portfolio  with  the  
lowest  target  semi-­‐deviation  will  have  the  least  risk  of  falling  short  of  Brook’s  cash  flow  
needs  (target  return).
 Since  the  client  is  highly  risk-­‐averse  as  is  apparent  from  his  current  asset
allocation  and  his  averseness  to  portfolio  volatility,  a  positively  skewed
30 C distribution  with  thinner  tails  (less  extreme  values)  would  be  most  appropriate.
This  is  given  by  Company  C,  which  has  a  platykurtic,  positively  skewed
distribution  of  returns.
In  candlestick  chart,  when  stock’s  high  price  is  same  as  low  price  and  opening  and  closing  
31 A price  is  same,  it  creates  a  cross  pattern  and  is  referred  to  as  ‘doji’  (used  in  Japanese  
terminology).
The  data  that  Harper  has  gathered  is  nominal  data.  The  mode  is  the  only  measure  of  
32 B
central  tendency  that  can  be  used  with  nominal  data.
The  question  describes  the  emergence  of  an  inflationary  gap.  In  such  a  scenario,  fixed-­‐
33 B income  securities  would  decline  in  value  as  interest  rates  rise,  so  exposure  to  them  should  
be  decreased.
When  TR  =  TC  and  MR  >  MC,  the  firm  is  operating  at  lower  breakeven  point.
34 C
The  firm  should  increase  quantity  to  enter  profit  territory.
An  increase  in  the  price  of  petrol  will  pivot  the  budget  constraint  downward  (as  petrol  
35 B plots  on  the  vertical  axis).  Hence,  the  budget  constraint  would  become  less  steep  meaning  
that  the  slope  will  decrease.
The  distance  equals  the  AFC.  As  quantity  produced  increases,  the  average  fixed  cost  starts  
36 B
decreasing  because  it  spreads  over  a  greater  number  of  units.
An  increase  in  human  capital  will  shift  the  SRAS  rightward,  and  it  will  also  shift  the  LRAS  
37 B
rightward.
38 C Slope:  -­‐3.5/2.5  =  -­‐1.4
Under  imperfect  competition  (downward  sloping  demand  curves),  the  breakeven  point  
39 C occurs  when  TR  equals  TC.  However  profit  maximization  does  not  necessarily  occur  when  
MR  equals  MC  (it  may  occur  at  a  point  where  MR  is  greater  than  MC).
MRSIC  =  1.25/1.55  =  0.806.  Since  the  consumer’s  MRS  is  smaller,  he  should
Economics % 40 B
spend  a  little  more  on  cake  and  a  little  less  on  ice  cream.
For  a  range  of  output  levels,  size  does  not  matter,  so  the  slope  of  the  long-­‐run
41 A supply  curve  is  zero  or  constant.  For  levels  above  that,  size  matters,  so  the
LRATC  curve  decreases  as  output  increases  (meaning  that  slope  decreases).
Option  A  is  correct.  During  the  boom  phase,  the  riskiest  assets  will  often  have  substantial  
price  increases.
Option  B  is  incorrect  as  safe  assets  such  as  government  bonds  that  are  normally  highly  
42 A priced  during  recessions  may  have  lower  prices  and  thus  higher  yields  during  the  boom  
phase.
Option  C  is  incorrect  as  investors  may  try  to  buy  shares  of  exporting  companies,  as  a  result  
of  restrictive  economic  policy  or  during  slowdowns  within  the  country.
The  optimal  indifference  curve  would  shift  leftward.  The  new  point  of  tangency  of  the  
indifference  curve  and  the  POF  would  indicate  a  rise  in  the  consumption  of  designer  shirts  
43 B
and  a  fall  in  the  consumption  of  t-­‐shirts.  This  is  because  as  income  rises,  consumption  of  
normal  goods  increase  (dress  shirts)  and  of  inferior  goods  decreases.
Nominal  GDP  =  550,000+145,300+15,500+190,678+30,000+320,666-­‐
44 A
312,865+500  =  €939,779  billion.
Options  A  and  C  are  correct  however  option  B  is  incorrect.  Gross  profit  margin  is  not  a  
45 B
liquidity  measure  but  a  performance/profitability  measure.
Increase  in  market  interest  rates  would  decrease  the  fair  value  of  the  firm’s  debt.  But  fair  
46 C value  is  not  reported  in  financial  statements,  and  hence,  will  not  affect  a  firm’s  CFF  (it  is  
not  a  cash  inflow).
ROE  will  only  increase  if  borrowing  costs  exceed  the  marginal  rate  earned  on
47 C
investing  in  the  business.
 48 A The  firm  has  no  accounts  receivables,  so  the  cash  ratio  and  the  quick  ratio  would  be  equal.
Under  U.S.  GAAP,  only  those  items  that  are  unusual  and  infrequent  can  be
49 B
recognized  as  extraordinary.  Only  Option  B  fits  this  criteria.
50 C Operating  profit:  405,000-­‐85,200-­‐75,000-­‐45,500=  63,800/405,000  =  15.75%
Diluted  EPS:
51 A
$2,750,000/1,050,000+500,000  (additional  shares  if  converted)  =  $1.77
Solvency  Ratios:
Firm  A:  $15.796/$9.876  =  1.60
52 A
Firm  B:  $22.90/$15.66  =  1.46
Both  companies  have  leverage  ratios  that  are  low,  so  their  solvency  positions  are  strong.
Interest  costs  decreased  by  0.30  whereas  tax  costs  decreased  by  0.20.

Return  on  assets:

2010:  0.0513(0.60)(0.50)(2)  =  3.078%
2011:  0.0729(0.90)(0.70)2.3)  =  10.56%

53 A ROE:
2010:  3.078%(1.80)=  5.54%
2011:  10.56%(2.50)  =  26.41%

Although  ROE  increased  by  20.87%,  most  of  the  increase  was  because  of  an
increase  in  ROA.
Net  profit  margin  contributed  the  most  to  the  increase  in  ROA.
Supplementary  schedules  provide  additional  information  and  details  regarding  assets  and  
54 B liabilities  of  a  company  e.g.  information  regarding  natural  resources,  overview  of  specific  
business  lines,  or  the  segmentation  of  business  or  other  line  items.
55 C 89,250+45,000+22,000/45,000  =  3.47
75,000  (45)  =  $3,375,000  (if  options  exercised)
3,375,000/65  =  51,923  shares  could  be  repurchased
56 A
Incremental  shares  issued  is  75,000-­‐51,923  =  23,077
Financial  Reporting  and  Analysis %
Diluted  EPS:  25,000,000/  (150,000,000+23,077)  =  $0.167
Operating  activities  include  cash  receipts  and  payments  related  to  dealing
57 B securities  or  trading  securities,  even  if  they  are  not  part  of  the  company’s  primary  business  
activity.
A  P/BV  ratio  of  1  means  that  a  company’s  expected  future  returns  are  exactly
58 A equal  to  the  returns  required  by  the  market.  Hence,  investors  would  earn  a  normal  profit  
only.
Under  U.S.  GAAP,  the  completed  contract  method  is  used  when  the  outcome
59 B cannot  be  measured  reliably.  However,  even  under  this  method,  if  a  loss  is
expected  on  a  contract,  it  is  reported  immediately.
When  the  income  tax  expense  in  the  income  statement  is  greater  than  current
60 C
income  tax  liability,  the  difference  will  increase  a  firm’s  deferred  tax  liabilities.
Indirect  borrowing  using  accounts  payable  is  not  considered  a  financing
61 A
activity—such  borrowing  is  classified  as  an  operating  activity.
FIFO  will  result  in  the  highest  inventory  values  and  lowest  cost  of  sales  values.  Thus  it  will  
62 A
result  in  the  lowest  inventory  turnover.
In  year  1:  4/9  =  44.44%  of  the  costs  have  been  spend  so  44.44%(15)  =
$6,666,666.67  of  revenue  will  be  recognized.
63 A In  year  2:  total  cost  spent  will  equal  7.5/9  =  83.33%  so  total  revenue  recognized:
0.8333(15)  =  $12,500,000.  Since  it  has  already  recognized  $6,666,666.67,  in  year  2  it  will  
recognize  12,500,000-­‐6,666,666.67  =  $5,833,333
 Under  IFRS,  interest  paid  can  be  reported  either  as  an  operating  activity  or  a
64 C financing  activity.  Interest  received  can  be  reported  as  an  operating  activity  or  an  investing  
activity.
For  an  issuing  company  interest  expense  reported  for  the  bonds  in  the  financial  statements  
65 B
is  based  on  effective  interest  rates  i.e.  the  market  rate  at  the  time  of  issuance.
Inventory  turnover  2012:  180,000/(70,000+50,000)  =  1.5
Inventory  turnover  2013:  45,000/66,000  =  0.682  Since  this  is  quarterly,  we  must  annualize  
66 A
by  multiplying  by  4:  4  (0.682)  =  2.73
Hence,  the  ratio  improved.
If  a  firm  capitalizes,  assets  would  appear  higher  (because  the  capitalized  amount  is  added  
67 A
to  assets)  but  debt  would  remain  the  same,  so  leverage  would  appear  lower.
Under  U.S.  GAAP,  inventory  is  reported  at  lower  of  cost  or  market.  Market  value  is  current  
market  value  but  with  upper  and  lower  limits:  it  cannot  exceed  NRV  and  cannot  be  lower  
68 B than  NRV  less  a  normal  profit  margin.  Therefore,  the  lower  limit  is  $80,000-­‐(15%  of  80,000)  
=  $68,000  Hence,  $68,000  is  the  lower  limit  for  market  value.  Hence  lower  of  cost  or  
market  is:  $60,000.
The  farther  unit  sales  are  from  the  breakeven  point  for  high-­‐leverage  companies,  the  
69 C
greater  the  magnifying  effect  of  leverage.
1.35/(1+[(1-­‐0.4)(1.20)]  =  0.785
70 C Levered  beta  for  private  company:  0.785[1+(1-­‐0.33)(0.75)]  =  1.179
Cost  of  equity:  3.5+  1.179(5.6)  =  10.105%
Breakeven  analysis  of  firms  with  low  business  cycle  sensitivity  and  low  operating  and  
71 C
financial  leverage,  and  lower  intangibles  is  relatively  less  important.
DOL@200,000  units
 =  200,000(250-­‐65)/200,000(250-­‐65)-­‐10,000,000  =  1.37037
72 C Units  sold  have  changed  by  10%  so  operating  income  will  change  by  1.37037
(10%)  =  13.7037%
Major  drags  on  liquidity  include:
•  Uncollected  receivables
•  Tight  credit
•  Obsolete  inventory
73 A
Corporate  Finance % Major  pulls  on  liquidity  include:
•  Making  payments  early
•  Reduced  credit  limits
•  Limits  on  short-­‐term  lines  of  credit
•  Low  liquidity  positions
Management  has  more  opportunity  to  manage  and  control  operating  risk  than  sales  risk.  
74 A DFL  is  also  most  often  the  choice  of  upper  management.  Hence,  sales  risk  is  least  likely  to  
be  controlled  by  a  firm’s  management.
Companies  with  high  operating  leverage  have  less  flexibility  in  making  changes,  and  
bankruptcy  protection  does  little  to  help  reduce  operating  costs.  However,  companies  with  
75 B
high  financial  leverage  can  use  bankruptcy  laws  and  protection  to  change  their  capital  
structure  and  emerge  as  ongoing  concerns.
On  a  staggered  basis,  only  a  portion  of  board  members  is  re-­‐elected  every  year.  A  
staggered  board  can  be  used  by  management  as  an  anti-­‐takeover  instrument.  However  
76 C staggered  board  facilitates  better  continuity  of  board  expertise.  An  annually  elected  board  
may  provide  more  flexibility  to  nominate  new  board  members  to  meet  changes  in  the  
marketplace,  if  needed,  than  a  staggered  board.
 ETF’s  trade  very  close  to  their  underlying  NAV.  Open-­‐ended  mutual  funds  also
77 C have  market  prices  close  to  the  underlying  NAV.  Close  ended  funds,  however,  most  often  
trade  at  discounts  or  premiums  to  NAV.
Sum  after  the  split:  65.12+42(after  split)+8.50+11.99  =  127.61
78 B
127.61/45  =  2.835778
According  to  statistical  approaches  companies  are  grouped  into  industries  based  on  
79 C
historical  correlations  of  their  securities’  returns.
Relative  to  the  other  options,  direct  real  estate  has  the  smallest  correlation  with  the  
80 A returns  to  stocks  and  bonds.  REITs  and  shares  in  companies  that  own  real  estate  have  
returns  that  are  similar  to  the  returns  of  the  overall  stock  market.
Francisco  is  an  investor.  He  is  trying  to  generate  wealth  by  investing  extra  income  in  
81 A attractive  securities.  There  is  no  indication  of  the  use  of  superior  information  by  Francisco  
to  profit  from  price  changes.
Rationally  investors  should  be  risk  averse  therefore  in  most  financial  models,  the  
82 A
assumption  is  that  the  investors  are  risk  averse.
Firm’s  intrinsic  value  using  Gordon  Growth  Model  (GGM):
Vo  =  [  D0  (1  +  g)  ]/  (r-­‐g)  =  2.5(1+9.4%)  /  (15%  -­‐  9.4%)=  $48.84
83 A $22.24  is  the  amount  that  the  dividend  growth  assumption  added  to  the  intrinsic
value  estimate,  as  calculated  below:
Equity  Investments % $48.84  –  𝟗($2.5/9.4%)𝟓  =  $22.24
The  futures  market  would  provide  greatest  liquidity  in  addition  to  minimal  credit  risk.  Also,  
84 B Anderson  does  not  have  the  facilities  to  hold  most  commodities,  so  the  spot  market  is  not  
suitable.
Elaine  is  trying  to  use  superior  information  to  generate  abnormal  returns.
Transparent  financial  and  economic  disclosures  do  not  necessarily  help  informed  trades  
85 C
profit  because  they  are  competing  with  each  other.  The  most  profitable  are  those  that  
have  unique  insights  into  future  values.
Price-­‐weighted  indices  are  not  rebalanced.  For  market-­‐cap  indices,  rebalancing  is  less  of  a  
86 A concern  because  the  indices  largely  rebalance  themselves.  Hence,  rebalancing  is  most  
important  for  equal-­‐weighted  indices.
Both  options  A  and  B  are  time  series  anomalies  while  option  C  is  not  a  time  series  anomaly.
87 C
Proceeds  on  sale:  $7,000
Payoff  loan:  -­‐$2,500  (50%  borrowed)
Margin  interest  paid:  -­‐$150  (@  6%)
88 A Dividends  received:  $50
Sales  commission  paid:  -­‐$5
Remaining  equity:  $4,395
Return  on  investment:  4,395-­‐2505/2,505  =  75.45%
The  buyer  of  a  credit-­‐linked  note  effectively  insures  the  credit  risk  of  the
89 C underlying  reference  security.  A  CDS  also  captures  many  of  the  essential  features  of  
insurance.  A  credit  spread  option  behaves  more  like  a  call  option.
90 C A  forward  transaction  that  starts  with  a  nonzero  value  is  called  an  off-­‐market  forward.
Derivatives  markets  provide  greater  liquidity  as  smaller  amount  of  capital  is
required  to  trade  derivatives.
Transaction  costs  of  derivatives  are  typically  low  compared  to  the  value  of
91 C underlying.
With  derivatives  it  is  nearly  as  easy  to  take  short  position  as  to  take  a  long
position.  In  case  of  underlying,  its  almost  always  much  more  difficult  to  go  short  than  to  go  
Derivative  Instruments  % long.
 Derivative  Instruments  %
Hammond  wants  to  hedge  the  risk  of  the  company’s  oil  production  234  days  from  now.  
The  time-­‐horizon  does  not  coincide  with  the  standardized  time  horizons  of  futures  
contracts.  Also,  since  he  wants  near  perfect  hedging,  a  customized  contract  that  considers  
92 C
all  his  concerns  would  be  most  appropriate.  This  can  be  achieved  using  a  forward  contract.  
Options  require  a  premium  to  be  paid  and  Hammond  wants  minimal  upfront  investment.

A  swap  is  closest  to  a  series  of  forwards  expiring  at  a  set  of  dates  coinciding  with  the  swap  
93 B
payment  dates.
The  higher  the  exercise  price  of  a  call  option,  the  lower  the  price  of  the  option  and  the  
94 B lower  the  premium  received  by  the  seller  of  the  call  but  the  greater  the  opportunity  to  gain  
on  the  upside.
Fixed-­‐income  securities  are  far  more  diverse  than  equity  securities.  The  other  two  options  
95 A
are  correct.
The  bond  with  the  highest  coupon  rate  and  lowest  maturity  will  have  the  lowest  interest  
96 B
rate  risk.  This  is  Bond  B.
97 A (1+0.03556/2)4  ×  (1+x)2  =  (1+  0.03786/2)6
x  =  0.021234  ×  2  =  4.24678%
For  the  same  time  to  maturity  and  yield  to  maturity,  the  Macaulay  duration  for  a  zero  
coupon  bond  tends  to  be  higher  than  for  a  low  coupon  bond  trading  at  a  discount.
98 C
Similarly  a  low-­‐coupon  bond  trading  at  a  discount  has  a  higher  duration  than  a  high  coupon  
bond  trading  at  a  premium.
The  sinking  fund  arrangement  on  a  term  maturity  structure  accomplishes  the  same  goal  as  
99 C the  serial  maturity  structure—both  resulted  in  a  portion  of  the  bond  issue  being  paid  off  
each  year.
For  a  fully  amortized  bond,  the  annual  payment,  which  includes  both  the  coupon  payment  
100 A
and  the  principal  repayment,  is  constant.
Yield  on  the  corporate  bond:  4.92%  (using  financial  calculator)
101 C Yield  on  the  T-­‐note  with  same  maturity:  2.725%
G-­‐Spread:  4.92%-­‐2.725%  =  2.195%
From  the  dealer’s  perspective,  this  is  a  reverse  repurchase  transaction  (borrowing  
102 C securities  and  lending  cash).  The  coupon  will  belong  to  the  owner,  that  is,  the  borrower  of  
Fixed  Income  Investments % cash  or  the  lender  of  the  securities.
Floating  rate  securities  have  little  interest  rate  risk.  However,  they  are  subject  to  credit  risk,  
103 A and  changing  market  conditions  can  result  in  a  significant  downgrade  of  such  securities.  As  
a  result,  they  may  deviate  considerably  from  par  value.
Option  cost:
ABC:  13-­‐9  =  4%
104 B DEF:  11-­‐8.5  =  2.5%
GHI:  15-­‐9.5  =  5.5%
DEF  has  the  lowest  option  cost  so  it  is  the  most  undervalued  relative  to  others.
For  security  A:
PV  =  100  ×  (1-­‐180/360  ×0.0678)  =  96.61
To  get  the  BEY:
(365/180)  ×  (100-­‐96.61/96.61)  =  0.071154
For  security  B:
105 C
FV  =  100  +  (100  ×  180/360  ×  0.0702)
FV  =  103.51
BEY:
(365/180)  ×  (103.51-­‐100/100)  =  0.071175
The  yields  are  almost  equivalent.
 The  lender  of  cash  accounts  for  credit  risk  by  lending  less  than  the  collateral’s  market  
106 B
value.  This  difference  is  called  the  repo  margin.
A  trade  sale  has  the  advantage  of  fast  execution,  higher  confidentiality  and  no  lock-­‐up  
107 A periods.  So  it  is  suitable  for  investment  A.  An  IPO  has  the  potential  for  the  highest  price  so  
it  is  appropriate  for  investment  B.
The  quantitative  directional  strategy  takes  long  and  short  positions,  however,  the  fund  
108 B typically  varies  levels  of  net  long  or  short  exposure,  depending  upon  the  anticipated  
direction  of  the  market.  The  other  two  have  a  zero  beta  exposure.
25%(200)  =  $50  million
Alternative  Investments % 250  million  (2%)  =  $5  million
109 B (250-­‐200-­‐7-­‐5)  (20%)  =  $7.6  million  incentive  fee
Total  fees:  $12.6  million
Return:  250-­‐200-­‐12.6/200  =  18.7%
110 B The  activist  hedge  fund  operates  in  the  public  market  only,  unlike  private  equity.
111 B Commodities  include  grains,  metals  and  crude  oil.
Activist  is  an  event  driven  strategy  that  focuses  on  the  purchase  of  sufficient
112 A
equity  to  influence  a  company’s  policies  or  direction.
The  execution  step  includes  asset  allocation,  security  analysis  and  portfolio
construction.
113 B
The  feedback  step  includes  portfolio  monitoring  and  rebalancing  and  performance  
measurement  and  reporting.
114 A Specific  return:  0.08  -­‐  (0.02  +  0.66  ×  0.05)  =  2.7%
An  investor  should  choose  the  portfolio  that  lies  at  the  point  where  his  highest  indifference  
115 C curve  is  tangent  to  the  capital  allocation  line.  This  will  define  his  optimal  portfolio.

An  insurance  company’s  risk  tolerance  is  typically  quite  low  and  the  time  horizon  is  short.  
Hence,  a  large  proportion  of  stocks  and  alternative  investments  would  not  be  appropriate.  
116 B
Foundations  have  a  very  long  time  horizon,  and  risk  tolerance  is  typically  high.  For  a  newly  
offered  DB  plan,  risk  tolerance  would  be  high  and  time  horizon  would  be  long.
Option  C  is  correct.  Delta  captures  only  small  changes  in  the  value  of  the
Porfolio  Management % underlying  whereas  large  changes  are  captured  by  gamma.
Option  A  is  incorrect.  Gamma  is  considered  a  second  order  risk  because  it  reflects  the  risk  
117 C
of  changes  in  delta.
Option  B  is  incorrect.  The  sensitivity  to  changes  in  the  volatility  of  the  underlying  is  
reflected  in  a  measure  called  vega.
An  insurance  policy  has  a  negative  beta.  Option  C  will  have  a  very  low  beta  and  option  A  
118 B
will  have  a  zero  beta.
Slope:  25%-­‐5%/37%  =  0.54054
Standard  deviation  is  calculated  using  the  following  CAL  equation:
119 A
0.15  =  0.05+0.540541(SD)
SD  =  18.49998%  or  18.5%.
Utility  from  risky  investment:  0.12-­‐0.5(4)(0.15)2  =  0.075
120 B To  get  the  same  utility,  the  risk  free  return  must  be  7.5%(because  the  second  term  
disappears).  Since  the  risk-­‐free  return  is  only  5.0%,  the  risky  investment  is  better.