CFA® Level II Chartered Financial Analyst
CFA® Level 2 Exam

Details: relate to Glenda Garvey.
Glenda Garvey is interning at Samson Securities in the summer to earn money for her last semester of studies for her MBA. She took the Level 3 CFA® exam in June but has not yet received her score. Garvey's work involves preparing research reports on small companies. Garvey is at lunch with a group of co-workers. She listens to their conversation about various stocks and takes note of a comment from Tony Topel, a veteran analyst. Topel is talking about Vallo Engineering, a small stock he has tried repeatedly to convince the investment director to add to the monitored list.
While the investment director does not like Vallo, Topel has faith in the company and has gradually accumulated 5, 000 shares for his own account. Another analyst, Mary Kennedy, tells the group about Koral Koatings, a paint and sealant manufacturer. Kennedy has spent most of the last week at the office doing research on Koral. She has concluded that the stock is undervalued and consensus earnings estimates are conservative. However, she has not filed a report for Samson, nor does she intend to. She said she has purchased the stock for herself and advises her colleagues to do the same. After she gets back to the office, Garvey purchases 25 shares of Vallo and 50 shares of Koral for herself. Samson pays its interns very little, and Garvey works as a waitress at a diner in the financial district to supplement her income. The dinner crowd includes many analysts and brokers who work at nearby businesses.
While waiting tables that night, Garvey hears two employees of a major brokerage house discussing Metrona, a nanotechnology company. The restaurant patrons say that the broker's star analyst has issued a report with a buy rating on Metrona that morning. The diners plans to buy the stock the next morning. After Garvey finishes her shift, restaurant manager Mandy Jones, a longtime Samson client, asks to speak with her. Jones commends Garvey for her hard work at the restaurant, praising her punctuality and positive attitude, and offers her two tickets to a Yankees game as a bonus. The next morning, Garvey buys 40 shares of Metrona for her own account at the market open. Soon afterward, she receives a call from Harold Koons, one of Samson's largest money-management clients. Koons says he got Garvey's name from Bertha Witt, who manages the Koons' account. Koons wanted to reward the analyst who discovered Anvil Hammers, a machine-tool company whose stock soared soon after it was added to his portfolio. Garvey prepared the original report on Anvil Hammers. Koons offers Garvey two free round- trip tickets to the city of her choice. Garvey thanks Koons, then asks her immediate supervisor, Karl May, about the gift from Koons but does not mention the gift from Jones. May approves the Koons' gift. After talking with May, Garvey starts a research project on Zenith Enterprises, a frozen-juice maker. Garvey's gathers quarterly data on the company's sales and profits over the past two years. Garvey uses a simple linear regression to estimate the relationship between GDP growth and Zenith's sales growth. Next she uses a consensus GDP estimate from a well-known economic data reporting service and her regression model to extrapolate growth rates for the next three years. Later that afternoon, Garvey attends a company meeting on the ethics of money management. She listens to a lecture in which John Bloomquist, a veteran portfolio manager, talks about his job responsibilities. Garvey takes notes that include the following three statements made by Bloomquist: Statement 1: I'm not a bond expert, and I've turned to a colleague for advice on how to manage the fixed-income portion of client portfolios. Statement 2: I strive not to favor either the remaindermen or the current-income beneficiaries, instead I work to serve both of their interests. Statement 3: All of my portfolios have target growth rates sufficient to keep ahead of inflation. Garvey is not working at the diner that night, so she goes home to work on her biography for an online placement service. In it she makes the following two statements:
Statement 1:
I'm a CFA Level 3 candidate, and I expect to receive my charter this fall. The CFA program is a grueling, 3-part, graduate-level course, and passage requires an expertise in a variety of financial instruments as well as knowledge of the forces that drive our economy and financial markets.
Statement 2:
I expect to graduate with my MBA from Braxton College at the end of the fall semester. As both an MBA and a CFA, I'll be in high demand. Hire me now while you still have the chance.

Details: relate to Maria Harris.
Maria Harris is a CFA® Level 3 candidate and portfolio manager for Islandwide Hedge Fund. Harris is commonly involved in complex trading strategies on behalf oflslandwide and maintains a significant relationship with Quadrangle Brokers, which provides portfolio analysis tools to Harris. Recent market volatility has led Islandwide to incur record-high trading volume and commissions with Quadrangle for the quarter. In appreciation of lslandwide's business, Quadrangle offers Harris an all-expenses-paid week of golf at Pebble Beach for her and her husband. Harris discloses the offer to her supervisor and compliance officer and, based on their approval, accepts the trip. Harris has lunch that day with C. K. Swarny, CFA, her old college roommate and future sister-in-law.
While Harris is sitting in the restaurant waiting for Swamy to arrive, Harris overhears a conversation between the president and chief financial officer (CFO) of Progressive Industries. The president informs the CFO that Progressive's board of directors has just approved dropping the company's cash dividend, despite its record of paying dividends for the past 46 quarters. The company plans to announce this information in about a week. Harris owns Progressive's common stock and immediately calls her broker to sell her shares in anticipation of a price decline. Swamy recently joined Dillon Associates, an investment advisory firm. Swamy plans to continue serving on the board of directors of Landmark Enterprises, a private company owned by her brother-in-law, for which she receives $2, 000 annually. Swamy also serves as an unpaid advisor to the local symphony on investing their large endowment and receives four season tickets to the symphony performances. After lunch, Alice Adams, a client, offers Harris a 1- week cruise as a reward for the great performance of her account over the previous quarter. Bert Baker, also a client, has offered Harris two airplane tickets to Hawaii if his account beats its benchmark by more than 2% over the following year. Juliann Clark, a CFA candidate, is an analyst at Dillon Associates and a colleague of Swamy's. Clark participates in a conference call for several analysts in which the chief executive officer at Dcx says his company's board of directors has just accepted a tender offer from Monolith Chemicals to buy Dex at a 40% premium over the market price. Clark contacts a friend and relates the information about Dcx and Monolith. The friend promptly contacts her broker and buys 2, 000 shares of Dex's stock. Ed Miehaels, CFA, is director of trading at Quadrangle Brokers. Michaels has recently implemented a buy program for a client. This buy program has driven up the price of a small-cap stock, in which Islandwide owns shares, by approximately 5% because the orders were large in relation to the average daily trading volume of the stock. Michaels' firm is about to bring shares of an OTC firm to market in an IPO. Michaels has publicly announced that, as a market maker in the shares, his trading desk will create additional liquidity in the stock over its first 90 days of trading by committing to minimum bids and offers of 5, 000 shares and to a maximum spread of one-eighth. Carl Park, CFA, is a retail broker with Quadrangle and has been allocated 5, 000 shares of an oversubscribed IPO. One of his clients has been complaining about the execution price of a trade Park made for her last month, but Park knows from researching it that the trade received the best possible execution. In order to calm the client down, Park increases her allocation of shares in the TPO above what it would be if he allocated them to all suitable client accounts based on account size. He allocates a pro rata portion of the remaining shares to a trust account held at his firm for which his brother-in-law is the primary beneficiary.

Details:relate to Snowboards and Skateboards, Inc.
Ota L'Abbe, a supervisor at an investment research firm, has asked one of the junior analysts, Andreas Hally, to draft a research report dealing with various accounting issues. Excerpts from the request are as follows:
· "There's an exciting company that we're starting to follow these days. It's called Snowboards and Skateboards, Inc. They are a multinational company with operations and a head office based in the resort town of Whistler in western Canada. However, they also have a significant subsidiary located in the United States." · "Look at the subsidiary and deal with some foreign currency issues including the specific differences between the temporal and all-current methods of translation, as well as the effect on financial ratios." · "The attached file contains the September 30, 2008, financial statements of the U.S. subsidiary. Translate the financial statements into Canadian dollars in a manner consistent with U.S. GAAP." The following are statements from the research report subsequently written by Hally:
Statement 1:
Subsidiaries whose operations are well integrated with the parent will use the all-current method of translation.
Statement 2:
Self-contained, independent subsidiaries whose operating, investing, and financing activities are primarily located in the local market will use the temporal method of translation.

· Beginning inventory for fiscal 2008 had been purchased evenly throughout fiscal 2007. The company uses the FIFO inventory value method.
· Dividends of USD 25, 000 were paid to the shareholders on June 30, 2008.
* All of the remaining inventory at the end of fiscal 2008 was purchased evenly throughout fiscal 2008.
· All of the PP&E was purchased, and all of the common equity was issued at the inception of the company on October 1, 2004. No new PP&E has been acquired, and no additional common stock has been issued since then. However, they plan to purchase new PP&E starting in fiscal 2009.
· The beginning retained earnings balance for fiscal 2008 was CAD 1, 550, 000. · The accounts payable on the fiscal 2008 balance sheet were all incurred on June 30, 2008. · The U.S. subsidiary's operations are highly integrated with the main operations in Canada. · The remeasured inventory for 2008 using the temporal method is CAD 810, 000.
· All monetary asset and liability balances are the same as they were at the end of the 2007 fiscal year, except that long-term debt was USD 467, 700.
· Costs of goods sold under the temporal method in 2008 is CAD 1, 667, 250.

Details:relate to Global Drug World.
Carl Warner, CFA, has been asked to review the financial information of Global Drug World (GDW) in preparation for a possible takeover bid by rival competitor Consolidated Drugstores International (Consolidated). GDW has produced impressive results since going public via an initial public offering in 1998. Through a program of aggressive growth by acquisition, GDW is currently seen as a major player and a threat to Consolidated's own plans for growth and profitability. In preparation for his analysis, Warner has gathered the following financial data from GDW's year-end statements:
GDW Statement of Income for Year ended May 31, 2008 Sales 4, 052, 173 Expenses
Cost of goods sold, general and operating expenses 3, 735, 397 Noncash charges 56, 293
Interest on long-term debt 20, 265
Other interest 5, 223
3, 817, 178
Income before income taxes 234, 995
Income taxes 70, 499
Net income 164, 497
Earnings per share 0.72
Partial GDW Balance Sheet on May 31, 2008
Assets
Current assets (excluding cash)
Accounts receivable 284, 762
Inventories 490, 755
Prepaid expenses 23, 743
Total current assets (excluding cash) 799, 260
Property, plant, and equipment 687, 890
Other assets 236, 417
Liabilities
Current liabilities (excluding notes payable)
Accounts payable and accrued liabilities 296, 564
Other 100, 039
Total current liabilities (excluding notes payable) 396, 603 Long-term debt 262, 981
Other liabilities 15, 484
Additional Information
Risk-free rate 4.5%
WACC 7.5%
2008 working capital investment $7, 325
2008 dividends $82, 248
Beta 1.10
Investment in fixed capital in 2008 $143, 579
Market risk premium 5%
Total equity May 31, 2007 $1, 019, 869
Principal repayment of long-term debt in 2008 $33, 275 Notes payable issued in 2008 $5, 866
2008 change in liabilities $27, 409
Tax rate 30%
As part of his analysis, Warner needs to forecast the free cash flow to the firm (FCFF) for 2009. The best information he has points to an increase in sales of 6%. The earnings before interest and tax (EBIT) margin is not expected to change from the rate of 6.4% achieved in 2008. Additional fixed capital spending is expected to be $36, 470. Investment in net working capital is expected to be $24, 313. Moreover, Warner notes that the only noncash charge is depreciation, which he estimates will be $60, 000. Warner has been asked to analyze the effect each of the following corporate events, if taken during 2009, would have on GDW's free cash flow to equity (FCFE):
· 20% increase in dividends per share. · Repurchase of 25% of the firm's outstanding shares using cash.
· New common share offering that would increase shares outstanding by 30%. · New issue of convertible bonds that are not callable for five years and would increase the level of debt by 10%.

Details:relate to Ferguson Department Stores, Inc.
Matthew Emery, CFA, is responsible for analyzing companies in the retail industry. He is currently reviewing the status of Ferguson Department Stores, Inc. (FDS). FDS has recently gone through extensive restructuring in the wake of a slowdown in the economy that has made retailing particularly challenging. As part of his analysis, Emery has gathered information from a number of sources. Ferguson Department Stores, Inc. FDS went public in 1969 following a major acquisition, and the Ferguson name quickly became one of the most recognized in retailing. Ferguson had been successful through most of its first 30 years in business and has prided itself on being the one-stop shopping destination for consumers living on the West Coast of the United States. Recently, FDS began to experience both top and bottom line difficulties due to increased competition from specialty retailers who could operate more efficiently and offer a wider range of products in a focused retailing sector.
When the company's main bank reduced FDS `s line of credit, a serious working capital crisis ensued, and the company was forced to issue additional equity in an effort to overcome the problem. FDS has a cost of capital of 10% and a required rate of return on equity of 12%. Dividends are growing at a rate of 8%, but the growth rate is expected to decline linearly over the next six years to a long-term growth rate of 4%. The company recently paid an annual dividend of $1. At the end of 2008, FDS announced that it would be expanding its retail operations, moving to a warehouse concept, and opening new stores around the country. FDS also announced it would close some existing stores, writedown assets, and take a large restructuring charge. Upon reviewing the prospects of the firm, Emery issued an earnings per share forecast for 2009 of $0.90. He set a 12-month share price target of $22.50. Immediately following the expansion announcement, the share price of FDS jumped from $14 to $18.
189.1
30.4
49.3
(71.1)
(21.8)
$52.2
$0.49
$0.49
106, 530, 610
5, 875.9
146.6
59.5
5.0
235.7
7.5
93.5
101.0
$134.7
$1.26
$1.26
106, 530, 610

In response to questions from a colleague, Emery makes the following statements regarding the merits of earnings yield compared to the P/E ratio:
Statement 1:
For ranking purposes, earnings yield may be useful whenever earnings are either negative or close to zero.
Statement 2:
A high E/P implies the security is overpriced.

Details: relate to Universal Home Supplies, Inc.
Michael Robbins, CFA, is analyzing Universal Home Supplies, Inc. (UHS), which has recently gone through some extensive restructuring. Universal Home Supplies, Inc. UHS operates nearly 200 department stores and 78 specialty stores in over 30 states. The company offers a wide range of products, including women's, men's, and children's clothing and accessories as well as home furnishings, electronics, and other consumer goods. The company is considering cutting back on or eliminating its electronics business entirely. UHS manufactures many of its own apparel products domestically in a large factory located in Kentucky. This central location penuits shipping to distribution points around the country at reasonable costs. The company operates primarily in suburban shopping malls and offers mid- to high-end merchandise mainly under its own private label. At present more than 70% of the company's customers live within a 10-minute drive of one of the company's stores. Web site activity measured in dollar sales volume has increased by over 18% in the past year. Shares of UHS stock are currently priced at $25. Dividends are expected to grow at a rate of 6% over the next eight years and then continue to grow at that same rate indefinitely. The company has a cost of capital of 10.2%, a beta of 0.8, and just paid an annual dividend of$ 1.25. UHS has faced serious cash flow problems in recent years as a consequence of its strategy to pursue an upscale clientele in the face of increased competition from several "niche retailers." The firm has been able to issue new debt recently and has also managed to extend its line of credit. The two financing agreements required a pledge of additional assets and a promise to install a super-efficient inventory tracking system in time to meet holiday shopping demand.

Details: relate to Barton Wilson.
Barton Wilson, a junior analyst, is a new hire at a money center bank. He has been assigned to help Juanita Chevas, CFA, in the currency trading department. Together, Wilson and Chevas are working on the development of new trading software designed to detect profitable opportunities in the foreign exchange market. Obviously, they are interested in risk-free arbitrage opportunities. However, they have also been instructed to investigate the possibility of longer-term currency exposures that are not necessarily risk- free. To test the logic of their new software, Wilson gathers the following market data:
· Spot JPY/USD exchange rate = 120.
· Spot EURJUSD exchange rate = 0.7224.
· U.S. risk-free interest rate 7%.
· Eurozone risk-free rate = 9.08%.
· Japanese risk-free rate = 3.88%.
· Yield curves in all three currencies are flat.
In addition to in-house currency transactions, the new software program is also intended to provide insight into currency exposure and hedging needs for the bank's major customers. These customers typically include large multinational firms. Essentially, the bank wants to provide consulting services to its clients concerning which currency exposures offer the greatest possibility of appreciation. In this process, the bank will rely on deviations from international parity conditions as an indicator of long-term currency movements. Wilson obtains the following data from the econometrics department:
· JPYIUSD spot rate one year ago = 116.
· EURJUSD spot rate one year ago = 0.7200.
· Anticipated and historical U.S. annual inflation = 3%. · Anticipated and historical Japanese annual inflation = 0%. · Anticipated and historical Eurozone annual inflation 5%. One of the bank's major customers has significant portions of its business in Japan, and the Eurozone and has long exposure to both currencies. The customer has traditionally hedged all currency risk. However, the customer's new risk manager has decided to leave some currency exposure unhedged in an attempt to profit from long-term currency exposure.

Details: relate to William Rogers.
William Rogers, a fixed-income portfolio manager, needs to eliminate a large cash position in his portfolio. He would like to purchase some corporate bonds. Two bonds that he is evaluating are shown in Exhibit 1. These two bonds are from the same issuer, and the current call price for the callable bond is 100. Assume that the issuer will call if the bond price exceeds the call price. Rogers is also concerned about increases in interest rates and is considering the purchase of a putable bond. He wants to determine how assumed increases or decreases in interest rate volatility affect the value of the straight bonds and bonds with embedded options. After Rogers performs some analysis, he and his supervisor, Sigourney Walters, discuss the relative price movement between the two bonds in Exhibit 1 when interest rates change significantly. During the discussions, Rogers makes the following statements:
Statement 1:
If the volatility of interest rates decreases, the value of the callable bond will increase.
Statement 2:
The noncallable bond will not be affected by a change in the volatility or level of interest rates.
Statement 3:
When interest rates decrease, the value of the noncallable bond increases by more than the callable bond.
Statement 4:
If the volatility of interest rates increases, the value of the putable bond will increase. Walters mentors Rogers on bond concepts and then asks him to consider the pricing of a third bond. The third bond has five years to maturity, a 6% annual coupon, and pays interest semiannually. The bond is both callable and putable at 100 at any time. Walters indicates that the holders of the bond's embedded options will exercise if the option is in-the-money.

Exhibit 1: Bond Descriptions

Details: relate to Marietta Tech, Inc.
Jerry Sanders, CFA, has been asked to analyze the 20-year bonds of Marietta Tech, Inc., which are currently being held in a corporate bond portfolio managed by a colleague, and to recommend whether the bonds should be sold or held. The bonds currently have a yield spread of 1.55% over Treasuries. Marietta Tech, Inc. designs, manufactures, and markets specialty trucks and truck bodies mounted on new truck chassis produced by others, including concrete mixers, refuse bodies, fire and emergency vehicles, defense trucks, cut- away and dry freight van bodies, refrigerated units, stake bodies, and other specialized trucks. Marietta also manufactures fiberglass wind deflectors, armored trucks, shuttle buses, and cargo vans. Marietta's customers are located in the United States and Canada.