Kaplan考試和QBank二級（考友版）：Heckpoint考試2：學(xué)習(xí)環(huán)節(jié) （題目+解析）9-14

CFALevelII

Questions#1-6of42

Questions91–96relatetoYiTang.

YiTangupdatesseveraleconomicparametersmonthlyforusebytheanalystsandtheportfoliomanagersatherfirm.If

economicconditionswarrant,shewillupdatetheparametersevenmorefrequently.Asaresultofaneconomicslowdown,

sheisgoingthroughthisprocessnow.

Thefirmhasbeenusinganequityriskpremiumof5.2%,derivedusinghistoricalestimates.Bycomparingtheyieldson

nominalbondsandrealbonds,Tangestimatestheexpectedinflationratetobe2.6%.Sheexpectsrealdomesticgrowth

tobe3.0%.Tangbelievesthatthemarketsarecurrentlyovervaluedby3%.Theyieldonthemarketindexis1.7%,and

theexpectedrisk-freerateofreturnis2.7%.

ElizabethTrotter,oneofthefirm'sportfolioManagers,asksTangabouttheeffectsofsurvivorshipbiasonestimatesofthe

equityriskpremium.Trotterasks,"Whichmethodismostsusceptibletothisbias:historicalestimates,Gordongrowth

modelestimates,orsurveyestimates?"

TangwishestoestimatetherequiredrateofreturnforNortheastElectric(NE)usingtheCapitalAssetPricingModel

(CAPM)andtheFama-Frenchmodel.Sheusesthefollowinginformationtoaccomplishthis:

FactorRiskPremiumFactorSensitivity

Market

Size

5.2%

3.2%

5.4%

1.1%

0.83(historical)

–0.76

Value

–0.04

Liquidity

0.20

TrotterhasonefinalquestionforTang.Trottersays,"WeneedtoestimatetheequitybetaforVixPRO,whichisaprivate

companythatisnotpubliclytraded.Wehaveidentifiedapubliclytradedcompanythathassimilaroperating

characteristicstoVixPRO,andwehaveestimatedthebetaforthatcompanyusingregressionanalysis.Weusedthe

returnonthepubliccompanyasthedependentvariableandthereturnonthemarketindexastheindependentvariable.

WhatstepsdoIneedtotaketofindthebetaforVixPROequity?Thecompanieshavedifferentdebt/equityratios.The

debtofbothcompaniesisverylowrisk,andIbelieveIcanignoretaxes."

Question#1of42

QuestionID:1214336

TheestimateoftheequityriskpremiumusingtheIbbotson-ChenmodelgiventheestimatesdeterminedbyTangis

closestto:

A)1.5%.

B)4.2%.

C)4.7%.

Question#2of42

QuestionID:1214337

QuestionID:1214338

QuestionID:1214339

QuestionID:1214340

QuestionID:1214341

ThebestresponsetoTrotter'squestionaboutsurvivorshipbiasis:

A)surveyestimates.

B)Gordonmodelestimates.

C)historicalestimates.

Question#3of42

TherequiredrateofreturnforNEestimatedwiththeCAPMisclosestto:

A)5.7%.

B)6.0%.

C)7.0%.

Question#4of42

TherequiredrateofreturnforNEestimatedwiththeFama-Frenchmodelisclosestto:

A)4.4%.

B)4.7%.

C)9.0%.

Question#5of42

UsingtheBlumemethod,theadjustedbetacomputedbyTangwouldbeclosestto:

A)0.90.

B)0.96.

C)1.03.

Question#6of42

WhatresponseshouldTanggiveTrotteraboutestimatingtheequitybetaforVixPRO?

A)EstimatethebetaforVixPRObyregressingthereturnsforVixPROagainstan

indexofnon-tradedequitymarketsecurities.

B)EstimatetheVixPRObetabymultiplyingthepubliccompanybetatimestheratioof

theequityriskpremiumofthemarkettotherisk-freerateofreturn.

C)Estimatetheunleveredbetaforthepubliccompanybasedonitsdebt/equityratio.

Then,usethatunleveredbetatoestimatetheequitybetaforVixPRObasedonthe

VixPROdebt/equityratio.

Questions#7-12of42

Questions7–12relatetoUniversalHomeSupplies,Inc.

MichaelRobbins,CFA,isanalyzingUniversalHomeSupplies,Inc.(UHS),whichhasrecentlygonethroughsome

extensiverestructuring.

UniversalHomeSupplies,Inc.

UHSoperatesnearly200departmentstoresand78specialtystoresinover30states.Thecompanyoffersawiderange

ofproducts,includingwomen's,men's,andchildren'sclothingandaccessories,aswellashomefurnishings,electronics,

andotherconsumergoods.Thecompanyisconsideringcuttingbackonoreliminatingitselectronicsbusinessentirely.

UHSmanufacturesmanyofitsownapparelproductsdomesticallyinalargefactorylocatedinKentucky.Thiscentral

locationpermitsshippingtodistributionpointsaroundthecountryatreasonablecosts.Thecompanyoperatesprimarilyin

suburbanshoppingmallsandoffersmid-tohigh-endmerchandisemainlyunderitsownprivatelabel.Atpresent,more

than70%ofthecompany'scustomerslivewithina10-minutedriveofoneofthecompany'sstores.Websiteactivity

measuredindollarsalesvolumehasincreasedbyover18%inthepastyear.SharesofUHSstockarecurrentlypricedat

$25.Dividendsareexpectedtogrowatarateof6%overthenexteightyearsandthencontinuetogrowatthatsamerate

indefinitely.Thecompanyhasacostofcapitalof10.2%,abetaof0.8,andjustpaidanannualdividendof$1.25.

UHShasfacedseriouscashflowproblemsinrecentyearsasaconsequenceofitsstrategytopursueanupscale

clienteleinthefaceofincreasedcompetitionfromseveral"nicheretailers."Thefirmhasbeenabletoissuenewdebt

recentlyandhasalsomanagedtoextenditslineofcredit.Thetwofinancingagreementsrequiredapledgeofadditional

assetsandapromisetoinstallasuper-efficientinventorytrackingsystemintimetomeetholidayshoppingdemand.

Exhibit1:SummaryIncomeStatementforUniversalHomeSupplies,Inc.(U.S.$millions,exceptpersharedata

andsharesoutstanding)

2018

2017

Sales

$7,400.1

7,081.3

157.7

161.1

42.6

$7,383.8

7,028.9

155.6

199.3

45.4

Costofgoodssold,operating,administrative,andsellingexpenses

Depreciationandamortization

Earningsbeforeinterestexpenseandincometaxes

Interestexpense

Earningsbeforetax

118.5

153.9

Incometaxes—current

Netearningsfortheyear

Earningspershare:Basic

Fullydiluted

40.3

$78.2

$0.82

$0.82

52.3

$101.6

$1.40

$1.34

Weightedaveragesharesoutstanding

95,366,00072,572,000

Exhibit2:BookValueperShare(BVPSin$)andReturnonEquity(ROE),UniversalHomeSupplies,Inc.

Year2018201720162015

BVPS$25.58$33.62$37.54$32.26

ROE3.2%4.0%4.5%3.9%

Exhibit3:2018SelectedIndustryInformation

Estimatedearningsgrowthrate0.10

Meantrailingprice/earnings(P/E)ratio22.50

Meanprice/sales(P/S)ratio0.50

Robbinsisaskedbyhissupervisortocarefullyconsidertheadvantagesanddrawbacksofusingtheprice-to-salesratio

(P/S)andtodeterminetheappropriatevaluationmetricstousewhenreturnsfollowpatternsofpersistenceorreversals.

Robbinsalsoestimatesacross-sectionalmodeltopredictUHS'sP/E:

predictedP/E=5?(10×beta)+[3×4-yearaverageROE(%)]+[2×8-yeardividendgrowthforecast(%)]

whereROEandgrowthforecastareinpercentages(i.e.,10insteadof0.10for10%).

Question#7of42

QuestionID:1214343

BasedontheH-model,theimpliedexpectedrateofreturnforUHSisclosestto:

A)8.8%.

B)10.2%.

C)11.3%.

Question#8of42

QuestionID:1214344

Robbinsshouldconcludethatakeydrawbacktousingtheprice-to-sales(P/S)ratiointheinvestmentprocessisthatP/S

is:

A)positiveevenwhenearningspershareisnegative.

B)notappropriateforvaluingtheequityofmaturecompanies.

C)susceptibletomanipulationwithrespecttorevenuerecognition.

Question#9of42

QuestionID:1214345

IsUHSstock,attheendof2018,bestdescribedasovervaluedorundervaluedaccordingtothe:

TrailingPEGratio?

P/Sratio?

A)

B)

C)

Undervalued

Undervalued

Undervalued

Overvalued

Overvalued

Undervalued

Question#10of42

QuestionID:1214346

QuestionID:1214347

QuestionID:1214348

Basedonthemethodofaveragereturnonequity(ROE),thenormalizedEPSforUHSisclosestto:

A)$0.94.

B)$1.00.

C)$1.26.

Question#11of42

ThepredictedP/EforUHSusingRobbins'smodelisclosestto:

A)20.7.

B)23.6.

C)30.5.

Question#12of42

Robbinsshouldconcludethatpatternsofpersistenceorreversalsinreturnsprovidethemostappropriaterationalefor

valuationusing:

A)unexpectedearnings.

B)relative-strengthindicators.

C)standardizedunexpectedearnings.

Questions#13-18of42

Questions13–18relatetoNataliaBerg.

NataliaBerg,CFA,hasestimatedthekeyratedurationsforseveralmaturitiesinthreeofherequally-weightedbond

portfolios,asshowninExhibit1.

Exhibit1:KeyRateDurationsforThreeFixed-IncomePortfolios

KeyRateMaturityPortfolio1Portfolio2Portfolio3

2-year

5-year

10-year

20-year

Total

2.45

0.20

0.15

2.20

5.00

0.35

0.40

4.00

0.25

5.00

1.26

1.27

1.23

1.24

5.00

Atafixed-incomeconferenceinLondon,Berghearsapresentationbyauniversityprofessorontheincreasinguseofthe

swapratecurveasabenchmarkinsteadofthegovernmentbondyieldcurve.WhenBergreturnsfromtheconference,

sherealizesshehaslefthernotesfromthepresentationontheairplane.However,sheisveryinterestedinlearningmore

aboutwhethersheshouldconsiderusingtheswapratecurveinherwork.

Asshetriestoreconstructwhatwassaidattheconference,shewritesdowntwostatementsabouttheswapratecurve:

Statement1:

Statement2:

Theswapratecurvetypicallyhasyieldquotesatmorematuritiesthangovernmentbondmarkets

have.

Retailbanksaremorelikelytousethegovernmentspotcurveasabenchmarkastheyhave

minimalexposuretoswapmarkets.

BergalsoobtainsinformationonseveralbondsissuedbySalantEnterprisesasshowninExhibit2.

Exhibit2:SelectedInformationonSalantEnterprisesBonds

Label

Bondtype

A

B

C

Callable

PutableExtendible

Optiontype

Exercisedate

Maturity

EuropeanEuropean

2years

3years

-

3years

4years

-

3years

1year

5%

Extensionperiod

CouponRate

Value

5%

5%

$99.50

$100.69

Bergdeterminesthattoobtainanaccurateestimateoftheeffectivedurationandeffectiveconvexityofacallablebond

usingabinomialmodel,thespecifiedchangeinyield(i.e.,?y)mustbeequaltotheOAS.

BergalsoobservesthatthecurrentTreasurybondyieldcurveisupwardsloping.Basedonthisobservation,Berg

forecaststhatshort-terminterestrateswillincrease.

Question#13of42

QuestionID:1214350

Ifthespot-ratecurveexperiencesaparalleldownwardshiftof50basispoints:

A)allthreeportfolioswillexperiencethesamepriceperformance.

B)Portfolio1willexperiencethebestpriceperformance.

C)Portfolio3willexperiencethebestpriceperformance.

Question#14of42

QuestionID:1214351

Ifthe5-and10-yearkeyratesincreaseby20basispoints,butthe2-and20-yearkeyratesremainunchanged:

A)allthreeportfolioswillexperiencethesamepriceperformance.

B)Portfolio1willexperiencethebestpriceperformance.

C)Portfolio2willexperiencethebestpriceperformance.

Question#15of42

QuestionID:1214352

ArethetwoobservationsBergrecordsafterthefixedincomeconferenceaccurate?

A)Bothstatementsareaccurate.

B)OnlyStatement1isaccurate.

C)OnlyStatement2isaccurate.

Question#16of42

QuestionID:1214353

BasedontheinformationinExhibit2,thevalueofBondCismostlikely:

A)$99.50.

B)between$99.50and$100.69.

C)$100.69.

Question#17of42

QuestionID:1214354

IsBergcorrectaboutthespecifiedchangeinyieldneededtoobtainanaccurateestimateoftheeffectivedurationand

effectiveconvexityofacallablebondusingabinomialmodel?

A)No,becausethespecifiedchangeinyieldmustbelargerthantheoption-adjusted

spread(OAS).

B)No,becausethespecifiedchangeinyieldmustbesmallerthantheOAS.

C)No,becausethespecifiedchangeinyieldcanbelargerthan,smallerthan,or

equaltotheOAS.

Question#18of42

QuestionID:1214355

IsBerg'sshort-terminterestrateforecastconsistentwiththepureexpectationstheoryandtheliquiditypremiumtheory?

A)Consistentwithboththeories.

B)Consistentwiththepureexpectationstheoryonly.

C)Consistentwiththeliquiditypremiumtheoryonly.

Questions#19-24of42

Questions19–24relatetoWilliamRogers.

WilliamRogers,afixed-incomeportfoliomanager,needstoeliminatealargecashpositioninhisportfolio.Hewouldliketo

purchasesomecorporatebonds.TwobondsthatheisevaluatingareshowninExhibit1.Thesetwobondsarefromthe

sameissuer,andthecurrentcallpriceforthecallablebondis100(callableattimet=4orfouryearsfromnow).Assume

thattheissuerwillcallifthebondpriceexceedsthecallprice.

Rogersisalsoconcernedaboutincreasesininterestratesandisconsideringthepurchaseofaputablebond.Hewantsto

determinehowassumedincreasesordecreasesininterestratevolatilityaffectthevalueofthestraightbondsandbonds

withembeddedoptions.AfterRogersperformssomeanalysis,heandhissupervisor,SigourneyWalters,discussthe

relativepricemovementbetweenthetwobondsinExhibit1wheninterestrateschangesignificantly.

Duringthediscussions,Rogersmakesthefollowingstatements:

Statement1:

Statement2:

Statement3:

Ifthevolatilityofinterestratesdecreases,thevalueofthecallablebondwillincrease.

Thenoncallablebondwillnotbeaffectedbyachangeinthevolatilityorlevelofinterestrates.

Wheninterestratesdecrease,thevalueofthenoncallablebondincreasesbymorethanthe

callablebond.

Statement4:

Ifthevolatilityofinterestratesincreases,thevalueoftheputablebondwillincrease.

WaltersmentorsRogersonbondconceptsandthenaskshimtoconsiderthepricingofathirdbondbythesameissuer.

Thethirdbondhasfiveyearstomaturity,a6%annualcoupon.Thebondisbothcallableandputableat100atanytime.

Waltersindicatesthattheholdersofthebond'sembeddedoptionswillexerciseiftheoptionisin-the-money.

Exhibit1:BondDescriptions

NoncallableBondCallableBond

Price

99.77

5

98.21

5

Timetomaturity(years)

Timetofirstcalldate(years)

Annualcoupon

n/a

4

6.00%

6.05%

6.00%

6.43%

Yieldtomaturity

RogersobtainedthepricesshowninExhibit1usingsoftwarethatgeneratesaninterestratelattice.Heuseshissoftware

togeneratetheinterestratelatticeshowninExhibit2.

Exhibit2:InterestRateLattice(AnnualizedInterestRates)

9.75%

8.95%

7.91%

6.40%

5.17%

4.18%

7.88%

6.37%

5.15%

4.16%

3.37%

7.35%

5.95%

4.81%

7.23%

5.85%

4.73%

3.82%

6.62%

5.36%

6.05%

Years

1

2

3

4

5

Question#19of42

QuestionID:1214357

QuestionID:1214358

QuestionID:1214359

EvaluateRogers'sstatements1and3.

A)OnlyStatement1iscorrect.

B)OnlyStatement3iscorrect.

C)Bothstatementsarecorrect.

Question#20of42

EvaluateRogers'sstatements2and4.

A)OnlyStatement2iscorrect.

B)OnlyStatement4iscorrect.

C)Bothstatementsarecorrect.

Question#21of42

ThemarketvalueoftheembeddedcalloptioninExhibit1isclosestto:

A)1.56.

B)1.65.

C)1.79.

Question#22of42

QuestionID:1214360

Forthisquestiononly,ignoretheinformationfromExhibit1andanyothercalculationsinotherquestions.Rather,assume

thattheinterestratelatticeprovidedinExhibit2isconstructedtobearbitrage-free.Rogerscalculatesthepriceofthethird

bondusingtheinterestratesinthelattice.

Isthepriceofthethirdcallableandputablebondlikelytobelessthan,equalto,orgreaterthanparvalue,andisthe

option-adjustedspread(OAS)onthethirdbondlikelytobezero,positive,ornegative?

Priceofthirdbond

OASofthirdbond

A)

B)

C)

Lessthanpar

Zero

Equaltopar

Positive

Greaterthanpar

Negative

Question#23of42

QuestionID:1214361

Usingtheinformationinthequestionandthefollowingrelevantportionoftheinterestrateandpricingtrees,Rogers

calculatesthevalueofthenoncallablebondatnodeA.

Correspondingportionoftheinterestratetree(givenasbond-equivalentyields):

8.95%

7.91%

7.23%

Years1

2.0

Correspondingportionofthebinomialpricetree:

$91.73

A→

$96.17

Years1

2.0

ThepriceofthenoncallablebondatnodeAisclosestto:

A)$89.84

B)$92.62

C)$96.14

Question#24of42

QuestionID:1214362

Usingtheinformationinthequestionandthefollowingrelevantportionoftheinterestrateandpricingtrees,Rogers

calculatesthevalueofthecallablebondatnodeB.

Correspondingportionoftheinterestratetree(givenasbond-equivalentyields):

3.44%

3.15%

2.77%

Years4.0

5

Correspondingportionofthecallablebondpricetree:

$100.00

B→

$100.00

Years4.0

5

ThepriceofthecallablebondatnodeBisclosestto:

A)$100.0

B)$101.40

C)$102.76

Questions#25-30of42

Questions25-30relatetoSusanEvermore.

TheWyromanInternationalPensionFundincludesa$65millionfixed-incomeportfoliomanagedbySusanEvermore,

CFA,ofBrightonInvestors.Evermoreisintheprocessofconstructingabinomialinterest-ratetreethatgenerates

arbitrage-freevaluesforon-the-runTreasurysecurities.Sheplanstousethetreetovaluemorecomplexbondswith

embeddedoptions.Shestartsoutbyobservingthattheyieldonaone-yearTreasurysecurityis3.50%.Shedeterminesin

herinitialattempttopricethetwo-yearTreasurysecuritythatthevaluederivedfromthemodelishigherthantheTreasury

security'scurrentmarketprice.

AfterseveraliterationsEvermoredeterminesthattheinterestratetreethatcorrectlyvaluestheoneandtwo-yearTreasury

securitieshasarateof4.50%inthelowernodeattheendofthefirstyearandarateof7.0%intheuppernodeattheend

ofthefirstyear.Sheusesthistreetovalueatwo-year,6%annualcouponbondwithaparvalueof$100thatiscallablein

oneyearat$99.50.ShedeterminesthatanOASof50bpsisappropriateforthisbond.

Evermorealsousesthesameinterestratetreetopricea2-year6%couponbondthatisputableinoneyear,andvalue

theembeddedputoption.Sheconcludesthatiftheyieldvolatilitydecreasesunexpectedly,thevalueoftheputablebond

willincreaseandthevalueoftheembeddedputoptionwillalsoincrease,assumingallotherinputsareunchanged.She

alsoconcludesthatthecomputedOASforthebondwoulddecreaseastheestimatedlevelofyieldvolatilitydecreases.

Evermorealsousestheinterestratetreetoestimatetheoption-adjustedspreadsoftwoadditionalcallablecorporate

bonds,asshowninthefollowingfigure.

Issuer

Option-AdjustedSpread

53basispoints

AA-ratedissuer

BB-ratedissuer

–18basispoints

Evermoreconcludes,basedonthisinformation,thattheAA-ratedissueisundervalued,andtheBB-ratedissueis

overvalued.

Atasubsequentmeetingwiththetrusteesofthefund,Evermoreisaskedtoexplainwhatabinomialinterestratemodelis

andhowitwasusedtoestimateeffectivedurationandeffectiveconvexity.Evermoreisuncertainoftheexact

methodologybecausetheactualcalculationsweredonebyajunioranalyst,butshetriestoprovidethetrusteeswitha

reasonablyaccuratestep-by-stepdescriptionoftheprocess:

Step1:

Step2:

Giventhebond'scurrentmarketprice,theon-the-runTreasuryyieldcurve,andanassumption

aboutratevolatility,createabinomialinterestratetree.

Add100basispointstoeachofthe1-yearratesintheinterestratetreetoderivea"modified"

tree.

Step3:

Step4:

Computethepriceofthebondifyieldincreasesby100basispointsusingthisnewtree.

RepeatSteps1through3todeterminethebondpricethatresultsfroma100basispoint

decreaseinrates.

Step5:

Usethesetwopriceestimates,alongwiththeoriginalmarketprice,tocalculateeffectiveduration

andeffectiveconvexity.

LucasDavenport,atrusteeanduniversityfinanceprofessor,immediatelyspeaksuptodisagreewithEvermore.Heclaims

thatamoreaccuratedescriptionoftheprocessisasfollows:

Step1:

Giventhebond'scurrentmarketprice,theTreasuryyieldcurve,andanassumptionaboutrate

volatility,createabinomialinterestratetreeandcalculatethebond'soption-adjustedspread

(OAS)usingthemodel.

Step2:

Step3

Imposeaparallelupwardshiftintheon-the-runTreasuryyieldcurveof100basispoints.

BuildanewbinomialinterestratetreeusingthenewTreasuryyieldcurveandtheoriginalrate

volatilityassumption.

Step4:

Step5:

AddtheOASfromStep1toeachofthe1-yearratesonthetreetoderivea"modified"tree.

Computethepriceofthebondusingthisnewtree.

Step6:

Step7:

RepeatSteps1through5todeterminethebondpricethatresultsfroma100basispoint

decreaseinrates.

Usethesetwopriceestimates,alongwiththeoriginalmarketprice,tocalculateeffectiveduration

andeffectiveconvexity.

Atthemeetingwiththetrustees,Evermorealsopresentstheresultsofheranalysisoftheeffectofchangingmarket

volatilitiesona1-yearconvertiblebondissuedbyHighfourCorporation.Eachbondisconvertibleinto25sharesof

Highfourcommonstock.Thebondisalsocallableat110atanytimepriortomaturity.Sheconcludesthatthevalueofthe

bondwilldecreaseifeither(1)thevolatilityofreturnsonHighfourcommonstockdecreasesor(2)yieldvolatility

decreases.

Davenportimmediatelydisagreeswithherbysaying"changesinthevolatilityofcommonstockreturnswillhavenoeffect

onthevalueoftheconvertiblebond,andadecreaseinyieldvolatilitywillresultinanincreaseinthevalueofthebond."

Question#25of42

QuestionID:1214364

QuestionID:1214365

QuestionID:1214366

Thevalueofthe2-year6%callablebondtodayusingtheinterestratetreeisclosestto:

A)$95.24.

B)$101.01.

C)$102.21.

Question#26of42

IsEvermorecorrectinheranalysisoftheeffectofachangeinyieldvolatility?

A)Incorrectontheputtablebondonly.

B)Incorrectontheputoptiononly.

C)Incorrectonboththebondandtheoption.

Question#27of42

IsEvermorecorrectabouttheeffectofadecreaseinestimatedlevelofyieldvolatilityonthecomputedOAS?

A)Yes.

B)No,OASdependsonlyoncreditandliquidityriskandhencewouldbeunchanged.

C)No,thecomputedOASwouldincrease.

Question#28of42

QuestionID:1214367

IsEvermorecorrectinheranalysisoftherelativevaluationofthebonds?

A)Correctonbothissues.

B)CorrectontheAAissueonly.

C)CorrectontheBBissueonly.

Question#29of42

QuestionID:1214368

Whichofthefollowingstatementsregardingthemethodologiesforestimatingeffectivedurationandconvexityismost

accurate?

A)Davenport’sdescriptionisamoreaccuratedepictionoftheappropriate

methodologythanEvermore’s.

B)Thetwomethodologieswillresultinthesameeffectivedurationandconvexity

estimatesonlyifthesameratevolatilityassumptionisusedineach.

C)Thetwomethodologieswillresultinthesameeffectivedurationandconvexity

estimatesonlyifthesameratevolatilityassumptionisusedineachandthebond’s

OASisequaltozero.

Question#30of42

QuestionID:1214369

Forthisquestion,analyzeeacheffectseparately.IsDavenportcorrectindisagreeingwithEvermore'sconclusions

regardingtheeffectonthevalueoftheconvertiblebondresultingfromachangeinvolatility?

A)Davenportiscorrectonbothconclusions.

B)Davenportiscorrectonstockreturnvolatilityonly.

C)Davenportiscorrectonyieldvolatilityonly.

Questions#31-36of42

Questions31–36relatetoGDBarton,Inc.

GDBarton,Inc.,(GD)isalargemultinationalcompanyheadquarteredintheU.S.Throughaseriesofsubsidiariesaround

theworld,GDoperatesinmultiplesectorsincludingretail,engineering,healthcare,andreinsurance.Thecompanyhasa

largetreasuryandriskmanagementarmbasedintheU.K.,andallresponsibilityforcashandriskmanagementis

centeredinthisLondonoffice.

Recently,amajorbreachofcontrolswasdiscoveredintheoffice;ajunioremployeehadbypassedinternalcontrolsand

openedlargepositionsinseveralderivativecontracts.Theemployeeinquestionwasonlyauthorizedtousesuch

contractsforhedgingpurposes,butthecompanyfearsthatitmayhaveexposureinexcessof$100milliononunhedged

positionsopenedbytheemployee.

Followinganinternalinvestigation,MiguelHernandez,CFA,hasbeenassignedtoreviewandvalueseveralcontractsthat

wereflaggedduringtheaudit.

Detailsofthreeofthecontracts,confirmedasbeingunauthorized(i.e.,notusedforhedging),havebeensummarizedin

anemailtoHernandez.ExtractsofthisemailareshowninExhibit1.

Exhibit1:UnauthorizedContracts

Contract1?InterestRateSwap

Term:

2years

Fixedrate:

3.50%

Settlement:

semi-annual(30/360)

Opened:

180daysago(firstsettlementjustoccurred)

$150million

Notional:

Position:

Fixed-ratepayer

Currenttermstructure:

LIBOR1802.90%,LIBOR3603.00%,LIBOR5403.20%

Contract2?EquitySwap

Term:

1year

3.70%

Fixedrate:

Equityindexatlastsettlement:1926.64

Settlement:

quarterly(30/360)

Opened:

120daysago

Notional:

$250million

Position:

Fixed-ratepayer

Currenttermstructure:

Currentequityindex:

LIBOR602.70%,LIBOR1502.85%,LIBOR2402.95%

1892.23

Contract3?ForwardRateAgreement

Contract:

90-dayforwardrateon180-dayLIBOR(i.e.,3×9FRA)

Price:

3.8%

Opened:

50daysago

Notional:

$125million

Currenttermstructure:

NOTE:WhichLIBORratesdoyourequirehere?

InadditiontotheconfirmedbreachesinExhibit1,theinvestigationalsodiscoveredanumberoftransactionsrelatedto

creditdefaultswaps(CDS).Hernandezhasreceivedanemailfromamemberoftheinvestigativeteamaskingforhis

adviceonGD'sexposureasaresultofthesetransactions.AnextractfromthatemailisshowninExhibit2.

Exhibit2:CreditDefaultSwaps

"…withoutauthorization,theemployeesold$350millionnotionalofprotectionontheiTraxxMain1index,apositionthat

remainsopen.GDhasnoexposuretodebtinstrumentsissuedbyanyoftheconstituentsoftheindex,andthereappear

tobenoothertransactionsinanyindexCDS.Therewere,however,twoothertransactionsinsingle-nameCDS.On

behalfofGD,theemployeepurchased$2.5millionofnotionalexposureonasingle-nameCDSprotectiononPOPRT

corporationdebtand$3.5millionofnotionalexposureonTRTRScorporationdebt.

POPRTisaconstituentoftheiTraxxMainindex,butTRTRSisnot.Sincethesingle-namepositionswereopened,the

creditspreadonbothPOPRTandTRTRShasincreasedbyover250basispoints."

1TheiTraxxMainisanequallyweightedCDSindexconsistingof125investment-gradeentities.

HernandezthinkstheTRTRStransactionmayactuallybealegitimatecontractundertakenbyanotheremployeeofthe

firm,DanEagen.HernandezrecentlyspokeinformallywithEagen,whostatedthathebelievesthat"TRTRSiscurrently

preparingtoundergoaleveragedbuy-outatasignificantpremiumtocurrentmarketvalue."Eagen'sintentionwasto

makeagainbytakingapositionintheCDSandTRTRSstock.

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