2008CFALevel2－Exam1（AM）Question1VeraSandrorecentlyjoinedSeamarkSecuritiesasaportfoliomanager.SandroalsorecentlytooktheLevelIIIexaminationintheCharteredFinancialAnalystprogram,buthasnotyetreceivedherresults.Seamarkisamedium-sizedfirmthatemploysmanyCFAInstitutemembers.Sandrohasbeenaskedbyhersupervisor,LediaFerrazzo,CFA,towriteabriefbiographytobeincludedinthepromotionalbrochureSandrohandsouttoprospectiveclients.Sandroincludedthefollowingsentencesinherbiography:“VeraSandro,aCharteredFinancialAnalystLevelIIIcandidate,hasfocusededucationalandinvestmentexperienceinthesmall-capstockmarket.Shehasconsistentlyachievedbetter-than-averagemarketreturnsandexpectstodosointhefutureaswell.”ThebrochurewasprintedandisbeingusedbySandroasamarketingtool.SoonafterjoiningSeamark,SandroattendedaconferenceatwhichLiamWrightpresentedseveralcomputerizedspreadsheetsthathehaddevelopedtovaluehigh-techstocks.Duringthepresentation,Sandrocopiedthespreadsheetsonherlaptopcomputer.Later,SandromademajorchangestoWright’sinitialmodel.Aftertestingthenewmodel,Sandrowasimpressedwiththeresults.WrightusedStandard&Poor’sdataasinputsforthemodel,butSandrouseddatasuppliedbyMoody’sInvestorsService.Sandrowrotearesearchreportdescribingtherevisedmodelanditsresultsindetailandsentthereporttoherbiggestclient,alongwithsomestockpicksselectedbythemodel.Ferrazzo,theheadportfoliomanagerforSeamark,oftenmeetscorporateexecutivesinthecourseofherevaluationofpotentialinvestments.Aweekago,FerrazzohadlunchwithRalphHenderson,aseniorvicepresidentofKelloggIndustries,amakerofluxurylinens.FerrazzotoldHendersonthatshewaslookingforanappropriateinvestmentinthefabricindustryforherlargeclient,ParkerJones.Hendersonrespondedthathethoughthiscompanywaswell-positionedinthemarket,thoughheadmittedtounderestimatingthedemandforsilksheetsintheregion.Afterlunch,FerrazzoreadaresearchreportthatsaidallofKellogg’ssilkplantswererunningatcapacity,andthecompanymighthavetroublemeetingthelong-termdemand.Twodayslater,FerrazzoobservedanotherseniorvicepresidentofKelloggatarestauranthavingdinnerwiththechieffinancialofficerofBradleyTextiles,amakerofvariouskindsofsilkfabrics.ItiswidelyknowninthemarketthatBradleyisseekingapotentialmergerpartner,asthefounderandCEOisreadytoretire.FerrazzodidadditionalresearchandconcludedthatKelloggIndustriesandBradleyTextileshadcomplementaryproductlinesinseveralareasandsimilarmanagementcultures.ShealsorememberedreadinginForbesastoryinwhichKellogg’sCFOwasquotedassayingthecompanyhadthefinancialwherewithalforamergerandaninterestinexpansion.Ferrazzo’sresearchindicatedthatBradley’smarketvalueexceededitsintrinsicvalue,suggestingthatKelloggwasunlikelytopayahighmergerpremium.Nonetheless,FerrazzoproceededtopurchasestockinBradleyonbehalfofherclients.Sixmonthslater,KelloggacquiredBradleyandpaida40percentpremiumovermarketprice.SandrosharesaworkspacewithDonWilson,aCFAcharterholder.WilsonrecommendsthatoneofhisclientsbuyAlphaCo.sharesbasedupondetailedresearchconductedbyaSeamarkanalyst.SandrorecommendsthatoneofherclientssellAlphaCo.sharesbaseduponcomprehensiveresearchconductedbyanotherbrokeragefirm.Seamarkhasevaluatedprospectivebrokerstoexecutetradesonbehalfofitsinvestment-managementclients.Thefindingsareasfollows:♣WhiteBrokerageCo.offersbestpriceandexecution,chargesanaverageof$99foratypicaltrade,andprovidesgeneroussoftdollars.♣GreenBrokersInc.,offersgoodpriceandexecution,chargesanaverageof$59foratypicaltrade,andprovidesmoderatesoftdollars.♣BlueBrokerageServicesInc.,offersbestpriceandexecution,chargesanaverageof$79foratypicaltrade,andprovidesmoderatesoftdollars.Part1)WithregardstoFerrazzo’spurchaseofBradleystock,sheviolated:A)StandardIII(E):PreservationofConfidentialityandStandardII(A):MaterialNonpublicInformation.B)StandardV(A):DiligenceandReasonableBasis,butnotStandardII(A):MaterialNonpublicInformation.C)StandardIII(E):PreservationofConfidentiality,butnotStandardV(A):DiligenceandReasonableBasis.D)StandardII(A):MaterialNonpublicInformationandStandardV(A):DiligenceandReasonableBasis.Part2)Regardingthehigh-techstockmodel,whichofthefollowingactionsisleastlikelytohelpSandroavoidviolatingthestandardsregardingplagiarismandresearchreports?A)Providingbasicinformationabouttechnologystocksintheresearchreport.B)AcknowledgingWright’sdevelopmentoftheinitialmodel.C)AcknowledgingStandard&Poor’sastheoriginaldatasourceandMoody’sInvestorsServiceasthenewdatasource.D)AcquiringWright’spermissiontocopythespreadsheets.Part3)Theproductionoftheadvertisingrepresentedaviolationof:A)StandardIV(C):ResponsibilitiesofSupervisors,butnotStandardVII(B):ReferencetoCFAInstitute,theCFADesignation,andtheCFAProgram.B)StandardIV(A):LoyaltytoEmployerandStandardI(C):Misrepresentation.C)StandardIV(A):LoyaltytoEmployer,andStandardIV(C):ResponsibilitiesofSupervisors.D)StandardVII(B):ReferencetoCFAInstitute,theCFADesignation,andtheCFAProgram,andStandardI(C):Misrepresentation.Part4)Ferrazzomayusewhichofthefollowingbrokers?A)Whiteonly.B)Blueonly.C)WhiteandBlueonly.D)BlueandGreenonly.Part5)WhichofthefollowingstatementsregardingAlphaCo.isleastaccurate?A)Sandrohasbreachedafiduciarydutytoherclient.B)BothWilsonandSandrohaveareasonablebasisfortheirrecommendations.C)Thefair-dealingstandardhasnotbeenviolated.IfSeamarkhasabuyratingonAlpha,Sandro’sclientshouldbeinformedofthisfactbeforethesellorderisD)placed.Part6)WhichofthefollowingstatementsregardingSandro'sbiographyisleastaccurate?A)Sandromustdiscloseherstakeinathinlytraded,family-ownedconstructioncompany.B)SandroneednotdeliveracopyoftheCodeandStandardstoFerrazzo.C)Sandrocannotusethedesignation“CFALevelIII.”D)SandrocanbeginusingtheCFAdesignationassoonasshereceivesherexamresults.Question2MinutronCorporationisaChicagobasedproduceroftechnologycomponents.Sinceitcompeteswithothertechnologyfirmsforexperiencedengineers,designers,salesrepresentativesandofficepersonnel,ithaslongfollowedcommoncompensationpracticesofthetechnologyindustry.OneaspectofMinutron’sapproachtocompensationistheissuanceofsignificantstock-basedcompensation.Minutron’sboardbelievesthatseniortechnicalstaffandallmanagementpersonnelshouldhaveafinancialstakeinthesuccessofthefirmandtheprofitabledevelopmentofnewtechnologies.Theboardhasconsequentlydeveloped,andovertheyearsgreatlyexpanded,agenerousstockoptionplanforalargeproportionofMinutron’semployees.Minutronhasalsosetupseveraljointventureswithothertechnology-relatedcorporatepartnerstoengageinresearchanddevelopmentalongspecificscientificlines.Thesejointventureshavegenerallybeenstructuredasspecialpurposeentities(SPEs)inanefforttoobtainlowercostfinancingthantheprojectswouldotherwisehaverequired.JackBeaumont,CFOofMinutron,hasquestionsabouttheimpactofFASBInterpretationNumber46(R),“ConsolidationofVariableInterestEntities”(FIN46R)andSFASNumber123(R),“Share-BasedPayment”onMinutron.Beaumontisconcernedthattheymayhaveadetrimentalimpactontheconsolidatedfinancialstatementsofthefirm.Ifso,hewantstoensurethattheboardisawareoftheissueandhastheopportunitytoreassessitscompensationplansandcorporatestructureaccordingly.Toassesstheeffectonthefirm,BeaumontaskedoneofMinutron’sstaffaccountants,RashidDavis,toinvestigatethedetailsofFIN46RandSFAS123RandhowtheiradoptionhasaffectedMinutron.DavisprovidedBeaumontthefollowingsummaryinformationaboutthetwoaccountingrequirements:Table1AccountingRequirementsFIN46R–SPEsmust:legalformstaffingonlybeacorporationorjointventurehaveseparatemanagement&employeesSFAS123R–effectivedates:fiscalyearsbeginningafter:publiccompaniesnon-publiccompaniesDecember31,2005December31,2007DavisinformsBeaumontthat,inhisview,theuseofstockoptionsishavingamaterialimpactonMinutron’sfinancialstatements.Hepointsout,“UnderSFASno(R),firmsarerequiredtorecognizecompensationexpensebasedonthebookvalueofstock-basedawardsasoftheexercisedate.”Heexplainsthatthelargenumberofstock-basedawardsgrantedtoMinutronemployeesmakesthemasignificantaspectofthefinancialperformanceofthefirm.DavismakesanumberofsuggestionstoBeaumontabouthowthefirmcouldreducetheimpactofitsstockoptionplanonfinancialperformancebyreviewingitspoliciesonperformance-basedawards.Davissuggestschangingthevestingpolicysince,“Ifanawardvestsautomaticallywhenanemployeeretires,therequisiteserviceperiodendswhentheemployeeiseligibletoretire,notwhenheactuallyretires.”Davisalsosuggeststhatthefirmmightconsiderreviewingitspolicyonmultipleperformanceconditions,remindingBeaumont,“Ifatleasttwoperformanceconditionshavetobesatisfied,therequisiteserviceperioddoesn’tenduntilalltheconditionsaremet.”BeaumontagreesthatMinutronneedstoreviewitspoliciesinlightoftheimpactonitsaccountingstatements.Hesuggests,“Sincevariableinterestentity(VIEs)havetobeconsolidatedbytheprimarybeneficiary,weshouldonlyhaveminorityvotingcontrolinourSPEssothatwearen’tconsideredtheprimarybeneficiary.”BeaumontalsosuggestsreviewingtheiruseofdebtintheirSPEstructures,“sincedebtguaranteesandholdingsubordinateddebtcanbothbeconsideredvariableinterests.”Part1)AreBeaumont’sstatementsaboutVIEscorrectwithregardto:primarybeneficiaries?debt?IncorrectIncorrectA)B)CorrectCorrectC)CorrectD)IncorrectCorrectIncorrectPart2)IstheinformationinTable1regardingthelegalformandstaffingofSPEscorrect?LegalformStaffingA)NoYesB)YesYesC)YesNoD)NoNoPart3)WhichofthefollowingconditionsisleastlikelytocauseanentitytobeconsideredaVIE?A)Shareholdersdonotabsorbtheexpectedlosses.B)Shareholdersdonotreceivetheexpectedresidualreturns.C)Shareholdershavedecisionmakingrights.D)At-riskequityislessthan10%oftotalassets.Part4)IsDavis’statementabouttherequirementsforcomputingcompensationexpenseunderSFASNo(R)correctwithregardto:valuationmethod?choiceofdate?A)NoYesB)YesYesC)YesNoD)NoNoPart5)Davis’statementsabouttherequisiteserviceperiodforperformance-basedawardsarebestdescribedas:incorrectaboutbothvestingandperformanceconditions.A)B)correctaboutvestingbutincorrectaboutperformanceconditions.incorrectaboutvestingbutcorrectaboutperformanceconditions.C)D)correctaboutbothvestingandperformanceconditions.Part6)WhichmostaccuratelydescribestheinformationinTable1regardingtheeffectivedatesofSFAS123Ron:non-publiccompanies?publiccompanies?IncorrectCorrectIncorrectA)B)C)CorrectIncorrectD)CorrectCorrectIncorrectQuestion3GeorgeHarperteachesinvestmentsatSouthwestTexasPolytechnicInstitute.Hehasfamiliarizedhisstudentswiththebasicsofinvesting,howmarketswork,commonvaluationmethods,andtheunderpinningsofmodernstockanalysis.Hecommentstotheclassthat,“Mostvaluationmodelscurrentlyusedbyfinancialprofessionalshavetheirrootsinafewbasicideassetdownbypioneersinthefielddecadesago.”Harpernowbelievestheclassisreadytomoveontoamoredetailedstudyofstockvaluation.Harperwarnedthestudentsthattheyshouldnotalwaystrustthestatisticsprovidedbycompanies.“Whenthenewsisnotgood,managementhasastrongincentivetodeceiveinvestors.”Harpersuggeststhattocombatthispotentialfordissembling,investorsreadthefootnotes.Heopensupthetopicfordiscussion,andfourstudentsmakepoints.JohnAble:JaneBaker:“Companymanagementhasalotoffreedomtosetdepreciationrates.Thiseffectivelyletsthecompanydeferrecognitionofrevenueandexpensestofutureyears.”“Enrontaughtusallalesson.Wemustpaycarefulattentiontothebalancesheettoensurethatmanagementisnotusingvariable-interestentitiestohidetheamountofliabilitiesthecompanyfaces.”JosephCutler:“Toguardagainstunderestimatingtheeffectofinflation,ananalystmustconsiderwhetherdifferentexpensesarecalculatedbasedonadifferentcoststructure.”JaniceDrake:“Cleardisclosurecanincreaseanalystandinvestorconfidenceinacompany.Unfortunately,thatincreasedconfidencedoesnottranslateintohigherstockvaluations.”