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CFA Level 2 Classroom Test 1

Answers

SECTION I - ECONOMICS
1. C
Changes in the growth rate of labor productivity may be decomposed into
two components: (1) the growth in physical capital per labor hour, and (2)
technological change. The one third rule is useful in this decomposition.
2. B
The nominal exchange rate is quite simply the price of one currency relative
to another. It is the quote observed in currency markets.
3. A
If the Japanese government wants to maintain a constant exchange rate
between yen and the U.S. dollar, then it would most likely shift to a more
expansionary monetary policy, decrease its tariffs, or eliminate its quotas. A
more expansionary monetary policy will decrease real yen interest rates,
reducing investment by foreigners in Japan (decrease yen demand), and
increasing investment abroad by Japanese investors (increases yen supplied).
4. B
Building an electronics plant in Mexico will require the German electronics
manufacturer to pay for expenses (construction fees, salaries, administrative
expenses, etc.) associated with the project in pesos. Therefore, the
manufacturer will need to convert euros to pesos thereby increasing the
supply of euros in the foreign exchange market and increasing the demand
for pesos.
5. A
If an American distributor is purchasing Korean televisions, then the
distributor will need to sell dollars and purchase won. This action will supply
dollars to the foreign exchange market. The sale of U.S. automobiles to
Vietnamese consumers would increase the demand for dollars as Vietnamese
consumers sell dongs and buy dollars. The sale of a U.S. company to a Dutch
investor would also increase the demand for the dollar in the foreign
exchange market and increase the supply of euros as the Dutch investor sells
euros and buys dollars.
6. A
Purchasing power parity states that exchange rates will change to reflect
differences in inflation between countries. Interest rate parity states that
exchange rates must change so that risk-adjusted returns on investments in
any currency will be equal.
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7. A
IRP means that interest rates and exchange rates will adjust so the risk
adjusted return on assets between any two countries and their associated
currencies will be the same. PPP is based on the idea that a given basket of
goods should cost the same in different countries after taking into account
the changes in exchange rates. PPP does not hold due to transportation costs
and other factors.
8. B
Purchasing power parity implies that changes in the price levels in two
countries should be reflected in changes in the exchange rate.
9. C
If the exchange rate rises above 110 yen /USD the Fed can decrease the rate
by selling dollars (supply of USD increases, yen/USD exchange rate falls) and,
conversely, if the exchange rate falls below 100 yen/USD, the Fed can
increase the rate by selling yen/buying dollars.
10.B
If one USD buys 120 JPY, 20 USD buys 2,400 JPY, which is the price of the
bottle of wine.
11.C
The percentage spread is the same irrespective of how the quote is made.
The percentage spread is calculated as: (1.435 ? 1.425) / 1.435 100 =
0.697%
12.C
First invert the EUR:USD quote by 1 / 0.9350 = 1.0695 and 1 / 0.9400 =
1.0638 for a quote of USD:EUR 1.0638 : 1.069. Then set up a bid-ask matrix.
1.4950 / 1.0695 = EUR:CAD 1.3978
1.5005 / 1.0638 = EUR:CAD 1.4105
The EUR:CAD bid-ask quote is 1.3978 : 1.4105
13.A
When the bank bids they are buying and you are selling. Spot exchange
rates, forward exchange rates, and interest rates are closely linked. The bidask spread between pesos and pounds is 6.0000/2.0015 = 2.9978 and
6.0025/2.0000 = 3.0013.
14.A
Since the forward rate is less than the spot rate, the Euro is selling at a
forward discount. The amount of the discount is calculated as follows:
Forward Discount = Forward rate Spot Rate = $1.1015 - $1.1525 = -$0.051.
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15.B
[(forward rate - spot rate) / spot rate] (360 / number of forward contract
days)
= [(0.0859 - 0.0887) / 0.0887] (360 / 90)
= - 0.1263 or - 12.63%.
16.C
An exchange rate is a ratio that describes how many units of one currency
you can buy per unit of another currency. The numerator will be in the
currency in which the quote is made, and the denominator is the other unit of
the currency you are comparing. A currency appreciates when it rises in
value relative to another foreign currency. Likewise, a currency depreciates
when it falls in value relative to another foreign currency. An appreciation in
value of a currency makes that country's goods more expensive to residents
of other countries. The depreciation of the value of a currency makes a
country's goods more attractive to foreign buyers.
17.C
The balance of payments (BOP) equation is:
Current Account + Capital Account + Official Reserve Account = 0
The current account measures the exchange of merchandise goods, services,
investment income, and unilateral transfers (gifts to and from other nations)
between nations. The BOP equation must equal zero and a surplus or deficit
in any account does not indicate an economic strength or weakness.
18.A
A large increase in Chinas current account can only mean that it has
received income from the sale of its trade merchandise (exports) and
payments on its existing investments. Both remaining transactions affect the
other elements of the balance of payment accounts. If China lends financial
assistance to other nations, it shows up in its capital account and if its
foreign currency reserves increase, it shows up in its official reserve account.
19.B
In order for relative PPP to hold, countries with higher rates of expected
inflation should see their currencies depreciate.
20.C
Solve for the expected inflation rate for Kenya implied in the forward rate (iK)
by using the same formula for relative PPP:
S1 = S0 [(1 + inflation-FC) / (1 + inflation-DC)]
S1 = KS95.7686 = KS90.772 [(1 + iK) / (1 + 0.09)]
iK = 15%

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SECTION II ETHICAL & PROFESSIONAL STANDARDS

21.A
Shermans comments about his staff and the CFA Program are all
acceptable.
22.B
Martineau need not remove her name from the report, but she should
document the difference of opinion.
23.C
The CFA Institute Research Objectivity Standards recommend that firms
provide full research reports on the subject companies discussed to
members of the audience at a reasonable price. At a minimum, the
covered employee should disclose whether a written research report is
available to members of the audience who are not clients of the firm, the
approximate cost, and how a listener might acquire the report. Firms
should make copies of the full research report available for purchase or
review; for example via the firms website.
24.C
Critique company policies and practices related to research objectivity and
distinguish between changes required and changes recommended for
compliance with the Research Objectivity Standards.
The CFA Institute Research Objectivity Standards requires firms to ensure
that covered employees and members of their immediate families do not
have the ability to trade in advance of or otherwise disadvantage investing
clients relative to themselves of the firm.
25.A
The Standards prohibit Sherman from revealing confidential information
about clients or former clients, including use of the clients name.
26.C
According to Standard III (A) Loyalty, Prudence, and Care, members must
act for the benefit of their clients and place their clients interests before
their own. Martineau puts her own interests ahead of that of her clients
when directing brokerage in exchange for client referrals. Martineau may
trade through RLB only if the accounts receive best price and execution
and the practice (i.e. the referral arrangement) is disclosed to clients.

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