Mock Test Session 1 – Question Sheet

Case No. 1
Chester Siggurdson, CFA, and Pamela Bowen, CFA, are both
with Conservative Capital. Siggurdson is a credit analyst and
Bowen is a financial adviser, and they often work together on
assignments. The firm serves as an underwriter for
government bonds and manages diversified portfolios as an
advisor for wealthy individuals.

Two years ago, Conservative Capital worked on a municipality's

successful bond issue to fund the construction of a
multipurpose convention center complex with public recreation
areas, a luxury hotel, and a world-class concert venue. Bowen
had placed many of the municipality's bonds from prior issues
with her clients, and she did so again with this issue. Often, but
not always, the municipality sent Bowen gifts to acknowledge
the placements.

Now the center is ready to open, and as a show of

appreciation, the municipality invites Bowen to attend the gala
opening, to be followed the next day by a meeting with officials
to discuss future bond underwritings. The municipality will pay
all expenses, including airfare, meals, and accommodation at
the convention center hotel.

Bowen accepts the invitation and attends the opening. Before

the next day's meeting, she overhears center staff say that the
convention center has not received as many bookings as
anticipated. During the meeting, she asks the center's director
whether the revenue from the center will be sufficient to
service the bonds. The director responds that while bookings
have been slower than projected, there is no risk of bond
obligations not being paid as scheduled.

Later that day, Bowen telephones Siggurdson from the airport

and says, "I don't have anything specific, but I'm not feeling
comfortable about the municipality's revenue forecasts."
Siggurdson replies that he has no information on the matter
but will check around. Siggurdson then speaks to sources at
one of the ratings agencies. One source tells him that some
bookings may have been canceled, but the agency has not
been able to assess whether that will negatively affect the
bonds. Siggurdson verifies approximately 15 cancellations
using public information, including concert performers' publicly
available websites.
Based on only the information he has compiled, Siggurdson
quickly prepares a report advising that the cancellations
may leave the municipality unable to pay interest on the
bonds when due. He concludes that investors should hold
the bonds until he can learn more, but several clients
immediately sell their holdings of the municipality's bonds.
The following day, the ratings agency downgrades the
convention center bond issue to junk bond status, causing
the price to fall significantly.
One of Bowen's advisory clients is a wealthy individual.
Bowen has prepared an investment policy statement (IPS)
and reviews it with the client annually. The client's
objectives and constraints, as identified in the IPS, indicate
that below-investment-grade bonds are not suitable for this
client's portfolio. However, yields have been very low for
several years, and the client has spoken to Bowen about the
need for the portfolio to generate higher returns from its
bond holdings.

The client has researched the recently downgraded

municipal bonds and is attracted by their high yields.
Bowen believes that the bonds' riskiness makes them
unsuitable, but she has had difficulty with this client in the
past and Bowen worries that she will lose his business if she
voices her concerns, so she remains silent. The client
places an order for a significant amount of the convention
center bonds, which Bowen instructs Conservative Capital's
trading desk to execute.

Without informing Conservative Capital, Siggurdson has

accepted an offer to work full time as an employee for one
of the firm's competitors. Siggurdson was previously an
employee of Conservative Capital, but several years ago he
and the firm mutually agreed to change his status to an
independent contractor. As an independent contractor,
Siggurdson:

works far fewer hours than analysts who are full-time

employees;
is free to accept assignments from Conservative Capital's
competitors, although he has not done so; and
works primarily from his home but sometimes visits the
firm's office, working at any empty desk when he is there.
Siggurdson has posted his new position on his personal
social media account, which is visible to some of
Conservative Capital's clients. He has also obtained
information about these clients from sources unrelated to
Conservative Capital.
Case No. 1
Case No. 2
Luca Albrecht and Katrin Sauer are quantitative analysts at a
hedge fund specializing in credit strategies. They are
developing machine learning (ML) models to predict the credit
ratings for new bond issues and/or changes in ratings for any
bond.

Albrecht plans to use an unsupervised clustering model to

predict credit ratings and is deciding between k-means
clustering and hierarchical clustering models. Sauer helps
Albrecht review the data being analyzed and states:

Statement 1: Since you know the number of clusters you plan

to use beforehand, this bypasses a limitation of k-means
clustering.
Statement 2: Since you are looking at the global structure of
the data and identifying large clusters, agglomerative clustering
would be better suited than divisive clustering.
Sauer has built a deep neural network (DNN) to analyze bonds
to estimate when there might be changes to an issuer's credit
rating. After going through several iterations of the model and
changing the hyperparameters, Sauer settles on a model with:

8 fundamental features
11 industry dummy variables
3 hidden layers with 80 nodes each
An output of the estimated credit rating over the next quarter
Albrecht suggests introducing a term to shrink the number of
nodes with nonzero weighting in the DNN to reduce overfitting
risk.

Then, Albrecht asks Sauer for an update on the ML algorithm

developed at the beginning of the year to predict market
sentiment based on social media posts. Sauer explains that:

the data set was split into training, cross-validation (CV), and
test data sets,
a logistic regression model was used to classify texts and
predict sentiments,
positive sentiments were classified as 1 and negative
sentiments as 0, and
the model was tested based on different threshold p-values.
Sauer tells Albrecht that she compared the model performance
on the training and CV data sets using three different threshold
p-values. The analysis included receiver operating
characteristic (ROC) plots and the area under the curve (AUC)
for each ROC curve. The conclusions of the analysis are
presented in Exhibit 1:
Case No. 1
Case No. 3
Ciara Amutenya is the head of research at Brandberg Asset
Management. She is currently reviewing the valuation and
growth outlook of two stocks in the firm's portfolio: Kunene
Semiconductors and Swakop Oil. She directs Linus
Nangombe, a junior analyst at Brandberg, to analyze both
companies.

Amutenya asks Nangombe to calculate Kunene's justified

trailing P/E based on the Gordon growth model and to
determine whether the stock is currently overvalued, fairly
valued, or undervalued. Nangombe gathers information
from Kunene, summarized in Exhibit 1:

Nangombe explains that the expected dividend growth rate

reflects Kunene's performance in the previous five years.
Amutenya knows that Kunene's competitors are making
substantial investments in innovative technologies and
expects these technologies to be market-ready in the
medium term. Therefore, she believes that Kunene will not
be able to maintain a dividend growth rate of 8.0% over
time. She asks Nangombe to estimate the value of
Kunene's stock using the H-model and assuming that the
dividend growth rate:

is initially 8.0%,
declines linearly during a 10-year period, and
stabilizes at a perpetual growth rate of 5.0%.
Amutenya then turns her attention to Swakop Oil, one of
the major operators of retail gas stations in the region. She
asks Nangombe to estimate the company's sustainable
growth rate. Nangombe decides to use DuPont analysis
and summarizes the information in Exhibit 2:
Amutenya is concerned about Swakop's ability to maintain
its current level of returns. Nangombe explains that he
conducted an industry and competitive analysis for Swakop
and the oil distribution industry. He lists the following
observations:

Observation 1:Swakop changed its gasoline suppliers

several times due to intense competition among the
suppliers to offer the best prices and terms.
Observation 2:Swakop is the lowest-cost producer; its
products are similar to competitors' and are priced slightly
below average market price.
Observation 3:Swakop has achieved above-average returns
in the previous five years, and the barriers to entry in its
industry are low.
After listening to Nangombe, Amutenya concludes that
Swakop's current level of returns may not be sustainable
and decides to reduce long-term growth rate forecasts.
Case No. 1
Case No. 4
Antti Laine is a portfolio manager for a large pension fund
and is responsible for the day-to-day management of the
fund's alternative investments. The fund has exposure to
commodities through numerous futures positions.
Six months ago, the fund took a fully collateralized position
in a gold futures contract at $1,750/ounce. Since then, the
collateral has earned a 1.50% annualized rate. Because the
contract was nearing expiration, Laine rolled the entire
position into the current 6-month gold futures contract. At
the time of the roll, the near-term contract was
$1,770/ounce and the farther-term contract was
$1,785/ounce.
Laine turns his attention to Alpha Fund, a private equity
fund with a 20X0 vintage. Alpha Fund has a 2%
management fee on paid-in capital and carried interest of
20% when NAV after distributions is greater than the
committed capital of $200 million. Laine notes that all the
capital calls occur at the beginning of the year, while all
other cash flows and fees occur at year-end. Information
on Alpha Fund is shown in Exhibit 1:

Laine is comparing Alpha Fund's performance to other

funds of the same vintage, including Beta Fund, which has a
net IRR of 6.80%, and Gamma Fund, which has a net IRR of
11.80%.

Laine intends to increase the pension fund's exposure to

real estate. He is considering both REITs and direct real
estate investment. When evaluating Tower Block, an
apartment REIT, Laine identifies raw land on the company's
balance sheet that was acquired 5 years ago. The land
remains undeveloped; given the market's growth, the land
value has appreciated significantly since it was purchased.

Laine then reviews a direct investment in a real estate

property, Casa Grande Apartments. Laine intends to hold
the investment for 3 years and wants to compare the
property's estimated value using the direct capitalization
method versus the discounted cash flow (DCF) method.
Laine collects information on the property, shown in Exhibit
2:

Laine expects Casa Grande's net operating income to grow

at a constant 2% rate into perpetuity.
Case No. 1
Case No. 5
Robert Lopez is a newly hired risk analyst at MultiStrat
Capital, a multi-strategy hedge fund. Paola Reyes is a senior
risk analyst at MultiStrat and Lopez's supervisor. Reyes
explains to Lopez that the firm has two hedge fund
strategies, both consisting of numerous independent sub-
portfolios. Each sub-portfolio has a different investment
strategy, portfolio manager, and risk budget. Due to the
varied nature of the investment strategies, the correlations
among strategies are relatively low.
Reyes explains that the firm's risk management and risk
budgeting process is based on parametric value at risk (VaR)
at the fund level and marginal value at risk (MVaR) at the
sub-portfolio level. Reyes states that the VaR for the Alpha
Fund is $100 million and provides Lopez with information
on the sub-portfolios, shown in Exhibit 1:

Lopez makes the following comments:

Comment 1: Since the portfolios are not highly correlated,
the firm is underutilizing the fund's full risk appetite.
Comment 2: MVaR is useful as a pre-trade evaluation tool
on the potential impact of a trade on total VaR.
Reyes explains that as part of the firm's risk management
process, the risk team conducts scenario risk analysis for
the fund and on a sub-portfolio basis each month. The
team begins the analysis by identifying each portfolio's five
most significant exposures and then assesses the potential
for unforeseen vulnerabilities. The analysis stresses
correlations and co-movement of assets.
Reyes then provides Lopez with VaR input assumptions for
the Sigma Fund and asks that he calculate VaR using the
parametric approach.
MultiStrat's business model calls for it to identify new
investment talent that complements existing strategies and
then provide capital, along with integrated technology
solutions, back office, and risk management services, to
implement those strategies.

The risk group at MultiStrat is one of the first to evaluate

new investment strategies presented by outside managers.
Most new strategies are quantitative factor strategies that
have been backtested but without real-world
implementation.

A recent manager submission included the following

information and attributes:

Historical investment simulation

Investment universe defined as benchmark securities
5, 10, and 15 years of historical data analyzed
Rolling windows approach analysis
Point-in-time data
Up to 10 factor portfolios
After backtesting dozens of strategies based on this
information, the outside manager presented MultiStrat
with a strategy for consideration. Based on 5 years of
historical data, a monthly rebalance, and 7 equally
weighted factors, the strategy produced a Sharpe ratio of
2.5 with realized volatility of 3%. This strategy also had the
highest t-statistic of 2.7 and lowest p-value of 1.4% of any
strategy tested.
Case No. 1
Case No. 1
Case No. 6
Luca Girardi is a fixed income portfolio manager at Bled
Capital. Girardi works closely with Eva Novak, Bled's chief
economist. The domestic economy has been in a sustained
expansion for the past few years. Recently, inflation has
accelerated well above the central bank's inflation target.

Novak's base case economic forecast is for the economic

expansion to continue in the coming year and for inflation
to continue rising over the next few quarters. Novak
forecasts that the central bank will respond to these
developments by aggressively raising its policy rate over the
next six months, resulting in a mild recession in the
following year.

The current government bond yield curve is the steepest it

has been in years, as the yield on the 10-year bond is
currently 300 basis points above the yield on the 2-year
bond. Girardi compares the government bond yield curve
with the interest rate swap curve to get a relative measure
of the credit and liquidity risks reflected in the corporate
bond market, as shown in Exhibit 1:

Girardi is evaluating the relative attractiveness of a BBB-

rated industrial bond. The bond matures in 5 years and is
continuously callable beginning in 2 years. Girardi will
determine the bond's attractiveness relative to similar
bonds based on its option-adjusted spread (OAS).
Case No. 1
Case No. 1
Case No. 7
Arianna Varela is the head of research at an asset
management firm. She directs Theron Misko, a senior
analyst who covers the technology industry, to analyze
Colossus Robotics and Acheron Semiconductors. Varela is
particularly interested in evaluating the quality of both
companies' financial reports and earnings.
Misko explains that Colossus Robotics has been operating in
the industrial robotics segment for over two decades, but
the company recently started manufacturing drones for
consumer and commercial uses. Investors see great growth
potential in this market and have been valuing drone
manufacturers at higher multiples; as a result, Colossus's
stock price has increased substantially. Misko reached the
following conclusions after analyzing the company's
financial reports:
Conclusion 1: Colossus's receivables turnover increased
significantly in recent quarters.
Conclusion 2: Colossus's drone segment had excellent
performance in the last two years, but the industrial
robotics segment performed significantly worse than
competitors.
Conclusion 3: Colossus has a Beneish's M-score of −2.70,
which is below the industry average.
Varela asks Misko to compare Colossus with its competitors.
Misko explains that Colossus adopted financial reporting
choices that overstate its assets, affecting the comparability
of the firm's financial statements.
Varela then asks Misko about Acheron Semiconductors.
After analyzing the company's financial statements, he
believes that Acheron has good reporting quality, but there
are warning signs suggesting that the company has low-
quality earnings. The analysis is summarized in Exhibit 1:
Varela is concerned that a new accounting rule may create
more restrictions on capitalizing installation and assembly
costs relative to capital projects. Currently, Acheron treats
such costs as capital expenditures and records them as part
of PPE. This change would decrease the portion of costs
that Acheron can capitalize and, consequently, increase the
portion that is expensed. Varela does not expect any other
factor to impact the firm's financial statements.
Case No. 1
Case No. 8
Paula Kostas is a junior analyst at InvestUp, a multi-strategy
asset management company. Kostas is analyzing a
conglomerate planning to divest one of its businesses. She
asks her supervisor, Vasso Tzortzi, about underlying
motivations that drive divestment actions and Tzortzi lists
the following:
Motivation 1: Raising cash to reduce financial leverage
Motivation 2: Selling undervalued businesses to reduce
conglomerate discount
Motivation 3: Complying with court decisions in antitrust
cases
InvestUp is considering a significant investment in
Chattergram, which has large cash reserves from its online
sales of social media applications. Although Chattergram
has never paid dividends, its shareholders have recently
urged the company's management to begin doing so.
However, management does not believe dividends are
warranted since it has identified several projects that would
require large cash outlays.
One area that InvestUp considers is a company's corporate
governance. Kostas is asked for information concerning
Chattergram's ownership structure. She provides the
following:
30% of Chattergram's common stock is owned by the
founder's family.
No other shareholder owns more than 1% of the stock.
None of the family members participate in Chattergram's
management, nor do they serve on the board of directors.
There is a dual class share structure:
Family members own Class A shares, with 1.6 votes per
share.
Nonfamily members own Class B shares, with 1 vote per
share.
Kostas turns her attention to Balaskas Group, a large
software developer that recently restructured its mix of
debt and equity through a dividend recapitalization.
Balaskas is a mature company with stable revenues and
cash flows. Kostas analyzes the company's financial
statements to understand the effects of this restructuring
action.
Case No. 1
Case No. 1
Case No. 9
Angelika Frueh is a senior analyst at Forschung Global Asset
Research. She is estimating the intrinsic value of Wohnung
GmbH, using a two-stage free cash flow valuation model.
Frueh uses Wohnung's cash flow statement for the most
recently ended fiscal year, shown in Exhibit 1:

She also makes the following assumptions when valuing

Wohnung:

WACC is 12%.
FCFF will grow at 10% annually for the next 5 years and
then grow indefinitely at 4% annually.
Market value of debt is €100 million.
There are 40 million common shares outstanding.
Frueh then meets with Laura Schriner, an intern, to review
the model. Schriner, who has little experience in valuing
companies using free cash flow, points out that Frueh has
not factored future corporate actions into this model and
asks how share buybacks, dividend payments, and debt
issuance affect free cash flows.
Frueh responds with the following statements:

Statement 1: Share repurchases will affect FCFE but not

FCFF since FCFE represents cash flows after accounting for
share buybacks.
Statement 2: Changes in the target debt ratio will impact
FCFE. For example, borrowing additional debt this year will
increase FCFE.
Statement 3: Paying dividends will decrease FCFE since
FCFE is calculated net of dividend distributions.
One month later, Frueh begins to cover Spielspas GmbH,
which is currently privately held, and meets with Spielspas's
founder and CEO, Dieter Kuster. During the meeting, Kuster
reveals near-term plans to take the company public and
asks Frueh to estimate the company's intrinsic value. When
Frueh states that she will do so by discounting FCFE, Kuster
asks why it is better to use FCFE instead of net income or
EBITDA. She notes three differences between them:

Difference 1: Unlike EBITDA, free cash flow is net of

depreciation and amortization.
Difference 2: Unlike net income, free cash flow is net of
dividends paid to shareholders.
Difference 3: Unlike net income and EBITDA, free cash
flow deducts investments in fixed capital.
Three years later, Spielspas is trading on Euronext for €48
per share with an estimated EPS of €2. To assess whether
Spielspas is fairly valued, Frueh gathers three similar
competitors' forward P/E ratios to compare with Spielspas's
P/E.
Case No. 1
Case No. 1
Case No. 10
Harold Harrison, a CFA Level I Candidate, works as an
investment analyst at Igneous Wealth. Igneous provides
financial and estate planning to high-net-worth and retail
investors. Igneous's investment process relies on numerous
third-party research providers. All third-party research
must be vetted and approved by Igneous's investment
committee.

Pumice Research publishes weekly macroeconomic

analyses and forecasts and is one of the firm's approved
research providers. Harrison often disagrees with Pumice's
conclusions regarding the expected impact on financial
markets but still finds its work interesting and thought-
provoking.

Annually, Igneous forecasts asset class returns for the next

five years and uses this information in constructing client
portfolios. Harrison is responsible for these forecasts and
uses many of Pumice's economic estimates to create them.
Harrison's entire personal investment portfolio is invested
in Igneous's most aggressive model portfolio, which consists
primarily of individual stocks. Harrison's account is at the
same brokerage firm as clients' accounts. The firm's trading
desk executes all model portfolio changes, including
Harrison’s.

Harrison's CFA Level I exam date is quickly approaching. He

has been working unusually long hours and is also studying
for a mandatory financial regulatory exam scheduled just a
week after the CFA exam. During the CFA exam, he notifies
the proctor that he needs to use the washroom. As he is
walking through the testing center, he glances at one of the
screens of another CFA Level I test taker. Harrison
recognizes the question and sees the other Candidate
select a different answer than he did. All of this goes
unnoticed by the proctor. Once Harrison resumes the
exam, he returns to that specific question, realizes he did
not read the question carefully, and confidently selects a
different answer. Harrison's new answer choice is not the
same answer that the other Candidate selected. Harrison
completes the remainder of the exam without incident.
Exhausted by work and by studying for the CFA exam,
Harrison is not confident in his ability to pass the regulatory
exam, which contains many country-specific questions on
rules, regulations, and taxes. Harrison's coworker Natalie
Grimes, who is also a CFA Level I Candidate, is taking the
same regulatory exam the day before Harrison is.

The morning that Harrison is scheduled to take the exam,

Grimes and Harrison are discussing Grimes's exam
experience in general, but nothing specific regarding the
test or question content. Grimes notices that Harrison has
a small piece of paper with what appear to be exam-related
notes. Harrison takes these notes into the exam room and
uses them during the exam to answer questions. After the
test, Harrison confides to Grimes that he would not have
passed the exam without using his notes. Grimes reassures
Harrison that his secret is safe and that she will not mention
this to anyone.
Case No. 1
Case No. 11
Claris Wentz is an interest rate derivatives trader for an
international hedge fund. She works with Todd Martens, an
analyst at the firm. Wentz believes EUR interest rates are
likely to increase over the next several months and enters
into an advanced set, advanced settled, €1 million notional,
3% pay-fixed/receive-floating, 2 × 5 forward rate agreement
(FRA). The market reference rates (MRRs) at the expiration
of the FRA are shown in Exhibit 1.

Wentz is also considering taking a position in a EUR fixed-

for-floating interest-rate swap. She asks Martens to price
an at-market, 3-year, annual-payment swap. Martens
gathers the necessary information on EUR interest rates,
which is shown in Exhibit 2.

Wentz also expects GBP interest rates to rise. However, she

wants to limit the firm's risk exposure on the GBP rate
speculation. She decides the best strategy is to buy an
interest rate call and asks Martens to develop a binomial
interest rate tree to value a £5 million notional, 2-year, 3%
European call. Exhibit 3 contains the binomial tree
constructed by Martens, which uses 50% as the probability
of an interest rate up move.
Wentz wants to understand the difference in approaches
used in binomial models compared with other methods for
pricing options. She asks Martens to contrast the Black
model with the binomial approach for pricing European
interest rate call options. In response, Martens makes the
following statements:

Statement 1: Both approaches value options based on the

PV of the expected payoff at expiration.
Statement 2: The Black model uses a single risk-free rate
and the binomial model uses different discount rates to
obtain values for each node prior to expiration.
Case No. 1