*** Level I
Question 1: What is the name of the act enacted in 1940 that
reflects a Congressional recognition of the "delicate" fiduciary
nature of an investment advisory relationship and the intent to
eliminate, or at least to expose all conflicts of interest?
a) The Investment Company Act
b) The Congressional Investor's Protection Act
c) The U.S. Fiduciary-Investor Act
d) The U.S. Investment Advisers Act
Question 2: If a cartel can maximize the joint profit of the
firms in an industry the industry price and output will most
closely resemble the outcome that would be present under
________.
a) a contestable market structure
b) monopolistic competition
c) pure competition
d) pure monopoly
Question 3: Given that the net annual sales are $400, cost of
goods sold is $320, beginning inventory is $60, and ending
inventory is $100, what is the average inventory processing
period?
a) 114 days
b) 73 days
c) 68 days
d) Not enough information
e) 91 days
Question 4: Effective duration is equal to
a) the percentage change in price divided by the change in the
interest rates in basis points divided by 100. The use of
effective duration has declined considerably because of the
widespread application of the more useful Macaulay and modified
durations.
b) the percentage change in price divided by the change in the
interest rates in basis points. The use of effective duration has
declined considerably because of the widespread application of
the more useful Macaulay and modified durations.
c) the negative of the percentage change in price divided by the
change in the interest rates in basis points divided by 100.
Effective duration has become increasingly popular because of the
limitations of Macaulay and modified durations.
d) the negative of the percentage change in price divided by the
change in the interest rates in basis points. Effective duration
has become increasingly popular because of the limitations of
Macaulay and modified durations.
Answer 1: d
Rationale & Reference:
The U.S. Investment Advisers Act of 1940 (Advisers Act) states
that advisors cannot employ any device or scheme to defraud any
client or prospective client; engage in any transaction or course
of business that may operate as a fraud or deceit upon any client
or prospective client; engage in transactions as a principle or
as an agent in a client's account without first disclosing the
transaction to the client and receiving the client's consent; or
engage in any act or course of business that is fraudulent,
deceptive, or manipulative.
Standards Handbook, pp. 162-163
Answer 2: d
Rationale & Reference:
Under oligopoly, joint profits are maximized by restricting
output and increasing price. They restrict joint output to the
point where MR = MC. Substantial profits prevail. This is the
same point of production that a pure monopolist would operate at.
Thus, the cartel is operating as a monopolist in the market.
Gwartney & Stroup, p. 562
Answer 3: e
Rationale & Reference:
Average inventory is equal to beginning inventory plus ending
inventory, divided by 2. In this question, it is equal to
(60+100)/2 = 80. Inventory turnover is equal to cost of goods
sold divided by average inventory. This is 320/80=4. The average
inventory processing period is equal to 365 divided by the
inventory turnover. In this case, it is 365/4 = 91 days.
Reilly & Brown, p. 387
Answer 4: c
Rationale & Reference:
Macaulay and modified durations cannot be used for large yield
changes, for assets with embedded options, or for other assets
that are affected by variables other than interest rates. For
this reason, many market practitioners use effective duration,
which is a direct measure of interest rate sensitivity.
Reilly & Brown, pp. 579-580
*** Level II
Question: Learning Outcome Statement:
Compare the three general methods for valuing minority interests.
Answer:
Method #1: Proportion of the Enterprise Value Less Discount(s)
This is a Top Down method, which involves a three-step process:
1. Estimate the value of the equity of the total enterprise
(control basis). Enterprise value is defined as the value of all
of the classes of equity taken as a whole, assuming no long-term
debt. In estimating an enterprise value as a starting point for
valuing minority shares, greater emphasis is usually placed on
operating factors, such as earnings and dividends or
dividend-paying capacity, than on value of assets. Another
distinction between estimating the enterprise value for a
controlling interest and estimating the enterprise value as a
starting point for valuing a minority interest is in the
adjustments to financial statements or in the projections. The
control buyer will assume changes that the buyer would make,
while the minority interest valuation will not project any
changes that the existing control owners do not contemplate.
2. Compute the minority owner's pro rata interest in the total.
When there is only one single class of stock and no warrants or
contingent interests, the proportionate value per share is
computed by dividing the enterprise value by the number of shares
outstanding. If there are different classes of interests, the
total enterprise value must be allocated among the classes and
the dilution resulting from any contingent interests must be
reflected.
3. Estimate the amount of discounts, if any, applicable to the
pro rate value of the total enterprise to properly reflect the
value of the minority interest. This step must also include
estimating whether a further discount for lack of marketability
is applicable, and how much, if so. Discounting from control
value usually is done as a two-step process, first for minority
interest, then for marketability. Done this way, the discounts
for minority interest is taken first; then the discount for lack
of marketability is taken from the net amount.
Method #2: Direct Comparison with Sales of Other Minority
Interests
This is a horizontal method that enables one to value a minority
interest by referencing other minority interest transactions. If
a direct comparison can be made with other closely held minority
interests, no discounts or premiums may be necessary. However, it
is generally impossible to find reliable data on minority
transactions in standard closely held company stocks, except for
past transactions in the subject company's own stock.
If using past transactions in the company's own stock,
fundamental factors should be updated. The extent to which the
transactions could be considered arm's length should be
considered and if they represent the standard value applicable to
the current valuation must be examined.
When valuing minority interest, more weight should be put on
earnings-related approaches and less on asset-related approaches
than when valuing a controlling interest. In addition, actual
dividends rather than dividend-paying capacity are relevant,
since the minority stockholder cannot force the payment of
dividends.
Method #3: The "Bottom-Up" Method
This method begins with nothing and builds up whatever elements
of value to ownership of the minority interests exist. Usually,
the values the minority interest holder may realize fall into two
categories: (1) distributions, such as dividends, and (2)
proceeds to be realized on the sale of the interest. The steps to
this approach are:
1. Project the flow of expected distributions (timing and
amounts).
2. Project an amount realizable on sale of the interest (timing
and amount). As an alternative, one could project the flow of
expected distributions into perpetuity and not assume any
residual sale value.
3. Discount the results of steps 1 and 2 to present value at an
appropriate discount rate, reflecting the degree of uncertainty
of realizing the expected returns at the times and in the amounts
projected.
Pratt, Reilly & Schweihs, pp. 312-316
*** Level III
Question: To claim compliance with AIMR-PPS Standards, the firm
must comply on a firmwide basis. Additionally, the firm must
state exactly how it is defining itself for purposes of
compliance. How do the Standards define a firm?
Answer:
A firm is defined as:
1. an entity registered with the appropriate regulatory authority
overseeing its investment management activities, or
2. an autonomous investment firm, subsidiary, or division held
out to the public as a separate entity (for example, a subsidiary
firm may claim compliance for itself without the parent
organization being in compliance), or
3. (for firms managing international assets) all assets managed
to one or more base currencies. For example, a firm entity could
be defined as all of the assets of a firm managed for clients
whose base currency is the U.S. dollar. For firm entities defined
as such, all assets managed to the selected base currency must be
included and presented in composites that meet compliance
requirements. In this example, both discretionary and
nondiscretionary U.S. dollar-based assets would be included in
the "total firm assets."
Performance Presentation Standards Handbook, pp. 2-3
*********************************************** |
