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CFA Level 2 Classroom Test 1

Subjects: Ethics & Economics

Time: 90 minutes

SECTION I - ECONOMICS
1) Labor productivity may be decomposed into which of the following two
factors?
a) Growth in both physical capital and human capital per labor hour.
b) Growth in physical capital per labor hour and growth in real interest rates.
c) Growth in physical capital per labor hour and technological change.
2) The Japanese government has decided that it wants to maintain a constant
exchange rate with the U.S. dollar at a time when supply and demand
conditions in the foreign exchange market are causing the Japanese yen to
appreciate. Which of the following actions would most likely achieve their
objective?
a) A shift to a more expansionary monetary policy.
b) Reduce taxes and create a budget deficit in order to increase domestic
interest rates.
c) A shift to a more restrictive monetary policy.
3) In the currency market, traders quote the:
a) base currency rate.
b) nominal exchange rate.
c) real exchange rate.
4) If a German electronics manufacturer builds an electronics plant in Mexico,
this action will create which of the following with regard to the demand and
supply of the euro and the peso in the foreign exchange market? This action
creates a:
a) demand for both pesos and euros in the foreign exchange market.
b) demand for pesos and a supply of euros in the foreign exchange market.
c) supply of pesos and demand for euros in the foreign exchange market.
5) Which of the following would increase the supply of dollars in foreign
exchange markets? The:
a) purchase of Korean televisions by an American distributor.
b) sale of a U.S. company to a Dutch investor.
c) sale of U.S. made automobiles to Vietnamese consumers.

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6) Which of the following statements regarding purchasing power parity is most
accurate? Purchasing power states that exchange rates:
a) will change to reflect differences in inflation between countries.
b) will change to reflect differences in real interest rates between countries.
c) will change to reflect differences in nominal interest rates between
countries.
7) Terrance Burnhart, a junior analyst at Wertheim Investments Inc., was
discussing the concepts of purchasing power parity (PPP) and interest rate
parity (IRP) with his colleague, Francis Ferngood. During the conversation
Burnhart made the following statements:
Statement 1: PPP is based on a number of unrealistic assumptions that limits
its real-world usefulness. These assumptions are: that all goods and services
can be transported among countries at no cost; all countries use the same
basket of goods and services to measure their price levels; and all countries
measure their rates of inflation the same way.
Statement 2: IRP rests on the idea of equal real interest rates across
international borders. Real interest rate differentials would result in capital
flows to the higher real interest rate country, equalizing the rates over time.
Another way to say this is that differences in interest rates are equal to
differences in expected changes in exchange rates.
With respect to these statements:
a) both are correct.
b) only statement 1 is correct.
c) only statement 2 is correct.
8) According to the concept of purchasing power parity, when the relationship
between prices in two countries changes, those changes should be reflected
in the:
a) interest rates.
b) exchange rate.
c) relative inflation rate.
9) The Federal Reserve has determined that, although the yen/USD exchange
rate is volatile, its equilibrium value is approximately 105 yen/USD. The Fed
has decided to intervene in foreign exchange markets to keep the exchange
rate in a fairly narrow band around 105 yen/USD. If the exchange rate rises
above 110 yen what should the Fed do? If the exchange rate falls below 100
yen what action should the Fed take?
Rise above 110 yen/USD Fall below 100 yen/USD
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a) Buy dollars Sell dollars

b) Buy dollars No action
c) Sell dollars Buy dollars
10)
If the exchange rate is USD:JPY 120, a bottle of rice wine that costs
JPY2,400 costs:
a) USD 24.
b) USD 20.
c) USD 200.
11)
Todays spot CAD bid exchange rate is EUR:CAD 1.425 and the ask
exchange rate is EUR:CAD 1.435. The percent spread is closest to:
a) 0.697%.
b) 0.702%.
c) 0.489%.
12)
A bank in Canada is quoting USD:CAD @ 1.4950 : 1.5005, and EUR:USD @
0.9350 : 0.9400. What is exchange rate bid and ask for EUR:CAD?
a) EUR:CAD - 1.5904 : 1.6048.
b) EUR:CAD - 0.6254 : 0.6264.
c) EUR:CAD - 1.3978 : 1.4105.
13)

Which of the following statements about exchange rates is most accurate?

a) The bid-ask spread is a function of breadth, depth, and volatility of the

market for a currency.
b) Given the bid-ask spread between pesos and dollars is 6.0000-6.0025, and
the bid-ask spread between pounds and dollars is 2.0000-2.0015, then the
bid-ask spread between pesos and pounds is 2.875-2.934.
c) A bid of USD:MXN 8.000, means the bank will sell you 1 USD for 8 MXN.
14)
The spot and 30-day forward rates for the Euro are $1.1525 and $1.1015,
respectively. The Euro is selling at a forward:
a) discount of $0.051.
b) discount of 0.956%.
c) premium of $0.051.
15)
Isaac Long is an English investor. He notices the 90day forward rate for
the Norwegian kroner is GBP 0.0859 and the spot rate is GBP 0.0887. Long
calculates the annualized rate of the kroner to be trading at a:
a) premium of 9.478%.
b) discount of 12.63%.
c) premium of 21.17%.
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16)
If the exchange rate value of the euro goes from $0.95 to $1.10, then the
euro has:
a) depreciated and the Dutch will find U.S. goods more expensive.
b) depreciated and the Dutch will find U.S. goods cheaper.
c) appreciated and the Dutch will find U.S. goods cheaper.
17)
Which of the following statements regarding the balance of payments
accounts is most accurate?
a) The total of the balance of payments accounts does not have to equal
zero.
b) A current account surplus is an indication of economic strength.
c) Running a deficit in the current account balance means a country imports
more than it exports.
18)
Larry Goren, CFA, is an economist for the Federal Reserve Bank. He is
interested in using a countrys balance of payments as a forecasting tool in
determining exchange rates. He notices that China has a high current account
balance resulting in a large surplus in its balance payments. It can be implied
that:
a) China received a great deal of income flows from the sale of trade
merchandise and services and payments on its existing investments.
b) China provided a great deal of financial assistance to other nations.
c) Chinas international currency reserve holdings have increased.
19)
Which of the following statements regarding relative Purchasing Power
Parity (PPP) is least accurate?
a) It claims that exchange rate movements should exactly offset inflation
differential between two countries.
b) In order for relative PPP to hold, countries with higher rates of expected
inflation should see their currencies appreciate.
c) Because PPP holds in the long run, it is somewhat useful in exchange-rate
determination in the short run.
20)
Kathy Smith, CFA, is an analyst with the Borderless Fund and is doing
research on the country of Kenya for her colleague, John Dolan. Smith wants
to calculate the inflation rate implied in the forward rates that she obtains
from her bank, Global Bank. The current spot exchange rate is 90.772 Kenyan
Shillings (KS) for one euro (EUR). The one-year forward rate for the Kenyan
Shilling is 95.7686 KS/EUR. The current rate of inflation the European
Economic Community is 9%. Smith does not know the current inflation rate
for Kenya. Assuming relative purchasing power parity (PPP) applies, the
calculated expected inflation rate implied in the forward rate is:
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a) 10%.
b) 17%.
c) 15%.

SECTION II ETHICAL & PROFESSIONAL STANDARDS

Ian Sherman, CFA, is a portfolio manager at SMC, an investment advisory firm

which offers investment products and services to individual and institutional
clients. SMC has adopted the CFA Institute Research Objectivity Standards and
implemented policies in compliance with the Standards.
All of SMCs investment professionals have earned CFA charters. Sherman tells
prospective clients, The CFA charter is the highest credential in the global
investment management industry. As charterholders we are committed to the
highest ethical standards. Completion of the program has dramatically improved
the teams portfolio management knowledge and their ability to achieve better
performance results.
Sherman has earned a reputation for consistently outperforming the market.
Over the long run, his mutual funds have outperformed their respective market
benchmarks by a wide margin. For the past 12 months the funds have slightly
underperformed the benchmarks. Some clients have noticed that Shermans
fund performance information has not been updated on the advisors website in
the past six months. When clients inquire about fund performance, Sherman
provides them with accurate updated information.
Annette Martineau, CFA, works as an analyst for Sherman and presents her
recently completed research report and sell recommendation on Muryan
Corporation, which is held in one of Shermans funds to SMCs Investment
Committee. After much debate about the company and its prospects, the
committee reaches a consensus recommendation that is contrary to Martineaus.
Martineau informs Sherman, I accept that the committees recommendation has
a reasonable basis, but I strongly believe that my recommendation is more
appropriate. I have been diligent in my research and have a deeper
understanding of the industry and its competitive factors.
The following week, Martineau prepares for an investment conference, open to
the general public but typically attended only by investment professionals, by
reviewing SMCs policies regarding public appearances. The policies state:

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1) Employees should remind audience members to judge the suitability of
the investment in light of their own unique circumstances.
2) Employees should make full disclosure of all conflicts of interest, both their
own and those of the firm.
3) Employees may not provide research reports to audience members.
Research reports are reserved exclusively for SMC clients.
During the conference, private equity firm Caruso Limited announces a takeover
bid for Muryan. Immediately, Muryan shares increase 30 percent in value.
Martineau is skeptical of the transaction as she doubts that the Caruso partners
fully understand the changing industry dynamics of the target firm. She
hypothesizes that they would cancel the deal if they did.
Concerned that Caruso will eventually cancel the deal, Martineau drafts an
updated report and reiterates her sell recommendation on Muryan. Since SMCs
Investment Committee had overturned her previous sell recommendation on
Muryan she goes into great detail as to why she believes Caruso will not
complete the deal. She emails the recommendation to Sherman the next
afternoon.
That evening, Martineau considers what action to take regarding the 5,000
shares of Muryan held in her husbands personal account. The firms policy on
personal investments and trading requires that Martineau receive approval from
the compliance department in advance of all trades in securities in subject
companies in her assigned industry. She is concerned that if Sherman accepts
her recommendation to liquidate all fund holdings of Muryan, the stock price will
drop before she receives approval from the compliance department. Martineau
decides to use derivatives to hedge her husbands position because these types
of trades do not require advance approval from the compliance department.
The next morning, on Martineaus recommendation, Shermans trader sells all of
SMCs mutual funds entire positions of Muryan for a sizable gain. Martineau
hedges her husbands position.
Several weeks later, as Martineau had hypothesized, Caruso cancels the deal
and Muryans stock price declines 20 percent. Martineaus derivatives position
effectively hedges her husbands position in the stock.
Sherman learns that a wealthy investor in the fund might liquidate his holdings
due to doubts about suitability and economic forecasts. Sherman carefully
reviews the clients investment objectives, and informs the client, You should
not sell. Our fund is still suitable for you. You have been invested with us
throughout the past 12 years and I urge you to continue to stay fully invested. I
was just looking at the investment record of a former client who happens to be a
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relative of mine, Karoll Reeves, who has traded in and out of our funds during
that same period. Her returns have badly lagged yours. The client elects to
maintain his holdings in Shermans fund.
A month later, Martineau leaves SMC and starts the Galaxy hedge fund with
Anjali Shah as her partner. The first client to commit to the hedge fund instructs
the Galaxy partners to direct its trades through RLB Securities. RLB charges
higher-than-average fees, but provides some unique informational services to
investors. In return for receiving Galaxys trading business, RLB promises to refer
potential clients to Galaxy. Shah tells Martineau A larger client base will create
economies of scale and will eventually allow Galaxy to lower its expenses for all
clients. Martineau agrees. She and Shah explain the directed brokerage
arrangement carefully to prospective clients. They require each client to sign a
statement that reads, It is not necessary for Galaxy to seek best price and
execution, and I am aware of the consequence for my account. I consent to
Galaxys trades being executed by RLB Securities.
21)
In which of the following actions does Sherman most likely comply with the
requirements and recommendations of the CFA Institute Standards of
Professional Conduct? When he:
a) references the CFA program and designation.
b) provides performance information on the advisors website.
c) references the enhanced portfolio management skills of his team.
22)
According to CFA Institute Standards, Martineaus best immediate course
of action regarding her initial research report and recommendation on Muryan
is to:
a) leave her name on the report and take no further action.
b) leave her name on the report and document her difference of opinion.
c) issue her own independent recommendation since she has a reasonable
basis.
23)
Which of SMCs policies regarding public appearances is least likely
consistent with both the requirements and recommendations of the CFA
Institute Research Objectivity Standards?
a) Statement 1.
b) Statement 2.
c) Statement 3.
24)
Martineaus actions regarding her husbands account most likely violate
the CFA Institute Research Objectivity Standards because she:
a) did not receive advance approval from the compliance department for
trades in her assigned industry.
b) trades within the restricted trading period of at least 5 calendar days prior
to and after issuing a research report.

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c) should seek to ensure that trades for immediate family members are not
done in advance of or disadvantage investing clients.
25)
Concerning the client who wants to liquidate his holdings, which of the
following CFA Institute Standards is most likely violated by Sherman?
a) Confidentiality.
b) Conflict of interest.
c) Communication with client.
26)
Which of the following actions correctly states why Martineaus
relationship with RLB Securities would most likely violate CFA Institute
Standards?
a) Galaxy is prohibited from referring brokers to any client.
b) Galaxy fails to explain the consequences of average quality execution.
c) Galaxy should trade client accounts through RLB only if the accounts
receive best price and execution.

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