CFA L2 Apostila 01 Exame 2018 - COMPLETA IMPRESSÃO

LOS 13.b Identify/Calculate Currency Exchange RatesSchweser B1 pg 248, CFAI V1 pg 520 Problem: Triangular Arbitrage Given the following bid/ask quotes: CHF / USD  1.2500 / 1.2510USD / GBP  1.8000 / 1.8010 CHF / GBP  2.3000 / 2.3010 Structure a profitable arbitrage trade© Kaplan, Inc. 12LOS 13.b Identify/Calculate Currency Exchange RatesSchweser B1 pg 248, CFAI V1 pg 520 Solution: Triangular Arbitrage Recall that you are given the following bid/ask quote:  CHF/GBP = 2.3000 – 2.3010 The correct CHF/GBP = 2.2500 / 2.2531 So, the GBP is OVERVALUED! We want to sell GBP vs. CHF in the triangle, so make trades that go in that direction (red arrows).© Kaplan, Inc. 14 ©2018 FK Partne

SS 04 - Economics for ValuationLOS 13.b Identify/Calculate Currency Exchange RatesSchweser B1 pg 248, CFAI V1 pg 520 Solution: Triangular Arbitrage (Method 1)1. Choose a direction USD CHF GBP© Kaplan, Inc. 13LOS 13.b Identify/Calculate Currency Exchange RatesSchweser B1 pg 248, CFAI V1 pg 520 Solution: Triangular Arbitrage USD CHF CHF/GBP 2.3000 GBP© Kaplan, Inc. 15ers - Exame CFA 4

LOS 13.b Identify/Calculate Currency Exchange RatesSchweser B1 pg 248, CFAI V1 pg 520 Solution: Triangular Arbitrage Convert USD to GBP at USD/GBP 1.8010 Down—divide Convert GBP to CHF at CHF/GBP 2.3000 Up—multiply Convert CHF to USD at CHF/USD 1.2510 Down—divide 1/1.8010 × 2.3000 ×1/1.2510 = 1.0208© Kaplan, Inc. 16LOS 13.c Distinguish/Calculate Currency Exchange RatesSchweser B1 pg 252, CFAI V1 pg 524 Forward Discount or Premium For base currency forward premium  or discount   forward rate  spot rate Often expressed as points (decimal × 10,000typically)Forward discount: Forward value < spot value  Negative pointsForward premium: Forward value > spot value  Positive points© Kaplan, Inc. 18 ©2018 FK Partne

SS 04 - Economics for ValuationLOS 13.c Distinguish/Calculate Currency Exchange RatesSchweser B1 pg 252, CFAI V1 pg 524 Spot Market vs. Forward Market Spot rates: Exchange rates for immediate delivery Forward rates: Exchange rates for currency exchange on a specified future date  Typically for 30, 60, or 90 days  Both parties are obligated to complete the transaction at the future date  (Bid-ask) spread is calculated just as for spot 17 rates  Typically, forward spreads > spot spreads© Kaplan, Inc.LOS 13.c Distinguish/Calculate Currency Exchange RatesSchweser B1 pg 252, CFAI V1 pg 524 Forward Discount or Premium: ExampleFind the forward GBP discount or premium for thefollowing USD/GBP quote expressed in points:spot = 1.8328; 30-day forward = 1.8432Premium = 1.8432 – 1.8328 = 0.01040.0104 = 0.0104 × 10,000 = 104 pointsNote: 10,000 is used for a quote of 4 decimal places.For a JPY/USD quote of 2 decimal places,×100 to get points.© Kaplan, Inc. 19ers - Exame CFA 5

LOS 13.d Calculate Currency Exchange RatesSchweser B1 pg 253, CFAI V1 pg 530 Mark-to-Market Value of ForwardAfter inception, a forward contract is valuedassuming an offsetting position is taken by the traderVprt ic=evcaulurereinncy Vt = (FPt –FP)(contract size) In units of longof the forward currencycontract (t < T) 1+R Days  Days = number 360   of days to maturity (T – t)Ft fPotr=a forward price (bid) at time R = the interest rate new contract maturing at of the price currencytime T (long currency = base)© Kaplan, Inc. 20LOS 13.d Calculate Currency Exchange RatesSchweser B1 pg 253, CFAI V1 pg 530Solution: Mark-to-Market Valuation Long NZD forward contract means that the trader wants to convert USD to NZD (i.e., down the quote). Use ask price of USD 0.8438/NZD. Offsetting contract would be to convert NZD for USD using a 2-month forward contract. Use bid price of USD 0.8433/NZD. Vt = ((00..88443333 –– 00..88443388))((11,,000000,,000000)) = – $499.92 11++(0(0.0.0001111))3636606000© Kaplan, Inc. 22 ©2018 FK Partne

SS 04 - Economics for ValuationLOS 13.d Calculate Currency Exchange RatesSchweser B1 pg 253, CFAI V1 pg 530 Problem: Mark-to-Market Valuation Trader is long 1M NZD 3-month forward against USD at USD/NZD 0.8436-38 One month later, FX quotes and interest rates are as follows: Spot 0.8198–99 Int. rates NZD USD 1-month 0.8244–45 30-day 0.33% 0.10% 2-month 0.8433–35 60-day 0.36% 0.11% Compute: Mark-to-market value of the contract in USD© Kaplan, Inc. 21LOS 13.e Explain Currency Exchange RatesSchweser B1 pg 255, CFAI V1 pg 533 Covered Interest Rate Parity (CIRP) CIRP: Forward discount will just offset differences in interest rates Big point #1: The currency with the higher nominal interest rate will trade at forward discount Big point #2: When CIRP holds, an investor will make the same return holding either currency If: The USD rate is 8% and the euro rate is 6%  Then: USD will depreciate by approximately 2% relative to the euro (if CIRP holds)© Kaplan, Inc. 23ers - Exame CFA 6

LOS 13.e Explain Currency Exchange RatesSchweser B1 pg 255, CFAI V1 pg 533Covered Interest Rate Parity (CIRP) The formal CIRP relationship: 1+rprice currency  n   360 Spot  = Forward (zero arbitrage) 1+rbase  n  currency  360 © Kaplan, Inc. 24LOS 13.e Explain Currency Exchange RatesSchweser B1 pg 255, CFAI V1 pg 533Solution: Covered Interest Arbitrage 90-day interest rate in CAD = 6.25% 90-day interest rate in CHF = 5.5% Current spot rate is CAD/CHF = 0.7901Arbitrage-free = 0.7901 1+0.0625  90   =0.7916 forward rate   360    1+0.055  90     360   © Kaplan, Inc. 26 ©2018 FK Partne

SS 04 - Economics for ValuationLOS 13.e Explain Currency Exchange RatesSchweser B1 pg 255, CFAI V1 pg 533Problem: Covered Interest Arbitrage  Suppose: 25  90-day interest rate in CAD = 6.25%  90-day interest rate in CHF = 5.50%  Current spot rate is CAD/CHF = 0.7901  Quoted CAD/CHF 90-day forward = 0.8100  Required:  Calculate the correct 90-day forward rate  Describe the correct arbitrage trade  Calculate arbitrage profits based on an initial CHF 1 million© Kaplan, Inc.LOS 13.e Explain Currency Exchange RatesSchweser B1 pg 255, CFAI V1 pg 533Solution: Covered Interest Arbitrage Quoted CAD/CHF of: 0.8100 > 0.7916 CHF is overpriced in the forward marketWhy? The CHF should buy 0.7916 CAD but isactually buying 0.8100 CAD. © Kaplan, Inc. 27ers - Exame CFA 7

LOS 13.e Explain Currency Exchange RatesSchweser B1 pg 255, CFAI V1 pg 533 Solution: Covered Interest ArbitrageIn 90 days, we need to convert CHF into CAD.Today CAD 0.7901 CHF (790,100) 1,000,000 × 1.015625 x 1.01375 90 (802,445) 0.8100 1,013,750 days 821,138 18,693© Kaplan, Inc. 28LOS 13.e Explain Currency Exchange RatesSchweser B1 pg 255, CFAI V1 pg 533 International Fisher Relation (IFR) Domestic Fisher Relation: R = r + E( ) R = nominal interest rate, r = real interest rate, = inflation International Fisher Relation: Assuming real rates are constant (real rate parity):  RA – RB = E( A) – E( B) (i.e., interest rate differential = inflation differential)© Kaplan, Inc. 30 ©2018 FK Partne

SS 04 - Economics for ValuationLOS 13.e Explain Currency Exchange RatesSchweser B1 pg 255, CFAI V1 pg 533 Relative PPP Relative PPP: Changes in exchange rates will just offset changes in price levels (i.e., differences in inflation) Ex-ante: E(%S) A/B = E( A ) – E(B ) Countries with higher (relative) inflation expect to see their currencies depreciate (by the inflation differential).© Kaplan, Inc. 29LOS 13.e Explain Currency Exchange RatesSchweser B1 pg 255, CFAI V1 pg 533 Uncovered Interest Rate Parity Relative form PPP + international Fisher relation = uncovered interest rate parity Links spot exchange rates, expected spot exchange rates, and nominal interest rates E(% S) A/B = R A – RB Uncovered IRP relies on both the International Fisher relation and relative PPP holding over time© Kaplan, Inc. 31ers - Exame CFA 8

LOS 13.f,g Describe/Explain/Evaluate Currency Exchange RatesSchweser B1 pg 261, CFAI V1 pg 546International Parity Relations Forward Forward rate parity Exchange ratediscount or expectations/ movements premium Covered interest Uncovered interest Relative purchasing parity rate parity power parity Interest rate International Inflation rate differentials Fisher effect differential© Kaplan, Inc. 32LOS 14.d Distinguish/Explain Economic GrowthSchweser B1 pg 286, CFAI V1 pg 611Capital Deepening and Technological Progress Cobb-Douglas production function: Y  TKL(1 ) α and (1 – α) are the shares of output allocated to capital (K) and labor (L); α < 1 T = total factor productivity Cobb-Douglas function: diminishing marginal productivity of labor and capital, but constant returns to scale. In steady state, marginal product of capital (MPK) = rental price of capital (r): αY/K = r 34© Kaplan, Inc. ©2018 FK Partne

SS 04 - Economics for Valuation Fixed Income Investments Economics Economics for Valuation 14. Economic Growth and the Investment DecisionLOS 14.d Distinguish/Explain Economic GrowthSchweser B1 pg 286, CFAI V1 pg 611Productivity Curve & Economic Growth Labor productivity More technology (real GDP per worker) Less technology LP2 Effect of capitalEconomicLP1 deepening (but Growth LP0 note diminishing returns)© Kaplan, Inc. C0 C1 Capital per worker35ers - Exame CFA 9

LOS 14.d Distinguish/Explain Economic GrowthSchweser B1 pg 286, CFAI V1 pg 611 Productivity Curve Productivity curve: Graph of labor productivity vs. capital per worker for given level of technology Two sources of economic growth (growth in labor productivity):1. Growth in capital per worker – capital deepening (movement along the productivity curve)2. Technological change (growth in total factor productivity)© Kaplan, Inc. 36LOS 14.e Forecast Economic GrowthSchweser B1 pg 289, CFAI V1 pg 613 Growth Accounting RelationsThe labor productivity growth accountingequation:Growth rate in potential GDP = long-term growth rateof labor force + long-term growth rate in laborproductivity Includes capital deepening and changes in total factor productivity© Kaplan, Inc. 38 ©2018 FK Partne

SS 04 - Economics for ValuationLOS 14.e Forecast Economic GrowthSchweser B1 pg 289, CFAI V1 pg 613 Growth Accounting RelationsCobb Douglas: Y  T K  L(1 ) long-term growthThe growth accounting equation: rate of capitalGrowth rate  Y  T  K  1  L in potential Y T K L GDP Growth rate of total elasticities long-term factor productivity growth rate of (technology) labor© Kaplan, Inc. 37LOS 14.e Forecast Economic GrowthSchweser B1 pg 289, CFAI V1 pg 613 Example: Growth AccountingFollowing information is available for Bundovia: Variable Forecast over next 10 years Labor force growth rate Cost of labor/total factor cost 1.2% Growth rate of capital Growth of labor productivity 54% 2% 2%Calculate the growth rate in potential GDP and thenthe impact of TFP on growth. 39© Kaplan, Inc.ers - Exame CFA 10

LOS 14.e Forecast Economic GrowthSchweser B1 pg 289, CFAI V1 pg 613 Solution: Growth AccountingBecause we are not given the growth rate intechnology, we have to the use the second relation:growth rate in potential GDP = long-term growthrate of labor force + long-term growth rate in laborproductivity  1.2%  2%  3.2%Now using the first relation, solve for growth fromTFP: T T 3.2%  +(0.46  2%)+(0.54  1.2%)3.2% – (0.92% + 0.648%) 0.92% 0.648% = 1.632%© Kaplan, Inc. 40LOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Classical Growth Theory Main point: No permanent improvement in standard of living from new technologies Technological advances lead to: 1. Short-term economic growth 2. Temporary improvement of standard of living Reversing mechanism is population growth  Economic growth leads to population growth© Kaplan, Inc. 42 ©2018 FK Partne

SS 04 - Economics for ValuationLOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 41 Growth Theories  Three growth theories: 1. Classical Growth Theory 2. Neoclassical Growth Theory 3. Endogenous growth theory  Be able to distinguish major tenets  Focus on the big picture! © Kaplan, Inc.LOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Classical Growth TheoryLabor productivity (real GDP per worker) More technology LP1 LP0 = Less technologysubsistence wage © Kaplan, Inc. C1 C0 Capital per worker 43ers - Exame CFA 11

LOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Neoclassical Growth Theory Main point: Economic growth results for lucky discoveries of new technologies Major difference with classical theory: Economic growth is independent of population growth Technological advances lead to:1. Short-term economic growth 2. Permanently higher living standard 44© Kaplan, Inc.LOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Neoclassical Growth Theory1. Sustainable growth rate of output per capita (g*) g* =  ) (1 –2. Sustainable growth rate of output (G*) G* =  + L (1– )In steady state, growth rate in productivitydepends only on technological growth and (1 – α)© Kaplan, Inc. 46 ©2018 FK Partne

SS 04 - Economics for ValuationLOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Neoclassical Growth Theory LP2 = MPK = rental price LP1 = More technologyLabor productivity MPK > rental price Less technology (real GDP per worker) LP0 = MPK = rental price© Kaplan, Inc. C0 C1 Capital per worker 45LOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Neoclassical Growth TheoryMajor tenets:1. Capital deepening occurs affecting output but not the growth rate2. Economy will move towards its steady state equilibrium regardless of initial capital to labor ratio or level of technology3. Steady state savings and investment are just sufficient to cover new workers and capital depreciation (capital per worker constant)© Kaplan, Inc. 47ers - Exame CFA 12

LOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Neoclassical Growth TheoryMajor tenets continued:4. Developing countries (with low capital to labor) would have lower diminishing marginal productivity of capital© Kaplan, Inc. 48LOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Endogenous Growth TheoryLabor productivity (real 4 Even more technology GDP per labor hour) 3 Even more technology More technology 2 Less technology 1 Capital / labor hour© Kaplan, Inc. 50 ©2018 FK Partne

SS 04 - Economics for ValuationLOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Endogenous Growth Theory Main point: Economy is perpetual motion machine  Why? No stopping mechanism!  Technological progress is endogenous.© Kaplan, Inc. 49LOS 14.i Compare Economic GrowthSchweser B1 pg 293, CFAI V1 pg 634 Endogenous vs. Neoclassical Innovation Neoclassical lacks this step Higher More Social Profits Investment Returns© Kaplan, Inc. 51ers - Exame CFA 13

Currency Exchange Rates Other LOS For SS4These LOS are not covered in live class: LOS 13.n Describe  LOS 15.a,b,c,d,e,g,h LOS 13.o Describe Describe LOS 13.p Describe LOS 14.a Compare  LOS 15.f Explain LOS 14.f Explain  LOS 15.i Evaluate LOS 14.g Explain LOS 14.h Explain© Kaplan, Inc. 52 Discussion QuestionsThe following information relates to Questions 1–6 Ed Smith is a new trainee in the foreign exchange (FX) services department of a major global bank. Smith’s focus is to assist senior FX trader, Feliz Mehmet, CFA. Mehmet mentions that an Indian corporate client exporting to the United Kingdom wants to estimate the potential hedging cost for a sale closing in one year. Smith is to determine the premium/discount for an annual (360 day) forward contract using the exchange rate data presented in Exhibit 1.© Kaplan, Inc. 54 ©2018 FK Partne

SS 04 - Economics for Valuation Fixed Income Investments Study Session 4 Discussion Questions CFA Institute Program Curriculum Level II, Volume 1, page 582, Questions 1–5 Discussion QuestionsExhibit 1. Select Currency Data for GBP and INR Spot (INR/GBP) 79.5093 Annual (360-day) Libor (GBP) 5.43% Annual (360-day) Libor (INR) 7.52% Mehmet is also looking at two possible trades to determine their profit potential. The first trade involves a possible triangular arbitrage trade using the Swiss, US and Brazilian currencies, to be executed based on a dealer’s bid/offer rate quote of 0.5161/0.5163 in CHF/BRL and the interbank spot rate quotes presented in Exhibit 2.© Kaplan, Inc. 55ers - Exame CFA 14

Discussion QuestionsExhibit 2. Interbank Market QuotesCurrency Pair Bid / OfferCHF/USD 0.9099 / 0.9101BRL/USD 1.7790 / 1.7792 Mehmet is also considering a carry trade involving the USD and the Euro. He anticipates it will generate a higher return than buying a one-year domestic note at the current market quote due to low US interest rates and his predictions of exchange rates in one year. To help Mehmet assess the carry trade, Mehmet provides Smith with selected current market data and his one year forecasts in Exibith 3.© Kaplan, Inc. 56 Discussion Questions Finally, Mehmet asks Smith to assist with a trade involving a US multinational customer operating in Europe and Japan. The customer is a very cost conscious industrial company with a AA credit rating and strives to execute its currency trades at the most favorable bid/offer spread. Because its Japanese subsidiary is about to close on a major European acquisition in three business days, the client wants to lock in a trade involving the Japanese yen and the Euro as early as possible the next morning, preferably by 8:05 AM New York time.© Kaplan, Inc. 58 ©2018 FK Partne

SS 04 - Economics for Valuation Discussion QuestionsExhibit 3. Spot Rates and Interest Rates for Proposed CarryTradeToday’s one-year Currency pair Spot rate Projected spotLibor (Price/Base) today rate in one yearUSD 0.80% CAD/USD 1.0055 1.0006CAD 1.71% EUR/CAD 0.7218 0.7279EUR 2.20%© Kaplan, Inc. 57 Discussion Questions At lunch, Smith and other FX trainees discuss how best to analyze currency market volatility from ongoing financial crises. The group agrees that a theoretical explanation of exchange rate movements, such as the framework of the international parity conditions, should be applicable across all trading environments. They note such analysis should enable traders to anticipate future spot exchange rates. But they disagree on which parity condition best predicts exchange rates, voicing several different assessments. Smith concludes the discussion on parity conditions by stating to the trainees:© Kaplan, Inc. 59ers - Exame CFA 15

Discussion Questions “I believe that in the current environment both covered and uncovered interest rate parity conditions are in effect.” The conversation next shifts to exchange rate assessment tools, specifically the techniques of the IMF Consultative Group on Exchange Rate Issues (CGER). CGER uses a three-part approach including the Macroeconomic Balance Approach, the External Sustainability Approach, and a Reduced Form Econometric Model. Smith asks Trainee #1 to describe the three approaches. In response, Trainee #1 makes the following statements to the other trainees and Smith:© Kaplan, Inc. 60 Discussion Questions Question 11. Based upon Exhibit 1, the forward premium (discount) for a 360-day INR/GBP forward contract is closest to:A. –1.546.B. 1.546.C. 1.576.© Kaplan, Inc. 62 ©2018 FK Partne

SS 04 - Economics for Valuation Discussion Questions Statement 1Macroeconomic Balance focuses on the stocks of outstandingassets and liabilities Statement 2Reduced Form has a weakness in underestimating futureappreciation of undervalued currencies. Statement 3External Sustainability centers on adjustments leading to long-term equilibrium in the capital account.© Kaplan, Inc. 61 Discussion Questions Solution 1Exhibit 1: Select Currency Data for GBP and INRSpot (INR/GBP) 79.5093 GBP at premiumAnnual (360-day) Libor (GBP) 5.43%Annual (360-day) Libor (INR) 7.52%Forward = 79.5093 × 1+ 0.0752 = 81.0855 1+ 0.0543Forward premium (INR) = 81.0855 – 79.5093 = 1.5762© Kaplan, Inc. 63ers - Exame CFA 16

Discussion Questions Solution 11. Based upon Exhibit 1, the forward premium (discount) for a 360-day INR/GBP forward contract is closest to: A. –1.546 B. 1.546 C. 1.576© Kaplan, Inc. 64 Discussion Questions Solution 21. Choose a direction: USD CHF BRL© Kaplan, Inc. 66 ©2018 FK Partne

SS 04 - Economics for Valuation Discussion Questions Question 22. Based on Exhibit 2, the most appropriate recommendation regarding the triangular arbitrage trade is to: A. decline the trade, no arbitrage profits are possible. B. execute the trade, buy BRL in the interbank market and sell it to the dealer. C. execute the trade, buy BRL from the dealer 65 and sell it in the interbank market.© Kaplan, Inc. Discussion Questions Solution 21 2. Set out quotes: Sell base currency buy quoted (bid rates) to move round the triangle CHF × BRL × USD USD CHF BRL = 0.9099 × 1/0.5163 ×1/1.7792 = 0.9905 < 1  no arbitrage in this direction© Kaplan, Inc. 67ers - Exame CFA 17

Discussion Questions Solution 23. Choose the other direction USD CHF BRL© Kaplan, Inc. 68 Discussion Questions Solution 22. Based on Exhibit 2, the most appropriate recommendation regarding the triangular arbitrage trade is to:A. decline the trade, no arbitrage profits are possible.B. execute the trade, buy BRL in the interbank market and sell it to the dealer. C. execute the trade, buy BRL from the dealer 70 and sell it in the interbank market.© Kaplan, Inc. ©2018 FK Partne

SS 04 - Economics for Valuation Discussion Questions Solution 24. Set out quotes BRL × CHF × USD USD BRL CHF 1.7790×0.5161×1/0.9101 = 1.00884 > 1  arbitrage is possible in this direction© Kaplan, Inc.  We buy BRL at 1.7790 in the interbank  We sell BRL at 0.5161 to the dealer 69 Discussion Questions Question 33. Based on Exhibit 3, the potential all-in USD return on the carry trade is closest to: A. 1.04%. B. 1.40%. C. 1.84%. © Kaplan, Inc. 71ers - Exame CFA 18

Discussion Questions Solution 3Exhibit 3: Spot Rates/Interest Rates on Proposed CarryTradeToday’s 1-year Libor Currency Spot E (Spot in 1 yr) 1.0006USD 0.80% CAD/USD 1.0055 0.7279 0.7283CAD 1.71% EUR/CAD 0.7218EUR 2.20% EUR/USD cross 0.7258“Mehmet is considering a carry trade involving the USD andthe Euro. He anticipates it will generate a higher return thanbuying a one-year domestic note at the current market quotedue to low U.S. interest rates and his predictions ofexchange rates in one year.”© Kaplan, Inc. 72 Discussion Questions Solution 33. Based on Exhibit 3, the potential all-in USD return on the carry trade is closest to: A. 1.04%. B. 1.40%. C. 1.84%.© Kaplan, Inc. 74 ©2018 FK Partne

SS 04 - Economics for Valuation Discussion Questions Solution 3T=0Borrow $1 at 0.80%. Loan at maturity = $1.008Convert 1 USD to EUR = €0.7258Invest €0.7258 @ 2.20% for 1 year. T=1 73 Receive 0.7258(1.022) = €0.7418 Convert €0.7418 to USD @ 0.7283 = $1.0185 Repay $1.008. Net return = 0.0105 or 1.05%© Kaplan, Inc. Discussion Questions Question 44. The factor least likely to lead to a narrow bid/offer spread for the industrial company’s needed currency trade is the:A. timing of its trade.B. company’s credit rating.C. pair of currencies involved. © Kaplan, Inc. 75ers - Exame CFA 19

Discussion Questions Solution 4Factors affecting spread: The spread in the interbank market  Currency pair involved  Time of day window  Market volatility The size of the transaction Dealer/client relationship© Kaplan, Inc. 76 Discussion Questions Question 55. If Smith’s statement on parity conditions is correct, future spot exchange rates are most likely to be forecast by:A. current spot rates.B. forward exchange rates.C. inflation rate differentials.© Kaplan, Inc. 78 ©2018 FK Partne

SS 04 - Economics for Valuation Discussion Questions Solution 44. The factor least likely to lead to a narrow bid/offer spread for the industrial company’s needed currency trade is the: A. timing of its trade. B. company’s credit rating. C. pair of currencies involved.© Kaplan, Inc. 77 Discussion Questions Solution 55. If Smith’s statement on parity conditions is correct, future spot exchange rates are most likely to be forecast by: If uncovered interest rate parity holds, thenA. current spot rates.B. forward exchange rates. the forward rate is an unbiased predictor ofC. inflation rate differentials. future spot rates “I believe that in the current environment both covered and uncovered interest rate parity conditions are in effect.”© Kaplan, Inc. 79ers - Exame CFA 20

Discussion Questions Question 66. Which of the following statements given by Trainee #1 in describing the approaches used by CGER is most accurate? A. Statement 1. B. Statement 2. C. Statement 3.© Kaplan, Inc. 80 Discussion Questions Solution 6Statement 1:Macroeconomic Balance focuses on the stocks of outstandingassets and liabilities.Statement 2:Reduced Form has a weakness in underestimating futureappreciation of undervalued currencies.Statement 3:External Sustainability centers on adjustments leading to long-term equilibrium in the capital account.Relative asset/debt to capital account flows© Kaplan, Inc. 82 ©2018 FK Partne

SS 04 - Economics for Valuation Discussion Questions Solution 6 IMF framework for assessment of long-run fair value of a currency 1. Macroeconomic balance approach—clues from current account deficits 2. External sustainability approach—clues from external debt relative to GDP 3. Reduced form econometric approach— estimation of equilibrium exchange rate path consistent with several key macroeconomic variables© Kaplan, Inc. 81 Discussion Questions Solution 66. Which of the following statements given by Trainee #1 in describing the approaches used by CGER is most accurate? A. Statement 1. B. Statement 2. C. Statement 3. © Kaplan, Inc. 83ers - Exame CFA 21

© Kaplan, Inc. Discussion Questions 84 ©2018 FK Partne

SS 04 - Economics for Valuationers - Exame CFA 22

Questions – SS 4 – Economics for ValuationQuestion 1 - 6Calisto is a developed market nation with large natural resources, oil and precious metals, withgrowing financial markets. Calisto is a stable constitutional monarchy with elected representativesas the legislative body, appointed and legislative-majority approved judges as the judicial body,and the ruling royal family as the executive body.Calisto is a member of COPA, an alliance of three bordering countries, Calisto, Olaguay, andPeristan, that formed a regional monetary union. The COPA currency is known as the 'copa' withthe symbol COP.As part of Calisto joining COPA Calisto has standardized their regulations and regulatory institutions.Regulatory standardization among the three countries was part of the prerequisite for each to join.The standard ization covers most major governmental agencies but does not cover all industries.Calisto anticipates having to bear additional costs and loss of productivity in some of their businesssectors. Oil and precious metal extractions are expected to be affected by environmentalregulations.Calisto has adopted the COPA Financial Intermediaries Standards (COPA FIS). COPA FIS covers allfinancial institutions: (1) commercial banks, (2) exchanges for bonds, stocks, commodities andderivatives, and (3) insurance companies and pension entities. The COPA FIS were rewritten aslegislation by Calisto's representatives and passed unanimously as the Financial IntermediariesStandards Act of 2001 (FISA).Calisto restructured their financial regulatory institutions into three different organizations with eachinstitution serving as government recognized self regulatory organizations (SRO) for oversight andenforcement for the industry.  Commercial Banking Standards Board (CBSB) - regulates all commercial banking including capital requirements, underwriting standards for loans and investments. Often coordinates policy and procedures with the independent Central Bank of Calisto (CBoC).  Exchange Trading Commission (ETC) - regulates all exchanges including margin requirements, counterparty stipulations, transactional information, transparency rules and market making standards.  Insurance and Pension Oversight Committee (IPOC) - regulates all insurance and pension related matters.One example of an ETC regulation is: All companies listed on the Calistose Stock Exchange arerequired to furnish audited financial statements on quarterly and annual basis prepared by Calistoseaccounting firms. The accounting standards of Calisto are a combination of US GAAP and IFRS thatis used throughout COPA.Before ETC rules and regulations, Calisto's equities markets were less liquid. The volume of tradeshave increased significantly since ETC has become the self regulatory organization for financialmarkets. More Calistose citizens are buying stocks and listing of both Calistose and foreign stockshas risen significantly over the last ten years (2002 - 2012).Calisto 2002 2012 2022 (est.)Population (in millions) 45.8 55.2 65.1GDP (in $ billions) $1,240.0 $2,000.0 $3,280.0Effective Income Tax Rate 19.5% 20.4% 22.5%Savings rate (average is 10.0%) 10.0% 9.8% 9.5%Number of listed stocks 120 1200 2400Calisto has a three tiered progressive income tax rates of 10%/20%/30%. Sales tax rates are 5%on most goods except food items and higher tax rates on snack foods, tobacco, alcohol and luxuryimports. Most food items are not taxed. Government revenues are derived from taxes and oilrevenues from government owned lands.Tobacco and alcohol consumption in Calisto has been on the rise over the last years. Over the sametime period smoking rates have fallen in Olaguay, and Peristan. Olaguay and Peristan both havehigher tax rates on tobacco products, government warnings on tobacco packaging and anti-smokingmarketing campaigns. Tobacco companies have purposefully targeted Calisto by lowering pricesbecause of the higher demand. Calisto government health leaders will combat the higher smoking ______________________ 1 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

rates by adopting similar measures of their COPA members or creating a COPA regional policy.Fines and penalties for insider trading are prohibitive high. Individuals who are fiduciaries andrepresent financial firms who are caught for insider trading can face more severe punishment forthemselves and their firms.Question 1What type of regulation is the Financial Intermediaries Standards Act of 2001 (FISA)? A) A statute. B) An administrative regulation. C) A judicial law.Question 2A possible economic rationale for Calistose increase in demand for equities is that the regulationintervention has lowered: A) Externalities of public goods. B) The savings rate. C) Informational friction.Question 3The differences in the consumption of tobacco is most likely a result of: A) Using pricing mechanisms. B) Regulatory capture theory. C) Regulatory arbitrage.Question 4Which industry could possibly benefit from Calisto's regulatory changes? A) Oil. B) Tobacco. C) AccountancyQuestion 5The most likely reason for an increase in demand for equities stemming from ETC's regulations isthat disclosure requirements lead to: A) Higher investor confidence. B) Mitigation of agency issues. C) Fiduciary responsibilities.Question 6The least likely tool of regulatory intervention of the anti-smoking campaign is: A) Anti-smoking advertisements as financing of private projects. B) Warning labels as restricting certain activities. C) Higher taxes as a price mechanism.Question 7 - 12Wisterbon, Pratia and Surico are neighboring nations. The three countries share borders andfrequently trade with each other.Pratia A developing nation with an abundant oil reserves Primary conomic activity is oil industry ______________________ 2 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

Wisterbon A developing nation focusing on labor intensive industries because it lacks many naturalresourcesSurico A developed nation Largest trading partner for both the other two countriesThe following economic and demographic statistics are available for the three countries.GDP (in $ billions) 10 years ago Wisterbon Pratia SuricoGDP (in $ billions) Current $100.0 $100.00 $3,000.00Long-term growth rate in $156.0 $164.00 $4,209.00technology (est.)Long-term growth rate of capital 1.5% 1.2% 2.1%Sovereign credit rating 4.9% 4.40% 3.4%Savings rate (average is 10.0%) AAAPopulation (in millions) A A+ 5.0%Labor Growth Rate 12.5% 10.0% 50.4Cost of capital relative to total 0.6%factor cost 10.2 10.0Capital Growth Rate 2.8% 2.5% 27.5%TFP Growth Rate 3.4% 30.0% 35.0% 2.1% 4.9% 4.4% 1.5% 1.2%The three countries have sent their top finance ministers and economists to the annual Trade andEconomic Growth Forum (TEGF) to discuss potential trade and growth opportunities. Commentspertaining to concerns regarding future growth potential included:Economist #1: We are concerned about the GDP per capita and population growth. The current GDPper capita appears to be beyond the subsistence level.Economist #2: We are concerned that the output per capital ratio has been constant. It is likelythat the equilibrium growth rate has been reached and the economy cannot grow any faster.Economist #3: We are concerned that we are not investing enough in infrastructure and educationto increase the growth rate.Some common initiatives for economic growth were listed from the TEGF: 1. Fund a technology research center 2. Lower trade barriers 3. Provide financial incentives for innovation 4. Coordinate energy policies 5. Invest in educationEach country decided to adopt four of the five initiatives. Pratia did not like lowering trade barriers.Surico did not like coordinating energy policies. Wisterbon did not like providing financial incentivesfor innovation.Question 7Which country is most likely to rely on improving technology rather than capital deepening forincrease in potential GDP growth? A) Pratia. B) Surico. C) Wisterbon. ______________________ 3 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.











LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Investments in Financial Assets1. Held-to-maturity (cont.)  Initially reported at:  Cost including transactions costs (U.S. GAAP)  Fair value including transactions costs (IFRS)  Carried on the balance sheet at amortized cost  Changes in market value NOT recognized unless impaired  Reclassification or sale prior to maturity may lead to disallowance of held-to-maturity classification© Kaplan, Inc. 4LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Investments in Financial Assets3. Available-for-sale securities: Debt and equity securities that are neither held-to-maturity nor trading securities Interest and dividend income reported on income statement Interest = coupon + amortized discount (or – amortized premium) Carried on the balance sheet at fair value Unrealized gain/loss reported indirectly in equity When sold, realized gain/loss is recognized on income statement 6© Kaplan, Inc. ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Investments in Financial Assets2. Held for trading (U.S. GAAP) fair value through profit or loss (IFRS): Debt and equity securities acquired for the purpose of selling in the near future  Interest and dividend income reported on income statement  Interest = coupon + amortized discount – amortized premium  Carried on the balance sheet at fair value  Unrealized gains/losses recognized on income statement© Kaplan, Inc. 5LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Investments in Financial Assets4. Designated at fair value: Management has the option to report financial assets and liabilities that would otherwise be classified as held-to-maturity or available-for-sale at fair value  Treated just like trading securities, reported on balance sheet at fair value  Unrealized G/L are recognized on income statement  Dividends and interest on the income statement© Kaplan, Inc. 7ers - Exame CFA 2

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Classification of Securities Security Classification Trading/Fair Available-for- Held-to- Value Sale Maturity AmortizedBalance Fair Value Fair ValueSheet Unrealized G/L CostValue Dividends Dividends InterestIncome Interest Interest Realized G/LStatement Realized G/L Realized G/L Unrealized G/L© Kaplan, Inc. 8LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Unrealized Gains/(Losses)Debt Securities:Fair value – amortized cost = cumulative unrealized gainEquity Securities:Fair value – purchase price = cumulative unrealized gainUnrealized gain/(loss) for period = ∆ cumulative unrealized gain© Kaplan, Inc. 10 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 IAS (old) vs. U.S. GAAP Type: Intent U.S. GAAP U.S. GAAP IFRS vs. U.S. B/S I/S GAAP Trading/ Fair Value Fair Value Interest, No difference Dividends, Available-for- Fair Value; Realized and FX gains and Sale: Sell for Unrealized G/L Unrealized G/L losses on debt liquidity direct to equity Held-to- Interest, to I/S Maturity: Amortized Dividends, No difference Don’t sell Cost Realized G/L 9© Kaplan, Inc. Interest, Realized G/LLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Financial Investment: ExampleAcme Corp. purchased a 3-year 6% annual couponbond for $900.53. Market rates were 10% at the timeof purchase. The bond was worth $950 at the end ofYear 1 and Acme sold the bond at the beginning ofYear 2 for $955.Determine the balance sheet and income statementeffects if the bond is classified as held-to-maturity,trading, or available-for-sale.© Kaplan, Inc. 11ers - Exame CFA 3