CFA Exam Question of the Day

Level I | Level II | Level III

2024-06-12

Question:
Below are assumptions about a company that will be acquired through a leveraged buy-out, its level of debt over time, and a table depicting the value of the company during a "most likely" exit scenario:

1-year Treasury rate 3%
Market risk premium 8%
Unlevered beta 0.8

Year 0 1 2 3 4 5
Senior debt 200.0 191.9 181.3 167.9 151.3 131.3
Junior debt 150.0 150.0 150.0 150.0 150.0 150.0
Total debt 350.0 341.9 331.3 317.9 301.3 281.3

Year 5 4 3 2 1 0
Total debt 281.3 301.3 317.9 331.3 341.9 350
Equity value 365.7 319.9 277.1 237.4 x x
Total enterprise value 647.0 621.2 595.0 568.7 x x
Percent debt 43.5% 48.5% 53.4% 58.3% x
Percent equity 56.5% 51.5% 46.6% 41.7% x
Equity beta 1.42 1.55 1.72 x x
Cost of equity 14.32% 15.43% 16.74% x x

Using the information provided, what is the equity beta in Year 2?

Select an Answer:
1.90
1.92
1.96
1.89
Rationale:
The equity beta in Year 2 is the unlevered beta divided by the percentage of equity financing:

0.80 / 41.7% = 1.92

2024-06-11

Vignette:
John Smyth is a foreign exchange trader for Lewiston Currency House in London, UK.

At the end of each trading week, John likes to assess the current economic environment and forecast the expected movement in exchange rates.

John primarily trades the pound, euro, and U.S. dollar.

When Friday rolls around, John has gathered the following market data and balance of payment information:
  UKU.S.
CPI180165
Expected 1-year inflation rate2.25%3.50%
Risk-free rate 6.00% 

Spot exchange rates:
₤/$0.47619
₤/€0.56022
$/€1.17647


Question:
According to absolute purchasing power parity, if the ₤/$ exchange rate increases to 0.48515:

Select an Answer:
the inflation rate in the UK will fall relative to the U.S.
the real price of each good in the UK will fall relative to the U.S.
the inflation rate in the UK will rise relative to the U.S.
the real price of each good in the UK will rise relative to the U.S.
Rationale:
Absolute PPP is derived from the law of one price, which states that the real value of a good across all countries is the same. Therefore, if the pound depreciates against the dollar, then the real prices of all goods in the UK must rise to balance this difference.

2024-06-10

Question:
Below are assumptions about a company that will be acquired through a leveraged buy-out, its level of debt over time, and a table depicting the value of the company during a "most likely" exit scenario:

1-year Treasury rate 3%
Market risk premium 8%
Unlevered beta 0.8

Year 0 1 2 3 4 5
Senior debt 200.0 191.9 181.3 167.9 151.3 131.3
Junior debt 150.0 150.0 150.0 150.0 150.0 150.0
Total debt 350.0 341.9 331.3 317.9 301.3 281.3

Year 5 4 3 2 1 0
Total debt 281.3 301.3 317.9 331.3 341.9 350
Equity value 365.7 319.9 277.1 x x x
Total enterprise value 647.0 621.2 595.0 x x x
Percent debt 43.5% 48.5% 53.4% x x
Percent equity 56.5% 51.5% 46.6% x x
Equity beta 1.42 1.55 1.72 x x
Cost of equity 14.32% 15.43% 16.74% x x

Using the information provided, find the equity value in Year 2?

Select an Answer:
$229.6 million
$221.5 million
$237.4 million
$234.3 million
Rationale:
To find the equity value in Year 2, take the equity value in Year 3 and discount it by the cost of equity in Year 3:

277.1 / (1.1674) = 237.4

2024-06-09

Question:
The following are details on TQD Private Equity Investors:
  • Vintage: 2005
  • Fund size (millions): 500
  • Management fees: 2%
  • Carried interest: 20%
  • Hurdle rate: 10%
  • Term: 2015
The GP will only receive carried interest according to the total return method after the fund has returned all committed capital to the LPs.

Below are two tables. The first provides year-by-year data on capital called, operating results, and distributions for the firm while the second tracks various components of the firm's performance.

  2005 2006 2007 2008 2009
Called down 300 150 25 20 5
Realized results 0 0 50 60 80
Unrealized results -40 60 30 -10 75
Distributions 0 0 110 120 150

  2005 2006 2007 2008 2009
Called down 300 150 25 20 5
Paid in Capital 300 450 475 495 500
Mgmt fees x x x x x
Operating results -40 60 80 50 155
NAV before distributions 254 455 550.5 610.6 760.6
Carried interest 0 0 10.1 12.02 30
Distributions 0 0 110 120 150
NAV after distributions 254 455 430.4 478.58 580.6

With the data provided, find the management fee for 2007.

Select an Answer:
$500,000
$9.9 million
$6 million
$9.5 million
Rationale:
To find the management fee, simply take the 2% in management fees and multiply it by accumulated paid-in capital for the respective year.

For 2007, the management fee is:

0.02 × $475 million = $9.5 million

2024-06-08

Question:
Which of the following statements are correct?

I. A greater accrual component of earnings typically means that unusually high or low earnings will revert to the mean more quickly.

II. The accrual component of earnings is where earnings are typically most sustainable.

III. Companies with the highest level of accruals tend to have higher rates of earnings restatements.

IV. Analysts should only focus on financial red flags when evaluating a company's financials.

Select an Answer:
III only
I and III
I, II, III, and IV
II and IV
Rationale:
I and III are correct.

Item II is incorrect, since the accrual component is typically less sustainable than other earnings items. Item IV is incorrect because the analyst should also look out for things like changes in management and changes in auditors.