CFA Exam Question of the Day

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2023-01-28

Vignette:
Ichi Yamamoto is a foreign exchange trader for a large Japanese bank. Ichi takes advantage of short-term currency arbitrage opportunities by using large amounts of leverage to exploit small differences in currency spreads.

Currently, the following market rates for three currencies are displayed:

 BidAsk
¥/$104.69104.72
$/€1.32621.3265

Ichi has also gathered data on three other currencies, as follows:

₤/CAD0.44579
CAD/AUD0.98256
₤/AUD0.40895


Question:
What should the ₤/AUD exchange rate be in order to prevent arbitrage?

Select an Answer:
0.43896
0.43554
0.43802
0.44526
Rationale:
Calculate the cross exchange rate between ₤/CAD and CAD/AUD:

₤/AUD = ₤/CAD × CAD/AUD

= 0.44579 × 0.98256

= 0.43802

2023-01-27

Question:
You are analyzing a stock with a current dividend of $1.00 per share and a current market price of $15 per share. You believe it has a dividend growth rate of 20% per year that will linearly decline to 8% per year over the next 6 years.

Find the implied rate of return on the stock.

Select an Answer:
17.30%
17.50%
17.60%
17.70%
17.40%
Rationale:
The setup of this problem implies the H-model. By rearranging the price formula for the H-model, we can obtain an implied rate of return:



Remember that here, H = 3. So, we get:

$1/$15[1.08 + 3(0.12)] + 8% = 17.60%

2023-01-26

Vignette:
Bob Hill has prepared data from the maintenance expenses incurred by Alpha Industries in servicing its machinery.

Three years ago, Alpha made changes to its machines in an effort to reduce maintenance expenses. The maintenance on the machines is higher in the summer months but some maintenance issues are deferred to fall and early winter.

The following information has been gathered: (all figures are in thousands)

QuarterMaint. Exp.Change in Maint. Exp.Lagging Change in Maint. Exp.Season Lag in Exp.
1A85   
1B48-37  
1C34-14-37
1D46+12-14
2A63+17+12
2B38-25+170
2C29-9-25-14
2D45+16-9+12
3A61+16+16+17
3B36-25+16-25
3C25-11-25-9
3D48+23-11+16


 Coefficients
Interest-3.25
Lag A+.52
Lag D+.85


Question:
Based on the model, what is the expected maintenance expense in the 4A quarter assuming the following information?

Select an Answer:
22.31
70.31
36.00
45.36
Rationale:
Substituting the 1 period lagged data from quarter 3D and the 4 period lagged date from 3A into the model the change in maintenance expense is predicted to be as follows:

= (-3.25 + (.52 × 23) + (.85 × 16) = 22.31 higher than in quarter 3D which is 48 + 22.31

= 70.31

2023-01-25

Vignette:
Ichi Yamamoto is a foreign exchange trader for a large Japanese bank. Ichi takes advantage of short-term currency arbitrage opportunities by using large amounts of leverage to exploit small differences in currency spreads.

Currently, the following market rates for three currencies are displayed:

 BidAsk
¥/$104.69104.72
$/€1.32621.3265

Ichi has also gathered data on three other currencies, as follows:

₤/CAD0.44579
CAD/AUD0.98256
₤/AUD0.40895


Question:
Calculate the widest interval between the euro and the yen that will not allow arbitrage to occur if the midpoint is 138.87 and transaction costs are 0.03%.

Select an Answer:
0.00043
0.000043
0.0043
0.0000043
Rationale:
The largest interval is found through the following equation:

X = -(1 / Direct exchange rate in foreign) + 1 / ((1 − Transaction cost)2 × Direct exchange rate in foreign)

= -(1 / 138.87) + 1 / ((1 − 0.03%)2 × 138.87)

= -(1 / 138.87) + 1 / (0.99972 × 138.87)

= 0.0000043225

2023-01-24

Vignette:
Use the information below to answer the following question about Visicare Inc.

Current dividend$1.50
Dividend growth rate 2.1%
Earnings per share$3.20
Required rate of return10%
Risk-free rate of return4%


Question:
Assume Visicare's stock is now trading at $40 per share. Calculate the PVGO (present value of its future investment opportunities) as a percentage of the stock's market price.

Select an Answer:
15%
10%
25%
20%
Rationale:
Use the equation:

Value = (E/r) + PVGO, where
E = earnings and r = req. rate of return

$40 = (3.20/0.10) + PVGO
PVGO = 40 − (3.2/0.10) = 8

As a percentage of market price:
PVGO/Price = $8/$40 = 0.20 = 20%