CFA Level 2 Free Practice Test

. Annisquam is correct with regards to his comments on calibrating a binomial interest rate tree. because his comments are correct. because his comments are correct.

. Both points that Marlin makes regarding structural models of credit risk are correct.
because the first point is correct.
because the second point is correct.

Swift’s functional currency is the AUD because sales are generated in AUD and the company operates within the competitive and regulatory environment of Australia. Under IFRS, when the subsidiary’s functional currency is the local currency, translations are done using the current rate method. Thus, Swift will use the current rate method for converting its financial statements.
The use of the current rate method depends on the identification of the functional currency, not on the local currency. Translations from the functional currency to the presentation currency is done using the current rate method. The local currency has an impact on translation only where it differs from the functional currency. In these cases, the translation from the local to the functional currency is done using the temporal method.
Swift’s functional currency is the AUD, not the USD, because sales are generated in AUD and the company operates within the competitive and regulatory environment of Australia. If it were the USD this answer would be correct.

. A reduced form model requires that one of the company’s liabilities trade; it can be a zero-coupon bond or an estimation of zero-coupon bonds from observable risky coupon bond prices that trade. In addition, the company’s default prospects are dependent on macroeconomic state variables. These explanatory variables can include such inputs as the growth rate of GDP and the level of unemployment. The model also requires a risk-free rate.
because a reduced form model requires that the state of the economy can be described as a vector of macroeconomic state variables. because a reduced form model requires that some of the company’s debt trades, either a zero-coupon or coupon bond.

1 Drawbridge sold AUD 5 million forward to the settlement date at an all-in forward price of 0.8940 (USD/AUD).
2 To mark the position to market, Drawbridge offsets the forward transaction by buying AUD 5 million three months forward to the settlement date.
3 For the offsetting forward contract, because the AUD is the base currency in the USD/AUD quote, buying AUD forward means paying the offer for both the spot rate and forward points.
I. The all-in three-month forward rate is calculated as 0.9066 – 0.00364 = 0.90296
II. This gives a net cash flow on settlement day of 5,000,000 × (0.8940 – 0.90296) = –USD44,800 (This is a cash outflow because Drawbridge sold the AUD for- ward and the AUD appreciated against the USD).
4 To determine the mark-to-market value of the original forward position, calculate the present value of the USD cash outflow using the three-month USD discount rate: –USD44,8000/[1 + 0.0023(90/360)] = –USD44,774.
The present value of the cash flow was not calculated (step 4 of
calculation).
The cash flow was calculated using the bid rate instead of the offer rate.
1 The all-in three-month forward rate = 0.9062 – 0.00368 = 0.90252
2 This gives a net cash flow on settlement day of 5,000,000 × (0.8940 – 0.90252) = – USD42,600, and the present value is calculated as –USD42,600/[1 + 0.0023(90/360)] = –USD42,576.