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CFA CFA-Level-II Exam Prep
CFA Level II Chartered Financial Analyst (Page 16 )

Updated On: 7-Sep-2026
Page 16 of 145
PDF with 715 Questions

In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.

For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year-end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.

At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.

For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:

LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4
Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 3 50.0 350.0
Retained earnings 622.0 610.0

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

When remeasuring International Oilfield's 2008 financial statements into the presentation currency, which of the following ratios is not affected by changing exchange rates under the temporal method9

  1. Current ratio.
  2. Total asset turnover.
  3. Quick ratio.

Answer(s): C

Explanation:

Both the numerator (cash + receivables) and denominator (current liabilities) of the quick ratio are remeasured at the current exchange rate under the temporal method. Inventories are ignored in the quick ratio. Since the same rate is used to remeasure both the numerator and denominator, the ratio does not change when stated in the presentation currency. (Study Session 6, LOS 23.d)



In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.

For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year-end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.


At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.

For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:


LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4
Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 350.0 350.0
Retained earnings 622.0 610.0

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

Assume the country where International Oilfield is operating has been experiencing 30% annual inflation over the past three years. Which of the following best describes the effect on Continental's consolidated financial statements for the year ended 2008?

  1. A gain is recognized in the income statement.
  2. A loss is recognized in the income statement.
  3. A gain is recognized as a direct adjustment to the balance sheet.

Answer(s): A

Explanation:

The temporal method is required if the foreign subsidiary is operating in a highly inflationary environment, defined as cumulative inflation of more than 100% in a 3-year period. Compounded inflation of 30% annually for three years is approximately 120% (1.30- 1). Under the temporal method, remeasurement gains and losses are recognized in the income statement. In this case. International Oilfield has a net monetary liability position (monetary liabilities of 600 million > monetary assets of 120 million). Holding net monetary liabilities denominated in a currency that is depreciating will result in a gain. (Study Session 6, LOS 23.f)



Viper Motor Company, a publicly traded automobile manufacturer located in Detroit, Michigan, periodically invests its excess cash in low-risk fixed income securities. At the end of 2009, Viper's investment portfolio consisted of two separate bond investments: Pinto Corporation and Vega Incorporated.

On January 2, 2009, Viper purchased $10 million of Pinto's 4% annual coupon bonds at 92% of par. The bonds were priced to yield 5%. Viper intends to hold the bonds to maturity. At the end of 2009, the bonds had a fair value of $9.6 million.

On July I, 2009, Viper purchased $7 million of Vega's 5% semi-annual coupon mortgage bonds at par. The bonds mature in 20 years. At the end of 2009, the market rate of interest for similar bonds was 4%. Viper intends to sell the securities in the near term in order to profit from expected interest rate declines.

Neither of the bond investments was sold by Viper in 2009.
O n January 1,2010, Viper purchased a 60% controlling interest in Gremlin Corporation for $900 million. Viper paid for the acquisition with shares of its common stock.
Exhibit 1 contains Viper's and Gremlin's pre-acquisition balance sheet data.



Exhibit 2 contains selected information from Viper's financial statement footnotes.



The carrying value of Viper's investment portfolio as of December 31, 2009 is closest to:

  1. $16.6 million.
  2. $17.2 million
  3. $17.5 million.

Answer(s): B

Explanation:

Held-to-maturity securities are reported on the balance sheet at amortized cost. At the end of 2009, the Pinto bonds have a carrying value of $9,260,000 (9,200,000 issue price + 60,000 discount amortization). The amortized discount is equal to the $60,000 difference between the interest expense of $460,000 (9,200,000 x 5%) and the $400,000 coupon payment (10,000,000 x 4%).

Trading securities are reported on the balance sheet at fair value. Ac the end of 2009, the fair value of the Vega bonds was $7,941,591 (N = 39,1 = 2, PMT = 175,000, FV = 7,000,000, Solve for PV).
Thus, at the end of 2009, the investment portfolio is reported at $17.2 million (9,260,000 Pinto bond + 7,941,591 Vega bond). (Study Session 5, LOS 21.a)



Viper Motor Company, a publicly traded automobile manufacturer located in Detroit, Michigan, periodically invests its excess cash in low-risk fixed income securities. At the end of 2009, Viper's investment portfolio consisted of two separate bond investments: Pinto Corporation and Vega Incorporated.

On January 2, 2009, Viper purchased $10 million of Pinto's 4% annual coupon bonds at 92% of par. The bonds were priced to yield 5%. Viper intends to hold the bonds to maturity. At the end of 2009, the bonds had a fair value of $9.6 million.

On July I, 2009, Viper purchased $7 million of Vega's 5% semi-annual coupon mortgage bonds at par. The bonds mature in 20 years. At the end of 2009, the market rate of interest for similar bonds was 4%. Viper intends to sell the securities in the near term in order to profit from expected interest rate declines.

Neither of the bond investments was sold by Viper in 2009.
On January 1,2010, Viper purchased a 60% controlling interest in Gremlin Corporation for $900 million. Viper paid for the acquisition with shares of its common stock.

Exhibit 1 contains Viper's and Gremlin's pre-acquisition balance sheet data.



Exhibit 2 contains selected information from Viper's financial statement footnotes.



If Viper had initially classified its Vega bond investment as available-for-sale, which of the following best describes the most likely effect for the year ended 2009?

  1. Lower asset turnover.
  2. Higher return on equity.
  3. Lower net profit margin.

Answer(s): C

Explanation:

A $941,591 unrealised gain (7,941,591 FV- 7,000,000 BV) was included in Viper's net income since the Vega bonds were classified as trading securities. Had the Vega bonds been classified as available-for-sale, the unrealized gain would have been reported as a component of stockholders' equity. In that case, net profit margin would have been lower (lower numerator). (Study Session 5, LOS 21.a)



Viper Motor Company, a publicly traded automobile manufacturer located in Detroit, Michigan, periodically invests its excess cash in low-risk fixed income securities. At the end of 2009, Viper's investment portfolio consisted of two separate bond investments: Pinto Corporation and Vega Incorporated.

On January 2, 2009, Viper purchased $10 million of Pinto's 4% annual coupon bonds at 92% of par. The bonds were priced to yield 5%. Viper intends to hold the bonds to maturity. At the end of 2009, the bonds had a fair value of $9.6 million.

On July I, 2009, Viper purchased $7 million of Vega's 5% semi-annual coupon mortgage bonds at par. The bonds mature in 20 years. At the end of 2009, the market rate of interest for similar bonds was 4%. Viper intends to sell the securities in the near term in order to profit from expected interest rate declines.

Neither of the bond investments was sold by Viper in 2009.

On January 1,2010, Viper purchased a 60% controlling interest in Gremlin Corporation for $900 million. Viper paid for the acquisition with shares of its common stock.
Exhibit 1 contains Viper's and Gremlin's pre-acquisition balance sheet data.



Exhibit 2 contains selected information from Viper's financial statement footnotes.



What is the appropriate adjustment, if any, if the Pinto bonds are reclassified as available-for-sale securities during 2010?

  1. The difference between the fair value and the carrying value on the date of reclassification is recognized in Viper's other comprehensive income.
  2. Any unrealized gain or loss, as of the date of reclassification, is immediately recognized in Viper's net income.
  3. No adjustment is necessary because reclassification to/from available-for-sale is strictly prohibited under U.S. GAAP and IFRS.

Answer(s): A

Explanation:

Reclassifying a hcld-to-maturity security to availablc-fbr-sale involves siating the investment on the balance sheet at fair value and recognizing the difference in the fair value and the carrying value as other comprehensive income. (Study Session 5, LOS 21.a)



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