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CFA Level II Chartered Financial Analyst Questions 60–64 (page: 34)

Lorenz Kummert is a junior equity analyst who is following Schubert, Inc. (Schubert), a small publicly traded company in the United States. His supervisor, Markus Alter, CFA, has advised him to use the residual income model to analyze Schubert.

In his preliminary report to Alter, Kummert makes the following statements:
Statement 1: Residual income models are appropriate when expected free cash flows are negative for the foreseeable future.

Statement 2: Residual income models are not applicable when cash flows are volatile.

Kummert has determined Schubert's cost of equity, cost of debt, and weighted average cost of capital (WACC) to be 12.8%, 8.4%, and 11.9%, respectively. The current price of the stock is $35 per share and there are 130,000 shares outstanding. The relevant tax rate is 30%, and return on equity (ROE) is expected to be 13%.

Summarized financial information about Schubert for 2008 is provided in Exhibits I and II.





Based on his analysis of several years of financial statements, Kummert notes that 2008 was an exceptionally profitable year for Schubert, and that its dividend payouts are usually low because the funds are mainly reinvested in the firm to promote growth. Furthermore, there are very few nonrecurring items on the income statement. Upon review of Kummert's preliminary report, Alter concurs with his analysis of the financial statements but reminds him that Schubert's long-term debt is currently trading at 95% of its book value. He also cautions Kummert that violations of the clean surplus relation can bias the results of the residual income model.

The consensus annual EPS estimate for 2009 is $6.15, and the dividend payout ratio for 2009 is estimated at 5%.

Regarding Alter's caution about violations of the clean surplus relationship, examples of items that can violate this relationship include:

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has been hired by Tryssen AG, a global research-based company that is preparing to go public after a long history of operating privately. The need to raise substantial amounts of capital to fund research and development activities is seen as the key motivation for the change in policy. Tryssen is engaged in the discovery, development, manufacture, marketing, and sale of medical products.

Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. One possibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous order- driven system. Another alternative that Tryssen is considering is to list on a different exchange that operates as a price-driven system.

As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs are negotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity. Although typically denominated in U.S. dollars, depository receipts can also be denominated in euros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on many European stock exchanges.

The increasing demand for depository receipts is driven by the desire of individual and institutional investors to diversify their portfolios, reduce risk and invest internationally in the most efficient manner possible. While most investors recognize the benefits of global diversification, there are many challenges presented when investing directly in local trading markets. Obstacles can include inefficient trade settlements, uncertain custody services, and costly currency conversions.

Depository receipts overcome many of the inherent operational and custodial hurdles inherent in international investing. Tryssen has decided to access the U.S. market by involving itself in an ADR program. Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registration and reporting requirements.

As an alternative to ADRs, investors interested in increasing their exposure to international investments can choose to acquire exchange traded funds (ETFs). Hagemann researches the advantages and disadvantages of ETFs.

Execution costs are always a concern, and perhaps even more so for international investors. At the present time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part of the cost estimation process, Hagemann is asked to provide a report on the advantages and disadvantages of techniques used to reduce execution costs.

Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's company starts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20 per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays a dividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investor is eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares had jumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just after the dividend was paid.

Which type of ADR is Tryssen most likely to undertake?

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has been hired by Tryssen AG, a global research-based company that is preparing to go public after a long history of operating privately. The need to raise substantial amounts of capital to fund research and development activities is seen as the key motivation for the change in policy. Tryssen is engaged in the discovery, development, manufacture, marketing, and sale of medical products.

Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. One possibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous order- driven system. Another alternative that Tryssen is considering is to list on a different exchange that operates as a price-driven system.

As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs are negotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity. Although typically denominated in U.S. dollars, depository receipts can also be denominated in euros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on many European stock exchanges.

The increasing demand for depository receipts is driven by the desire of individual and institutional investors to diversify their portfolios, reduce risk and invest internationally in the most efficient manner possible. While most investors recognize the benefits of global diversification, there are many challenges presented when investing directly in local trading markets. Obstacles can include inefficient trade settlements, uncertain custody services, and costly currency conversions. Depository receipts overcome many of the inherent operational and custodial hurdles inherent in international investing. Tryssen has decided to access the U.S. market by involving itself in an ADR program. Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registration and reporting requirements.
As an alternative to ADRs, investors interested in increasing their exposure to international investments can choose to acquire exchange traded funds (ETFs). Hagemann researches the advantages and disadvantages of ETFs.
Execution costs are always a concern, and perhaps even more so for international investors. At the present time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part of the cost estimation process, Hagemann is asked to provide a report on the advantages and disadvantages of techniques used to reduce execution costs.

Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's company starts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20 per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays a dividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investor is eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares had jumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just after the dividend was paid.

Which of the following best describes a comparative advantage of a price-driven system over an order-driven system?

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has been hired by Tryssen AG, a global research-based company that is preparing to go public after a long history of operating privately. The need to raise substantial amounts of capital to fund research and development activities is seen as the key motivation for the change in policy. Tryssen is engaged in the discovery, development, manufacture, marketing, and sale of medical products.

Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. One possibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous order- driven system. Another alternative that Tryssen is considering is to list on a different exchange that operates as a price-driven system.
As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs are negotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity. Although typically denominated in U.S. dollars, depository receipts can also be denominated in euros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on many European stock exchanges.

The increasing demand for depository receipts is driven by the desire of individual and institutional investors to diversify their portfolios, reduce risk and invest internationally in the most efficient manner possible. While most investors recognize the benefits of global diversification, there are many challenges presented when investing directly in local trading markets. Obstacles can include inefficient trade settlements, uncertain custody services, and costly currency conversions.

Depository receipts overcome many of the inherent operational and custodial hurdles inherent in international investing. Tryssen has decided to access the U.S. market by involving itself in an ADR program. Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registration and reporting requirements.

As an alternative to ADRs, investors interested in increasing their exposure to international investments can choose to acquire exchange traded funds (ETFs). Hagemann researches the advantages and disadvantages of ETFs.

Execution costs are always a concern, and perhaps even more so for international investors. At the present time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part of the cost estimation process, Hagemann is asked to provide a report on the advantages and disadvantages of techniques used to reduce execution costs.

Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's company starts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20 per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays a dividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investor is eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares had jumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just after the dividend was paid.

Which of the following alternatives best describes the main benefits of ETFs?

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has been hired by Tryssen AG, a global research-based company that is preparing to go public after a long history of operating privately. The need to raise substantial amounts of capital to fund research and development activities is seen as the key motivation for the change in policy. Tryssen is engaged in the discovery, development, manufacture, marketing, and sale of medical products.

Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. One possibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous order- driven system. Another alternative that Tryssen is considering is to list on a different exchange that operates as a price-driven system.

As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs are negotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity. Although typically denominated in U.S. dollars, depository receipts can also be denominated in euros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on many European stock exchanges.

The increasing demand for depository receipts is driven by the desire of individual and institutional investors to diversify their portfolios, reduce risk and invest internationally in the most efficient manner possible. While most investors recognize the benefits of global diversification, there are many challenges presented when investing directly in local trading markets. Obstacles can include inefficient trade settlements, uncertain custody services, and costly currency conversions.

Depository receipts overcome many of the inherent operational and custodial hurdles inherent in international investing. Tryssen has decided to access the U.S. market by involving itself in an ADR program. Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registration and reporting requirements.

As an alternative to ADRs, investors interested in increasing their exposure to international investments can choose to acquire exchange traded funds (ETFs). Hagemann researches the advantages and disadvantages of ETFs.

Execution costs are always a concern, and perhaps even more so for international investors. At the present time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part of the cost estimation process, Hagemann is asked to provide a report on the advantages and disadvantages of techniques used to reduce execution costs.

Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's company starts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20 per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays a dividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investor is eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares had jumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just after the dividend was paid.

Which of the following combinations best describes the four most important execution costs in increasing order of estimation reliability?