DOES OKELLO’S STATEMENT 2 MOST LIKELY MEET THE RECOMMENDED PROCEDU...

12. Does Okello’s Statement 2 most likely meet the recommended procedures for compliance with the CFA Standards? A. Yes. B. No, with regard to investment statements. C. No, with regard to the company’s website. By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currently-registered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose. James Stam Case Scenario James Stam is a currency management consultant at Horizon, a Canadian asset management firm. Stam consults with portfolio managers within the firm as well as external clients. In September, Amanda Lee, a Canadian equity portfolio manager at Horizon, approached Stam for advice about a ₤5,000,000 position in a U.K. stock she had just purchased in her portfolio. She believed the stock would outperform similar Canadian stocks over the next three months; however, she was concerned that the British pound (£) would weaken relative to the Canadian dollar (C$) during that period. Stam recommended that Lee hedge 100% of the position’s pound exposure. Lee immediately executed the hedge by entering into enough December futures contracts to sell ₤5,000,000 for Canadian dollars at a futures exchange rate of C$1.75/₤. At the time, the spot exchange rate was C$1.80/£. One month later, the U.K. stock is valued at £5,200,000, the spot exchange rate is C$1.70/£ and the futures rate is C$1.65/£. Lee asks Stam to calculate the net profit or loss on the hedged stock position. Before Stam begins his analysis, he makes the following statement to Lee: “The return on a hedged stock will differ from the stock return achieved in foreign currency for the following reasons: foreign exchange transaction costs, stock price volatility, and the interest rate differential.” Aaron Sykes is a Canadian bond portfolio manager at Horizon who wants to add a Mexican peso-denominated bond to his portfolio. Sykes’ objective is to implement a currency hedge to minimize the Mexican bond’s exposure to exchange rate changes. He consults with Stam, who notes that the foreign currency values of Mexican peso-denominated bonds react systematically to exchange rate movements and that the covariance between bond returns and movement in the peso’s value is positive. Stam analyzes the position to determine an appropriate Mexican peso hedge ratio for Sykes. The international equity portfolio manager at Horizon, Blain DuPont, believes the Canadian dollar will appreciate over the next two years against all of the six foreign currency exposures within his portfolio. DuPont approaches Stam for advice on hedging these exposures. Stam recommends directly hedging the major currency exposures (euro, pound, and yen) and cross-hedging the remaining three minor currency exposures using the euro, pound, or yen. The hedging currency will be the one with the closest correlation with the minor currency. Stam provides the following three facts in support of this hedge structure: Fact 1. Currency futures and forward contracts are actively traded only for major currencies. Fact 2. In portfolios with assets in many currencies, the residual risk of each currency is partly diversified away. Fact 3. Changes in the exchange rates for major currencies are often closely related to changes in other currencies. Stam recommends that DuPont implement the hedges with short-term futures contracts with a maturity of 3 months or less. He justifies the use of short-term futures contracts by stating: “Short-term futures contracts are preferable to long-term futures contracts because they offer greater liquidity and lower transaction costs.” A pension plan client of Horizon approaches Stam for advice on hedging foreign currency exposures within the plan’s asset mix. Stam considers three factors before recommending a strategic benchmark hedge ratio to the client: Factor 1. Asset types held by the plan. Factor 2. Forecasted short-term changes in exchange rates. Factor 3. Transaction and interest differential costs of hedging.