Q 10 - Does Bond insurance pay BOTH interest and principal or just principal? I got this Q correct, but was confused about that. Q 19 - When calculating Investment in Fixed Capital, are you supposed to take the Net of (Investments in additional FC - Sale of FC)? or do you solely look at Investments in additional FC? In this Q, they only take the Investments in Additional, but I was pretty sure we are supposed to look at the NET. Thoughts? Q 30 - Don’t we normally finance BOTH WC and FC with debt? Q 45 - It was my understanding the net effect of increased interest rates on the value of an IO was that the IO increases in value due to lower prepayments. I answered this correctly several times in the QBank - has anyoen seen differently, or what’s going on? Q 46 - did anyone else find it difficult to choose between PAC1 and PAC3?
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Q10 - Bond insurance covers the whole payment which includes both principal and interest. Q19 - I think for the exam you only look at additional investments but in reality if it was a usual occurrence you would most likely add it. For the test I wouldnt bother. Q30 - I dont know about the CFA curriculum but I can tell you from experience that WC is financed internally as it really is the difference between your current assets and current liabilities. This is generally covered by retained earnings generated during the year and revolving lines of credit (which doesnt really change as a business stops growing rapidly so your short term liabilities stay the same). So not really debt. Q45 - I find this confusing too but when interest rates rise too much, then the IO starts going down in value and the face value starts dropping in order for it to compete with other instruments and new issues. Q46 - You can see that PAC 3 has better risk reward characteristics than PAC 1. I’ll say it another way, and look at the last two columns. Which investment would you like best one that goes up $39 or loses $76 (a ratio of almost .5 to 1) or something that goes up $187 or loses $137 (a ratio of almost 1.3 to 1)? Oh, and investment two (PAC 3) is better priced because it has a higher OAS. So higher OAS and better risk characteristics.
q1. - q2. its in the errata. you deduct the sale of FC. q3. came across this one twice, and twice it was only fixcap.investement q4. - If prevailing mortgage rates fall below the contract rate of outstanding mortgages we would expect prepayments to speed up to take advantage of the lower market rates. This is bad for IOs. Their expected cash flow deteriorates and while the discount rate at which we discount the cash flows has fallen the net effect typically is a decline in the price of the IO. If mortgage rates rise above contract rates the expected cash flow improves but our discount rate has risen as well. The net effect, here, is either a rise or fall for the IO. q5. found it tricky too. did not answer correctly.
Is it confirmed that working capital is not funded with debt? I disagree with sebrock, as many companies finance their working capital needs with short-term/revolving lines of credit (i.e. comercial paper and other facilities), which bear interest that gets reflected on the income statement.
FYI - page 359 of Vol 4 says “If a company receives cash in disposing of any of its fixed capital, the analyst must deduct this cash in arriving at investments in fixed capital. For example, supposed we had a sale of equipment for $100,000. This cash inflow reduces the company’s cash outflows for investments in fixed capital” So, from this I am reading that Q19 is incorrect since they ignore the sale of the equipment when calculating NET investment in FC.