CHARTERED INSTITUTE OF STOCKBROKERS
March 2015 Examination Diet
Paper 2.1 Solution
Section “B” - Financial Accounting and Financial Statement Analysis
Solution to Question 2 (Section B):
The Conceptual Framework for Financial Reporting implies that the two
fundamental
qualitative
characteristics
(relevance
and
faithful
representation) are vital as, without them, financial statements would not be
useful, in fact they may be misleading.
As the name suggests, the four enhancing qualitative characteristics
(comparability, verifiability, timeliness and understandability) improve the
usefulness of the financial information. Thus financial information which is
not relevant or does not give a faithful representation is not useful (and
worse, it may possibly be misleading); however, financial information which
does not possess the enhancing characteristics can still be useful, but not as
useful as if it did possess them.
In order for financial statements to be useful to users (such as investors or
loan providers), they must present financial information faithfully, i.e.
financial information must faithfully represent the economic phenomena
which it purports to represent (e.g. in some cases it may be necessary to
treat a sale and repurchase agreement as an in-substance (secured) loan
rather than as a sale and subsequent repurchase). Faithfully represented
information should be complete, neutral and free from error. Substance is
not identified as a separate characteristic because the IASB says it is implied
in faithful representation such that faithful representation is only possible if
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transactions and economic phenomena are accounted for according to their
substance and economic reality.
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Section “C” - Financial Accounting and Financial Statement Analysis
Solution to Question 5 (Section C):
5 a1
Note: The answer should be focused on using the current and quick ratios.
While the current ratio has steadily increased, it is to be noted that the
liquidity has not resulted from the most liquid assets as the CEO proposes.
Instead, from the quick ratio one could note that the increase in liquidity is
caused by an increase in inventories. For a fresh food firm one could argue
that inventories are relatively liquid when compared to other industries. Also,
given the information, the industry-benchmark can be used to derive that the
firm's quick ratio is very similar to the industry level and that the current ratio
is indeed slightly higher - again, this seems to come from inventories.
5 a2
Note: Inventory turnover, days sales in receivables, and the total asset
turnover ratio are to be mentioned here.
a) Inventory turnover has increased over time and is now above the industry
average. This is good - especially given the fresh food nature of the firm's
industry. In 1999 it means for example that every 365/62.65 = 5.9 days
the firm is able to sell its inventories as opposed to the industry average
of 6.9 days. Days' sale in receivables has gone down over time, but is still
better than the industry average. So, while they are able to turn
inventories around quickly, they seem to have more trouble collecting on
these sales, although they are doing better than the industry. Finally, total
asset turnover went down over time, but it is still higher than the industry
average. It does tell us something about a potential problem in the firm's
long term investments, but again, they are still doing better than the
industry.
5 a3
b) Solvency and leverage is captured by an analysis of the capital structure
of the firm and the firm's ability to pay interest.
Capital structure: Both the equity multiplier and the debt-to-equity ratio tell
us that the firm has become less levered. To get a better idea about the
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proportion of debt in the firm, we can turn the D/E ratio into the D/V ratio:
1999: 43%, 1998: 46%, 1997:47%, and the industry-average is 47%. So
based on this, we would like to know why this is happening and whether
this is good or bad. From the numbers it is hard to give a qualitative
judgement beyond observing the drop in leverage. In terms of the firm's
ability to pay interest, 2014 looks pretty bad. However, remember that
times interest earned uses EBIT as a proxy for the ability to pay for
interest, while we know that we should probably consider cash flow
instead of earnings. Based on a relatively large amount of depreciation in
2014 (see info), it seems that the firm is doing just fine.
5b
The issued share capital is the key number here.
Jan 2nd
400,000 new shares (2.4 million total) and raising N848,000.
March 3rd
1,12,0000,00 new shares (2.5 million total). No money raised.
So 2.5 million shares and N2.4,000 raised.
Authorised capital stays the same.
5c
Manufacturing assets are expensive and mean a great deal of capital is
tied up and a return needs to be made on this investment. The return
can only be achieved in two ways - charging a mark-up on cost or by
getting more sales out of the assets. Asset turnover measures the latter
of the two.
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Section “B” - Economics and Financial Markets
Solution to Question 3 (Section B):
The long-run average total cost curve is U-shaped showing that it falls
at first and then rises
Cost per unit
LATC
Output per period
The falling average total cost curve at first is as a result of the
possibility of economies of scale accruable to a growing firm while the
rising portion reflects the diseconomies of scale that could result later.
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Section “C” - Economics and Financial Markets
Solution to Question 6 (Section C):
Money Supply
6(a1): The cash reserve requirement is the minimum amount of money
that banks must hold in reserve, usually given as a percentage of
customer deposits. The requirement is set by each country’s Central
Bank. Raising or lowering the reserve requirement will subsequently
influence the money supply in the economy. In a situation of
increased cash reserve requirements banks will have less money to
loan out and this effectively reduces the amount of monetary base,
therefore lowering the money supply.
6(a2):
The sale of government –issued bonds is an aspect of open market
operations aimed at raising fund for government in the open market.
The buyers of these bonds will draw cheques on their account to
pay for them and the Bank’s excess reserves will be reduced. This
means the Bank’s ability to increase credit is reduced and, with this
credit reduction, money supply is also reduced.
6(b):
 The money supply exercises significant influence on price level
and price stability in the economy. As predicted by the quantity
theory of money, the general price level varies directly and
proportionately with money supply. An excessive money supply
could bring about inflationary situation, especially when it is not
accompanied by increased economic activities or in a situation of
near full employment. This implies that to check inflation, a cut
back in money supply becomes necessary.
 As for exchange rate, increases in money supply could lead to a
higher demand for exchange and hence a depreciation of the
exchange rate. Higher liquidity tends to bring about an increase
in the ability of banks to purchase foreign exchange as well as
provide loans to the public to buy foreign exchange thereby
depreciating the exchange rate in terms of local currency. It
therefore follows that decreases in money supply could limit
ability of banks to purchase foreign exchange and hence an
appreciation of exchange rate
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Section “B” - Quantitative Analysis and Statistics
Solution to Question 4 (Section B):
4(a1): A shadow price is the incremental change in the objective function
for a one-unit change in the value of a constraint. It is also
referred to as the benefit or the marginal revenue of an additional
resource.
4(a2): The feasible region is the area that yields all possible production
combinations given the constraints. It is a set of all possible points
that satisfy the model’s constraints.
4(b): Limitations of Linear Programming model
(i) The objective function and constraints may not be directly
specified by linear inequality equations.
(ii) The values or the coefficients of the objective function as well
as the constraint equations must be completely known and
assumed to be constant over a period of time. However, in
real life practical situations often it is not possible to
determine the coefficients of objective function and the
constraints equations with absolute certainty.
(iii) Once a problem has been properly quantified in terms of
objective function and the constraint equations and the tools
of Linear Programming are applied to it, it becomes very
difficult to incorporate any changes in the system arising on
account of any change in the decision parameter. Hence, it
lacks the desired operational flexibility.
(iv) No Scope for Fractional Value Solutions. There is absolutely
no certainty that the solution to a LP problem can always be
quantified as an integer.
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Section “C” - Quantitative Analysis and Statistics
Solution to Question 7 (Section C):
7(a)
Using a 10-day moving average:
At every point in time, the 10-day moving average is the simple
average of exchange rates in the preceding 10 days.
Date
14-March-13
15-March-13
16-March-13
17-March-13
18-March-13
19-March-13
20-March-13
21-March-13
22-March-13
23-March-13
24-March-13
25-March-13
26-March-13
27-March-13
28-March-13
Exchange
Rate
120.0
120.5
121.0
121.4
121.9
122.4
122.9
123.8
124.6
125.5
126.4
127.3
128.2
129.1
130.0
Moving
average
122.4
123.0
123.7
124.4
125.2
126.0
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7(b)
Since the time series model is autoregressive (order 1), the
dependent variable is a one-day lagged value of the exchange rate.
Date
14-March-13
15-March-13
16-March-13
17-March-13
18-March-13
19-March-13
20-March-13
21-March-13
22-March-13
23-March-13
24-March-13
25-March-13
26-March-13
27-March-13
28-March-13
Dependent (t)
120.0
120.5
121.0
121.4
121.9
122.4
122.9
123.8
124.6
125.5
126.4
127.3
128.2
129.1
130.0
7(c)
Victor’s model
Yt=1.06t-1 - 6.58
t = 29th March 2013
t-1= 28th March 2013
Yt= 1.06(130.0)-6.58
=137.76-6.58
=131.2
7(d)
Abubakar’s model
Yt=0.72t+118.5
Independent (t-1)
120.0
120.5
121.0
121.4
121.9
122.4
122.9
123.8
124.6
125.5
126.4
127.3
128.2
129.1
For 30-March-2013, t=15
Yt=0.72 (15)+118.5
Yt= 129.3
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