CHARTERED INSTITUTE OF
STOCKBROKERS
ANSWERS
Examination Paper 2.1
Financial Accounting and Financial Statement Analysis
Economics and Financial Markets
Quantitative Analysis and Statistics
Professional Examination
September 2013
Level 2
SECTION A: MULTI CHOICE QUESTIONS
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
B
D
D
A
C
A
D
C
B
C
B
B
D
B
D
D
D
C
A
D
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
D
D
C
D
D
A
D
B
B
D
D
D
C
A
D
A
A
D
C
B
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SECTION B: SHORT ANSWER QUESTIONS
Question 2 - Financial Accounting and Financial Statement Analysis
The Honey Group is made up of the following entities:
1. Honey Limited, which is the parent company
2. Berry Limited is a wholly owned subsidiary of Honey Limited
3. Flames Limited is also a subsidiary of Honey limited, but it is not
wholly owned due to minority interest of (20%)
4. Cherry Limited is a 60% subsidiary of Flames Limited.
5.
(½ mark)
(½ mark)
(½ mark)
(½ mark)
Consequently Honey Limited has control over Cherry Limited, even though the share
of the parent is only 48% (80% X 60%).
(1 mark)
Question 3 - Economics and Financial Markets
Real Interest Rate:
This is the money rate of interest minus inflation rate (or expected inflation rate) which
expresses the real return on a loan.
Question 4 - Quantitative Analysis and Statistics
Given:
Population mean (µ) = 69%, standard deviation (s) = 18%
Sample mean (x) = 78%, Sample size (n) = 36
Significance level = alpha risk (α) = 0.01
Ho : µ0 = 69 (there is no change in candidates’ scores)
H1 : µ1 ≠ 69 (there is a change in candidates’ scores)
Zcal = x - µ
s/√n
=
78 – 69
18/√36
=
9
18/6
=
3.0
Ztab, at 1% for 2 tail = 2.58
(1 mark)
(1 mark)
(1 mark)
Zcal > Ztab
If we reject the Null Hypothesis, then we will accept the alternative that there is a change in
candidates’ scores.
(1 mark)
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SECTION C: ESSAY TYPE, CALCULATION AND/OR CASE STUDY QUESTIONS
Question 5 - Financial Accounting and Financial Statement Analysis
5(a):
Leverage Appraisal
Unilever is financed mainly through external debt, whereas Nestle is financed to a large
extent by equity.
Half of the debt of Unilever is short-term debt, which is usually more expensive than long
term-debt.
It was observed that Unilever has a significantly higher gearing level than the two other
companies, which implies that the financial risk of Unilever is higher.
Through this high leverage, Unilever is able to increase its ROE substantially if ROA is above
the cost of debt.
Furthermore, the debt/equity ratio could be influenced by corporate policy/objective
differences of the three companies such as credit orientation, financial status, product
financing styles etc.
Liquidity Appraisal
Current assets are supposed to be converted into cash in the current operating cycles of
the companies. The higher the current ratio the more resources a company has available to
repay the short term debts.
In this scenario, PZ is most liquid followed by Nestle with 1.16 and these two companies will
be able to address any financial liquidity promptly. The reverse will be the case of Unilever
which reveals higher current liabilities compared with the current assets.
In the Acid test or Quick ratio, the inventory (stock) is excluded from the current assets as
it is the least convertible item of the company. This ratio further tests the liquidity position
of the companies.
It is obvious that Nestle is the most liquid among the three companies, this again buttress
the earlier current ratio applied and reflects that its working capital structure will not hinder
its operations.
On the contrary, Unilever is illiquid in its operations. That is its current liabilities exceed its
current assets less inventory. This is a delicate position because at any time the operations
of the company could be hindered due to unavailability of working capital. Also the
confidence of its shareholders and investors could be of concern.
Q5(b):
Depreciation is an attempt to spread the cost of a non-current asset over its estimated
useful life. This effectively implies matching expenses with the income generated in each of
the period. It also accrues expenses to the relevant period even though cash is not being
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paid at that particular period.
A number of factors should be considered in estimating the useful life of an asset:
I.
Intensity of use
II.
Rate of obsolescence
III.
Wear and tear
Q5(c):
Fair value is the amount for which an asset could be exchanged or a liability settled between
knowledgeable willing parties in an arm’s length transaction.
5(d) An executive is given 10,000 share options on 1st May 2012, with immediate
vesting, as a reward for past services. The shares are currently priced at N2.50 and
the option strike price is N3.00. An appropriate valuation technique gives a value of
N1.25 for each of the options. Assuming that the executive has yet to exercise the
option by the year end date, how should this transaction be included in the
company’s accounts?
(4 marks)
Q5(d):
The transaction will be accounted for in full on the grant date since the options vest
immediately.
10,000 x 1.25 = N12,500
Debit:
Credit:
Employment cost
Equity
(5 marks)
Question 6 - Economics and Financial Markets
6(a):
The increase in demand for goods and services that accompanies economic expansion will
cause a shift in the IS Curve to the right.
LM
Interest rate
r11
r
IS
yss
s1
ys1
IS11
yss
(income/outpour)
(income/outpour)
(3 marks)
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With the equilibrium in the money market (LM) remaining unchanged, the shift will
result in:
 A rise in equilibrium rate of interest.
 Greater equilibrium output.
(2 marks)
Q6(b):
Raising the Credit Reserve ratio (CRR) on public sector deposits from 12% to 50% amounts
to restricting the credit-creating power of banks – a tight monetary policy.
The tight monetary policy will result in a left ward shift in the LM curve.
LM1
LM
Interest rate
r1
r
IS
ys1
ys
ys
(income/outpour)
As shown in the figure, the impact of the policy is to raise the interest rate and
consequently a reduction in national output.
(2 marks)
Reasons for the policy:
(i) To mop up excess liquidity in the economy.
(ii) To restrict the demand for foreign exchange and thus imports.
(iii) To curb inflationary pressure.
(11/2 marks each for any 2 points) = (3 marks)
Q6(c):
The foreign exchange market refers to the market where foreign exchange (or foreign
currencies) are being traded at a price that is expressed by the exchange rate.
(2 marks)
Q6(d):
Types of Exchange Management Policy:
(i) What has been described in the question is a managed floating exchange rate
system or “dirty” float exchange rate system. It is an exchange rate system that
is market – determined subject to periodic monetary authorities’ intervention
with a view to stabilising rates within certain margin.
(2 marks)
(ii) Advantages of the policy:
(a) The managed float attempts to combine the advantages of both the fixed
and flexible exchange rate systems, depending on the degree of instability –
the less instability, the less intervention is necessary by central banks.
(b) With this arrangement, central banks can pursue quasi-independent
domestic monetary policies to stabilise their own economies.
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(c)
(d)
There is the high propensity to achieve a near - stability in the exchange
rate system, a requirement for inflow of investment.
It eradicates speculation.
(2 marks each for any 2 points) = (4 marks)
Question 7 - Quantitative Analysis and Statistics
7(a):
The maximum contribution possible with the available resources and in view of the
production constraints is N1,880
Q7(b):
There are four constraints:
I.
II.
Leather – Maximum available is 600m2 per week.
(1/2 mark)
Labour – maximum labour hours
6 labourers @ 35 hours
Weekly = 210 hours
(1/2 mark)
III.
Quota – The restriction that KG Limited has to produce as many handbags as purses
i.e. P ≤ H
(1/2 mark)
IV.
Non-negativity – General assumption in LP that negative output is Not possible.
(1/2 mark)
Q7(c):
Leather and labour hours have shadow prices of N2.667 and N1.333 respectively.
This implies that they are binding constraints. It also means that if an extra unit of leather
or labour is introduced, there will be a increase in the objective function of N2.667 and
N1.333 respectively.
Q7(d):
Since leather and labour hours are binding constraints, there are no left-overs, hence the
slack is N0.000.
Only the quota restriction has a slack of 20. It mean there is room to produce 20 more
purses. (180 handbags and 160 purses are to be produced to maximize contribution).
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