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Introduction
PortfolioManagementIndividualRichards
Totalscore:1outof6,17%

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Block1:TOS

Question
1of1
Byaccessingthisassessment,youagreetothefollowingtermsofuse:Thepracticetestsandmockexamsare
providedtocurrentlyregisteredCFAcandidates.Candidatesmayviewandprinttheexamsforpersonalexam
preparationonly.Thefollowingactivitiesarestrictlyprohibitedandmayresultindisciplinaryand/orlegalaction:
accessingorpermittingaccessbyanyoneotherthancurrentlyregisteredCFAcandidatesandcopying,postingto
anywebsite,emailing,distributing,and/orreprintingthepracticetestsandmockexamsforanypurpose.

Iagree.

0outof0

Block2:PortfolioManagementIndividualRichards

Question
1of6
UsingtheplanningframeworkthatRichardssuggests,whichperson'sestimateoftheaftertaxprimarycapitalis
mostaccurate?
Richards
Boshe
Adams

0outof1

EdvardRichardsispresidentandsoleownerofMoreThanLumberCorporation(MTL),aprivatelyheldbuildingmaterials
company.FoundedbytheRichardsfamily,thecompanyhasbeenrunbyEdvardRichardsformorethan40years.
RichardsalsoownsinvestmentrealestateintheformofawarehouseunrelatedtoMTL,aswellas70,000common
sharesofpubliclytradedCintas(CTAS)thatheinherited.Hewantsthesetwoitemstobeconsideredconcentrated
positions.

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Now68,Richardsisseekingadviceonhowtotransitiontoretirement.Heprovidesinformationabouthisholdings,
showninExhibit1,totwocompetingfinancialadvisers,ToddAdamsandLindaBoshe.

Exhibit1

RichardssValues

CostBasis
EstimatedValue
Asset
($thousands)
($thousands)

Primaryresidence(nomortgage) 2,000 2,000

MTLCorp 11,000 2,000

Commonstock(70,000sharesCTAS) 4,000 1,000

Warehouse 3,000 4,300

Municipalbondportfolio 3,000 3,150

Globalallcapequityfund 3,400 1,650

Cashequivalents 300 300

TaxRates
Capitalgainstaxrate=20% Incometaxrate=40%

Richardsaskseachadvisertoapplyagoalbasedplanningframeworkhehasreadaboutthatusesthreeriskbuckets:
personal,market,andaspirational.Asafirststep,heestimateshisownaftertaxprimarycapitalassumingthatall
assetsaresoldtodayandconvertedintocash.Heasksthetwoadviserstoassesshisaftertaxprimarycapitalunder
thesameassumptions(allthreeestimatesareprovidedinExhibit2).

Exhibit2

EstimatesofAfterTaxPrimaryCapital

($thousands)

Richards 11,780

Adams 8,380

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Boshe 11,640


RichardswantstomonetizeandeliminatetheconcentrationriskofhisCTASholdingwithoutpayingtaxesoncapital
gainsandtheninvesttheproceedsinabalancedportfolio.Henotesthefollowingcommentsinhisdiscussionswiththe
twoadvisers:

Richards:MybrokersayshecanarrangeacashlesscollaragainstCTASorashortsaleagainstthebox.I
understandthatbothmethodswillavoidincurringanimmediatecapitalgainandbothwillexposemeto
thesamelevelofmarketrisk.Icanborrowagainstthepositioninbothcasesandoffsetthecostof
borrowingwiththeCTASdividends.

Adams:Wecouldhelpyoucompleteashortagainsttheboxtransaction.Thisstrategywillprovideahighloan
tovalue(LTV)ratioandavoidcounterpartyrisk.Atotalreturnequityswaphasthesesameadvantages.
YoucanthusrealizetheeconomicgainonCTASwhiledeferringcapitalgainstaxes.

Boshe:Wesuggesteitheraforwardconversionwithoptionsoranequityforwardsale.Eitherwillachievehigh
LTVratiomonetizationwithoutincurringimmediatecapitalgainstaxes,andbothmethodsavoid
counterpartyrisk.

AdamshasstrongconnectionstotherealestatemarketandinformsRichardsthatthemarketvalueestimateof$3
millionforthewarehouseismuchtoolow.HeadvisesRichardstoconsiderreducinghisrealestateriskdirectlyby
usingtheimmediatecashinflowsnetoftaxliabilitiesandcoststoincreasehisstockandbondportfolios.Adamsis
confidenthecanarrangeanyofthefollowingrealestateoffers:

1.Sellthewarehousefor$4.8milliontoanoutsideinvestor.
2.Enterintoarecoursemortgageloan,withthewarehousevaluedat$5.8millionbythelenderandanLTVratioof
80%.
3.Enterintoasaleandleaseback,withthewarehousevaluedat$4.9millionandthefirstyearsrentalpaymentof
$150,000payableatthestartofthelease.

Boshehasstrongconnectionstotheinvestmentbankingcommunity.Richardshasauthorizedhertoascertainthelevel
ofinterestforthesaleofMTL.Bosheisconfidentshecanarrangeanyofthefollowingstrategies:

MTLStrategy1:AprivateequityfirmcanarrangetoleverageMTL,payingRichards40%ofhisestimatedvalueofMTL
(asshowninExhibit1)incashupfrontandrollingtheremaining60%ofthevalueintonewsharesthatpayno
dividends.Richardswillstayonaspresidentforfiveyears,duringwhichtimehewillhelptransitionleadershipto
anewteam.Afterfiveyears,hewillsellormonetizetheremainingownership.

MTLStrategy2:Asmallbutrapidlygrowingpubliclytradedbuildingmaterialscompanyiswillingtoacquire100%
ownershipandpayRichards$7millionincashupfrontandemployeestockoptionsthathecanexerciseafter
twoyearsandthatexpireinfiveyears.Thepubliccompanyistoosmalltosupportpubliclytradedstockoptions.
Shouldthepubliccompanysstockrise,Richardscanexercisehisemployeestockoptions,whichwillbetaxed
asordinaryincome.Toprotectthevalueofhisappreciatedstockwhileparticipatinginfurtherupsidepotential,he
canpurchaselongtermprotectiveputoptionsonanindustryexchangetradedfund(ETF)thatcloselytracksthe
buildingmaterialsindustry.Ifthepubliccompanysstocksubsequentlydropsalongwiththeindustry,hecansell
theputs.

MTLStrategy3:Createanemployeestockownershipplan(ESOP)thatwouldborrowsufficientfundstopurchase40%
ofRichardssownership.Richardswouldmaintainupsidepotentialinhisretainedshares,whichcouldbesoldat
somepointinthefuture.

Incorrect.

Primarycapitalisthesumofassetsthatfallintothepersonalandmarketriskbuckets.Itincludestheresidence,
municipalbondportfolio,globalequityfundandcashequivalents.ItexcludesthevaluesofMTLandthe
concentratedpositionsinCTASpublicstockandthewarehouse(investmentrealestate)thoseareconsidered
aspirational.
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Asset Value Cost Gain= Tax= NetValue


($000s) ($000s) ValueCost Gainx0.20 aftertax
($000s) ($000s) ($000s)
Residence 2,000 2,000 0 0 2,000
MuniBonds 3,000 3,150 (150) 30 3,030
GlobalEquities 3,400 1,650 1750 350 3,050
CashEquivalents 300 300 0 0 300
TotalNetValue= 8,380

Adamshasthecorrectvalue.

CFALevelIII

"ConcentratedSingleAssetPositions,"ThomasJ.BoczarandNischalR.Pai

Section3

Question
2of6
Richards'sunderstandingaboutmonetizingCTASismostaccuratewithrespectto:
usingtheCTASdividendstooffsetborrowingcosts.
avoidingimmediatecapitalgainsunderbothstrategies.
theriskexposureofbothstrategies.

0outof1
Incorrect.

Richards'sunderstandingaboutavoidingimmediatecapitalgainsiscorrect.Theshortsaleagainsttheboxapproach
deferscapitalgains.Nosaleofstockoccursinestablishingthecollar.Theshortagainsttheboxstrategyisriskless
whereasthecollardoescarryriskwithintherangebetweentheexercisepricesoftheputandthecall.The
dividendswillcontinuetobepaidtoRichardsonlyinthecollar.Thedividendswillpassthroughtothelenderofthe
sharesthatwereborrowedintheshortagainsttheboxstrategyandthusnotavailabletoRichards.

CFALevelIII

"ConcentratedSingleAssetPositions,"ThomasJ.BoczarandNischalR.Pai

Section4.3

Question
3of6
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WhichofAdams'sandBoshe'scommentsaboutcounterpartyriskismostaccurate?Thecommentmadeby:
Bosheaboutherproposedstrategies.
Adamsabouttheshortsaleagainstthebox.
Adamsaboutthetotalreturnequityswap.

1outof1
Correct.

Adams'sstatementabouttheshortsaleagainsttheboxiscorrectbecauseitcreatesarisklessposition.Although
theforwardconversionwithoptionsavoidscounterpartyrisk,theequityforwardsaleandthetotalreturnequity
swapuseaderivativesdealerandthusincludecounterpartyrisk.

CFALevelIII

"ConcentratedSingleAssetPositions,"ThomasJ.Boczar,andNischalR.Pai

Section4.2,4.3

Question
4of6
UsingtheinformationinExhibit1andAdams'srealestateproposals,whichofferwillprovidethelargest
immediateadditionoffundstoRichards'sstockandbondportfolios?
Offer1
Offer3
Offer2

Questionnotanswered

ImmediatecashinflowsavailablewouldincludeproceedsandthepossiblefirstrentalpaymentinOffer2allcash
flowsarenetoftaxes.AsshowninthetablebelowOffer1,sellingthewarehouseoutright,producesthehighest
immediatecashflownetoftaxes:

Incometax
Offer Offer Cost TaxesPaid Loan Initial deduction NetTo
Amount GainsTaxes Proceeds Lease onrent Reinvest
=20% LTV=80% Payment IncomeTax Offerlessall
rate=40% taxes
1 4,800,000 4,300,000 (100,000) 4,700,000
2 5,800,000 4,300,000 0asnosale 4,640,000 4,640,000
occurs
3 4,900,000 4,300,000 (120,000) (150,000) 60,000 4,690,000

CFALevelIII

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"ConcentratedSingleAssetPositions,"ThomasJ.Boczar,andNischalR.Pai

Section6

Question
5of6
WhichofBoshe'sMTLstrategiesleastlikelydescribesastagedexitstrategy?
MTLStrategy2
MTLStrategy3
MTLStrategy1

Questionnotanswered

MTLStrategy2isnotastagedexitstrategybecauseitdoesnotprovidefortwospecificliquidityevents:cashup
frontandasaleormonetizationoftheremainderofRichards'sownershipinthefuture.Strategies1and3are
stagedexitstrategiesthatprovidefortwoliquidityevents.

CFALevelIII

"ConcentratedSingleAssetPositions,"ThomasJ.Boczar,andNischalR.Pai

Section4.3

Question
6of6
WhichofthefollowingstatementsaboutBoshe'sproposedexitstrategiesfromMTLismostaccurate?
MTLstrategy3exhibitsamismatchincharacter.
MTLstrategy2exhibitscrosshedging.
MTLstrategy2providesforthepossibilityofyieldenhancement.

Questionnotanswered

EvidenceofbothcrosshedgingandamismatchincharacterispresentinMTLStrategy2.Buyingputoptionson
theETFisacrosshedgeagainsttheindustryriskfacedbythepubliccompany.Thescenariooutlinesanexercise
ofemployeestockoptions,whichwillbetaxedasordinaryincome,andaneventualprofitfromaputoption,which
willbetaxedasacapitalgain.Thisdifferenceintaxtypeisamismatchincharacter.

CFALevelIII

"ConcentratedSingleAssetPositions,"ThomasJ.Boczar,andNischalR.Pai

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Section4

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