Research Objectivity Requirement 5, Research Analyst Compensation, rec- ommends that analysts’ compensation be based on the accuracy of recommendations over time. In addition, compensation should not be directly linked to investment banking or other finance activities, which it is not in this case. LeCompte’s bonus is based on the group’s overall performance and is not specific to the research support she provides to various divisions.
The Research Objectivity Standards recommend that analysts’ compensation be based on the accuracy of recommendations over time.

. A reduced form model requires that one of the company’s liabilities trade; it can be a zero-coupon bond or an estimation of zero-coupon bonds from observable risky coupon bond prices that trade. In addition, the company’s default prospects are dependent on macroeconomic state variables. These explanatory variables can include such inputs as the growth rate of GDP and the level of unemployment. The model also requires a risk-free rate.
because a reduced form model requires that the state of the economy can be described as a vector of macroeconomic state variables. because a reduced form model requires that some of the company’s debt trades, either a zero-coupon or coupon bond.

1 Drawbridge sold AUD 5 million forward to the settlement date at an all-in forward price of 0.8940 (USD/AUD).
2 To mark the position to market, Drawbridge offsets the forward transaction by buying AUD 5 million three months forward to the settlement date.
3 For the offsetting forward contract, because the AUD is the base currency in the USD/AUD quote, buying AUD forward means paying the offer for both the spot rate and forward points.
I. The all-in three-month forward rate is calculated as 0.9066 – 0.00364 = 0.90296
II. This gives a net cash flow on settlement day of 5,000,000 × (0.8940 – 0.90296) = –USD44,800 (This is a cash outflow because Drawbridge sold the AUD for- ward and the AUD appreciated against the USD).
4 To determine the mark-to-market value of the original forward position, calculate the present value of the USD cash outflow using the three-month USD discount rate: –USD44,8000/[1 + 0.0023(90/360)] = –USD44,774.
The present value of the cash flow was not calculated (step 4 of
calculation).
The cash flow was calculated using the bid rate instead of the offer rate.
1 The all-in three-month forward rate = 0.9062 – 0.00368 = 0.90252
2 This gives a net cash flow on settlement day of 5,000,000 × (0.8940 – 0.90252) = – USD42,600, and the present value is calculated as –USD42,600/[1 + 0.0023(90/360)] = –USD42,576.

. Although Lin is correct that the DCF method takes into account the cash flows that investors care about, she is not correct in stating that DCF takes into account the cyclical nature of the real estate market.
. Lin is correct about the cost approach.
. Lin is correct about the sales comparison approach.

. Betta has taken the correct approach in using actual coupon bonds for Bay Corp and estimating implied zero-coupon bonds. Because the bonds rank equally, there is no need to adjust for differences in priority in case of default. In practice, bond prices will be affected by liquidity, and investors expect additional spread or a liquidity premium to compensate for less liquid corporate bonds relative to sovereign bonds.
because there is a need to convert coupon bonds to implied zero-coupon bonds to infer the spread.
because no adjustment is necessary for differences in priority since all the bonds in this case rank equally.