2012.06 CFA Level-3
CFAI Sample Exams Questions, Answers and Explanations
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Trang 2Sue Kim Case Scenario
Sue Kim, CPA, is a hedge fund manager who specializes in biotechnology stocks Kim has spent many years investing in biotech companies and in the past, worked as an equity portfolio manager for a large bank with substantial research capabilities Two years ago, Kim started a hedge fund, GreenNote Investments (GI) She manages segregated accounts for several wealthy individuals Now that she no longer has the resources of the bank to support her research, Kim relies on a network of experts to help her search for profitable investment opportunities in the biotechnology area These experts include legal, business, and political contacts
Kim purchases information from several biotechnology company employees, who moonlight as consultants or experts These consultants work with Kim without the knowledge of their employers and provide her information about quarterly earnings and other confidential data related to their companies performance Kim then incorporates the information received into her final investment decision
Kim is actively seeking new investors in Gl In order to spread the news about the positive returns her fund has achieved, she hires a publicist, Takehiko Akagi, CFA Akagi tells Kim that in order to have an effective marketing campaign she needs more than the two-year performance history she currently presents Akagi requests a five-year return history, suggesting Kim use her performance history at the bank Kim tries to retrieve her performance history from the bank but is denied her request Unknown to the bank, Kim has historical bank performance data on her home computer, which she uses to re-create the first two years of the requested five-year performance data For the third year she simulates her investment performance by applying her current investment strategy using all available historical data Akagi provides the five-year performance history to interested investors, telling them the simulated results reflect what might have been achieved had Kim been running GI during that time period
Trang 3months in the fund, Akagi agrees to this arrangement and Kim makes sure to disclose this to prospective clients by verbally telling them that GI compensates Akagi for his efforts to find investors for the fund, which is the first time clients are made aware of this arrangement
Kim’s university roommate, Donna Miriam, is now a legal expert in mergers and acquisitions Miriam
has a number of connections to senior associates who specialize in this area of law at large, well-known law firms Miriam updates Kim when she hears a deal is about to be completed Kim uses this information as part of a mosaic of information she gathers from her own research and information from other experts in her network Once Kim has determined that Miriam’s information is likely to be correct, Kim trades derivative securities of the acquisition target In the past 18 months her merger and acquisition investments have resulted in profits of $10 million for the hedge fund Kim also manages a separate account for Miriam, who has authorized Kim to replicate the trades in the acquisition targets for her account Because Miriam provides this valuable information, Kim makes sure she trades Miriam’s account before any other client trades
Julian Huang, a government lobbyist, is another key member of Kim’s expert network Huang keeps in constant contact with the many lobbyists involved in biotechnology issues and has dose relations with many legislators
Recently, legislators proposed restricting biotechnology research If the legislation had passed it would have reduced valuations across the board for biotech stocks Kim led the hedge fund industry’s efforts to fight this change Kim personally donated a large sum of money to support these efforts and was also very successful in raising funds from the hedge fund community to fight the passing of this proposed legislation
Kim’s efforts to grow her fund result in new clients and rapid growth of assets under management Faced with a significant increase in her workload, Kim realizes she needs to change her investment process to meet these new demands In order to bring specialized experience to her investment decision-making process, Kim hires several competent outside advisers, who she worked with for many years at the bank Kim also subscribes to several well- known third-party research vendors that are so expensive they were not considered previously With higher fees earned from the increased assets under management, Kim is able to request information from these vendors tailored to her specific needs Because this research is so specialized and detailed, Kim is able to use the reports, with a few minor changes, as her own Other than showing off her new reports, Kim does not tell clients of the changes made to her investment process and reports
Question 1
Trang 4based on this information, she is least likely to violate the CFA Institute Standards of Professional
Conduct concerning:
A Market manipulation
B Diligence and reasonable basis C Material nonpublic information
Question 2
Regarding Gl’s five-year investment performance history, Kim least likely violated the CFA Institute Standards of Professional Conduct concerning which of the following?
A Performance as a hedge fund manager B Simulated performance of current strategy
C Performance when she was an equity portfolio manager Question 3 Regarding Kim’s fee arrangements, who has most likely violated the CFA Institute Standards of Professional Conduct? A Kim B Akagi C Both Kim and Akagi Question 4
Regarding the information Kim receives from Miriam, she least likely violated the CFA Institute Standards of Professional Conduct concerning: A Fair dealing B Priority of transaction C Material nonpublic information Question 5 Regarding the proposed biotech legislation, has Kim most likely violated the CFA institute Standards of Professional Conduct? A No
B Yes, concerning personal donations
Trang 5Question 6
Concerning the changes Kim has recently made to her investment process, she is least likely violated the CFA Institute Standards of Professional Conduct concerning:
A Misrepresentation
B Research due diligence
Trang 6Minglu Li Case Scenario
REDD Partners specializes in forecasting and consulting in particular sectors of the equity market Minglu Li is an analyst for REDD Partners who specializes in the consumer credit industry Last year (2010), Li and her team gathered data to determine the expected return for the industry (see Exhibit 1) Exhibit 1
Returns & Premiums Data (2010)
Securities and Interest Rates: Expected Yield:
30-day U.S Treasury Securities 2.6% 10-Year U.S Treasury Securities 3.8%
Short-term Real Rate 2.0% Long-term Real Rate 2.3% Type of Premium: Premium: Inflation premium 0.6% Illiquidity premium 0.9% Equity risk premium 8.4%
After considering a number of approaches, Li and her team decided to use the bond-yield-plus-risk-premium method The method had worked well in 2010, but a new assignment presented to Li’s team the previous week posed a new challenge
A new consumer credit mechanism was being tested on a small scale using a “smart” phone application to pay for items instead of the traditional credit card The application had proved successful in the use of microloans in developing countries and was now being applied to a much broader consumer base The new challenge for Li’s team is to develop a model for the expected return for these new consumer credit companies, called “smart credit” companies, that combine the consumer credit industry and what had traditionally been considered the telecommunications industry
Although smart credit company returns data is sparse, a five-year monthly equally weighted index called the Smart Credit Index (SCI) was created from the existing companies’ returns data The number of companies in the index at a given time varies due to firms failing and also combining through time
Trang 7Exhibit 2 Data, Statistics, and Regression Results Index: Mean: Variance: SCIRP 5.4% 0.2704 CCIRP 4.6% 0.0784 TELIRP 2.8% 0.1024 Note: CCIRP and TELIRP are uncorrelated Regression Coefficient: a: B(CCIRP): B(TELIRP): Coefficient Value: 0.011 1.020 1.045
Note: All coefficients are statistically significant at the 95% level
Although volatility information is available from the SCI data and correspondingly for the SCIRP, Li’s
team wants to determine the statistical relationship between the SCIRP and both the consumer credit index risk premium (CCIRP) and the telecommunications index risk premium (TELIRP), because forecasting the CCIRP and TELIRP is much less difficult than forecasting the SCIRP After some discussion, the team believes that the volatility measure for the SCIRP data based on the volatility of CCIRP and TELIRP through the regression should be adjusted to incorporate a correlation coefficient of 0.25 between the CCIRP and TELIRP Although the two index risk premiums were uncorrelated in the past and within the regression, Li’s team believes the two technologies will become more correlated in the future
Li’s team also examined survey data within the consumer credit and telecommunications industries over the same time period for which the actual data was collected They found that projections in the surveys of the CCI and TELI tended to be more volatile than the actual data However, Li’s team has decided not to make any adjustments because a definitive procedure could not be determined
Given the effect of short-term interest rates on consumer credit, Li’s team then decides to determine
where the short-term interest rate is expected to be in the future The Central Bank recently issued a statement that 2.5% appeared to be the appropriate rate assuming no other factors Li’s team then considers potential factors that may make the Central Bank behave differently from the 2.5% rate in the statement (see Exhibit 3) Exhibit 3 Central Bank Factors: GDP Growth Forecast: 2.0% GDP Growth Trend: 1.0% Inflation Forecast: 1.5% Inflation Target: 3.5% Earnings Growth Forecast: 4.0% Earnings Growth Trend: 2.0%
Trang 8
flatten
Question 7
Based on Exhibit 1 and the method used by Li’s team, the expected return for the consumer credit industry in 2010 was closest to: A 10.7% B 12.2% C 12.5% Question 8 The SCI data most likely exhibits which type of bias? A Time-period B Data-mining C Survivorship Question 9
Based on the correlation that Li’s team believes to exist between the CCIRP and TELIRP, the new
volatility for the SCIRP is closest to: A 31.8%
B 49.1% C 56.4%
Question 10
A comparison between the survey data containing projections of the CCI and TELI and the actual CCI and TELI most likely exhibits:
Trang 9C 2.8%
Question 12
Tolliver’s statement regarding the yield curve is most likely:
A Correct
Trang 10Nova Abordagem, LLC Case Scenario
Nova Abordagem, LLC (NA) is an investment management firm that focuses on identifying appropriate asset allocations to meet clients’ needs The firm charges a management fee of 70 bps per year, which covers all services provided NA’s senior client consultant, Diogo Gomes, has meetings
with three clients today: Catarina Valente, an individual; Rui Noronha, an individual; and an
investment officer with Braga Humanidades, a small foundation dedicated to promoting the arts At his meeting with Valente, Comes learns that she is concerned about the firm’s investment management skills because her portfolio had a lower return last year than her brother’s, her cousin’s and her best friend’s, which are managed elsewhere She makes it clear that she will take her business elsewhere if this happens again next year and asks that her portfolio asset allocation be changed to look more like those of the others she has mentioned In particular, Valente says the other portfolios have allocations to hedge funds, while her portfolio does not Gomes responds that NA does not consider hedge funds to be an appropriate asset class for its clients’ portfolios for three reasons:
Reason 1: Hedge funds follow a wide range of investment strategies and invest in many different assets
Reason 2: Combinations of the asset classes NA employs can closely mimic hedge fund returns with minimal tracking risk
Reason 3: Hedge fund returns are lower and their volatility higher than other asset classes that NA includes in its client portfolios
At his meeting with Noronha, a sophisticated investor, Gomes provides a list of the five asset classes NA typically includes in client portfolios, along with their expected returns and standard deviations
14
(see Exhibit 1, below) In addition, Gomes provides a list of optimal “corner” portfolios constructed from these assets, along with their expected returns and standard deviations (see Exhibit 2, below) Exhibit 1
Nova Abordagem’s Asset Classes
Trang 11Exhibit 2
Nova Abordagem’s Optimal Corner Portfolios Corner Expected | Standard | Asset Class Portfolio Weight
Portfolio Return Deviation 1 2 3 4 5 1 13.5% 18.3% 0% 100% 0% 0% 0% 2 11.8% 13.3% 0% 68% 0% 0% 32% 3 10.5% 10.4% 12% 37% 10% 0% 41% 4 9.4% 8.5% 14% 19% 23% 0% 44% 5 7.7% 5.9% 18% 0% 31% 23% 28% 6 6.8% 4.7% 7% 0% 35% 37% 21%
Noronha’s Investment Policy Statement specifies a minimum expected return of 9.0% and further states that risk should be as low as possible, subject to the return constraint Gomes and Noronha have a conversation about the approaches that are used for asset allocation Noronha states that he would prefer a method that reflects market views on returns and is unlikely to result in large weights on only one or two asset classes
During his meeting with the investment officer from Braga Humanidades, Gomes learns the foundation’s investment committee has decided on a long-term spending rate of 4.5% of assets, net of investment costs The foundation also wants to preserve the real value of assets NA is the foundation’s only investment manager Gomes recommends a minimum required return for the foundation’s investment policy statement based on a long-term expected inflation rate of 5.8% and the costs of investment Gomes is also informed that the foundation’s board of directors is considering two mandates for the investment portfolio:
Mandate 1: Because the foundation receives public money, at least 60% of the portfolio should be invested in government bonds
Mandate 2: Because the foundation’s first major donor was an entrepreneur, at least 25% of the portfolio should be invested in venture capital
Gomes is asked to provide feedback on the appropriateness of the two mandates, solely from an
Trang 12likely appropriate? A Reason 1 B Reason 2 C Reason 3 Question 15
Based on the information in Exhibits 1 and 2 and Noronha’s investment policy statement, the weight on domestic bonds in his optimal portfolio is closest to: A 23.0% B 24.9% C 27.0% Question 16 Which approach to asset allocation would most likely match Noronho’s preferences? A Mean-variance B Black-Litterman C Resampled efficient frontier Question 17 What required return does Gomes most likely recommend for Braga Humanidades’ investment policy statement? A 10.6% B 11.0% C 11.3% Question 18
Gomes evaluation of the two proposed mandates for the Braga Humanidades portfolio will most likely conclude that which mandate is appropriate?
Trang 13Franconia Notch Case Scenario
Mark Whitney, CFA, is the Chief Investment Officer of Granite State Partners, a fixed-income
investment boutique serving institutional pension funds Paula Norris, a partner at consulting firm Franconia Notch Associates, is conducting due diligence of Granite’s capabilities At a meeting they go over a presentation Whitney has prepared
The first page of the presentation addresses Granite’s investment style for managing portfolios It states:
“Granite adjusts the portfolios duration slightly from the benchmark, and attempts to increase relative return by tilting the portfolios in terms of sector weights, varying the quality of issues, and anticipating changes in term structure The mismatches are expected to provide additional returns to cover administrative and management costs.”
Norris asks Whitney about Granite’s ability to successfully reflect in portfolios its views on the market and the direction of interest rates Whitney makes the following statements:
Statement 1:
“Granite uses effective duration to measure the sensitivity of the portfolio’s price to a relatively small parallel shift in interest rates For large parallel changes in interest rates, we make a convexity adjustment to improve the accuracy of the estimated price change We believe that parallel shifts in the yield curve are relatively rare; therefore duration by itself is inadequate to capture the full effect of changes in interest rates.”
Statement 2:
“We address yield curve risk by using key rate durations When using this method, we stress the spot rates for all points along the yield curve simultaneously By changing the spot rates across maturities, we are able to measure a portfolio’s sensitivity to those changes.”
Statement 3
We also measure spread duration contribution This analysis is not related to interest rate risk This measure describes how securities such as corporate bonds or mortgages will change in price as a result of the widening or narrowing of the spread to Treasuries.”
Norris provides information on three clients he might refer to Whitney for portfolio management services, and asks him to design a dedication strategy for each Whitney makes the following recommendations:
Client 1:
Trang 14Client 2:
The defined benefit pension plan for this client has an economic surplus of zero In order to meet the liabilities for this plan, | will construct the portfolio duration to be equal that of the liabilities In addition, | will have the portfolio payments be less dispersed in time than the liabilities
Client 3:
This client’s long-term medical benefits plan has known outflows over ten years Since perfect matching is not possible, | propose a minimum immunization risk approach that is superior to the sophisticated linear program model used in the current cash flow matching strategy
Norris asks Whitney what steps he takes to reestablish the dollar duration of a portfolio to the desired level in an asset-liability matching (ALM) application Whitney responds: “First, | calculate a new dollar duration for the portfolio after moving forward in time and shifting the yield curve Second, | calculate the rebalancing ratio by dividing the original dollar duration by the new dollar duration and subtracting one to get a percentage change Third, | multiply the new market value of the portfolio by the desired percentage change from step two.”
Norris then asks Whitney, ‘What sectors are you currently recommending for client portfolios?’ Whitney responds: “I recommend investing 25% of the portfolio in mortgage-backed securities because they are trading at attractive valuations | will not, however, buy floating rate securities because these do not hedge liabilities appropriately ”
Norris asks how changing market conditions lead to secondary market trading in Granite’s client portfolios Whitney responds: ‘Our research teams run models to assess relative value across fixed
income sectors which, combined with our economic outlook, leads to trade ideas For example, currently our macroeconomic team is concerned about the situations in several sovereign nations
and the spillover effect to capital markets These issues range from geopolitical risks that will likely increase the price of oil to outright sovereign defaults or restructuring.”
Question 19
The style of investing described in Whitney’s presentation is most likely: A A full replication approach
B Enhanced indexing by small risk factor mismatches C Active management by large risk factor mismatches
Question 20
Trang 15A Statement 1 B Statement 2 C Statement 3
Question 21
Which of the following statements regarding Whitney’s recommendations for Norris’ three clients is most likely correct?
A Client 1 will achieve the guaranteed value only if the term structure of interest rates is downward sloping
B Client 2 will meet the necessary conditions for a multiple-liability immunization in the case of a non-parallel rate shift
C Client 3 will require less money to fund liabilities because a less conservative rate of return can be assumed for short-term balances
Question 22
ls Whitney’s approach to rebalancing a portfolio using dollar duration most likely correct?
A Yes
B No, there is no need to move forward in time
C No, the steps do not provide the amount of cash needed for rebalancing
Question 23
The two risks that Whitney’s is most likely exposed to given his recommendations on sectors are: A _ interest rate risk and cap risk
B contingent claim risk and cap risk
Trang 16Laura Hackett Case Scenario
Laura Hackett is a risk management consultant who helps investment companies build and enhance their risk management process Jardins Advisors, a financial services firm with equity, fixed-income, and commodity trading desks, recently hired her to evaluate and recommend improvements to their processes The firm’s policies specify their back-office function is independent from the trading function and each trading desk has position limits assigned to each trader Senior management discovered that their commodity-trading desk lost $10 million over the course of the previous year when traders repeatedly violated position limits The traders involved were dismissed
Alpha Asset Management Inc., another client of Hackett’s, hired her to identify and separate their market risk exposures into categories Alpha was incorporated during the current year and focuses on one investment strategy to generate returns Alpha issues debt with a maturity of less than one year and invests the proceeds in emerging market debt Hackett creates a list of Alpha’s market risk
categories
Hackett asks Anthony Mackenzie, a recently hired associate, to apply the analytical method to estimate the VAR for Alpha Asset Management’s portfolio, which is valued at $20 million The portfolio has an expected annual return of 7.5%, and a standard deviation of 22.4%
Hackett evaluates a problem faced by one of her international clients, Beta Investment Advisors Beta invests in a variety of asset classes and geographical markets It has recently implemented a model that uses the VAR methodology to measure its risk The methodology uses a historical VAR estimate based on the previous 24 months of market data and aggregates individual portfolio VARs based on size and portfolio return correlations Backtesting shows that the frequency of loss experienced by the firm is materially greater than the VAR estimate Hackett recommends a number of areas to evaluate in order to determine the source of the measurement discrepancy
Sigma Investment Management Inc is a potential new client that wishes to measure credit risk of an over-the-counter American call option on a security The call option has a strike price of $65 and wax purchased at a price of $3.35 per option The option’s current value is $8.50 per option
Trang 17Question 25
What recommendation should Hackett least likely make to Jardins Advisors? The firm should: A quantify risk exposures
B _ initiate a reporting system
C monitor compliance with policies Question 26 Which of these risk categories is least likely to be on Hackett’s list for Alpha? A Political risk B Liquidity risk C Interest rate risk Question 27 Assuming normally distributed returns, the 5% yearly VAR for the Alpha Asset Management portfolio is closest to: A $2,980,000 B $5,892,000 C $8,052,000 Question 28 Hackett’s recommendation to Beta Investment Advisors will least likely include an evaluation of: A incremental VAR
B analytical VAR estimation
C portfolio VAR aggregation based on asset class Question 29 If the security held by Sigma Investment Management Trades at $70, the credit risk is closest to: A $3.35 B $5.00 Cc $8.50 Question 30
Trang 18A Netting
B Limiting counterparty exposure
Trang 19Kingsbridge Case Scenario
London-based Kingsbridge Partners has been selected to manage a £150 million global bond portfolio for a pension fund Jonathan Bixby, CFA, Kingsbridge’s portfolio manager, meets with lain Seymour, CFA, a fixed-income analyst at the firm, to review the portfolio and its holdings relative to the client’s objectives
The pension fund allows the use of 100% leverage to generate incremental returns Bixby evaluates the use of leverage in the portfolio using the data in Exhibit 1 Exhibit 1 Asset and Liability Data Assets Liabilities Portfolio (£ millions) 300 150 Duration 5.50 1.00 Expected Return or Cost (%) 4.75 3.95
Bixby’s current macro view is that the economy is growing at a rate above the trend rate and, as a
result, interest rates are likely to rise Given his view, he is concerned that the duration of the
portfolio is inappropriate and plans to use the futures market to manage its interest rate risk His new duration target for the asset portfolio is 4.25 and he uses the data in Exhibit 2 to reposition the portfolio Exhibit 2 Futures Market Data Futures Contract Price £100,500 Conversion Factor 1.12
Duration of Cheapest to Deliver Bond 5.3
Price of Cheapest to Deliver Bond £97,750
Seymour tells Bixby, “International interest rates are not perfectly correlated We can see the impact of a change in U.S interest rates on our model global bond portfolio This portfolio contains U.S and German bonds and is not currently hedged regarding currency or interest rates Our analysis shows the country beta between the U.S and Germany is 0.62.” Model global bond portfolio data is provided in Exhibit 3 Exhibit 3 Global Bond Model Portfolio Duration Allocation (%) U.S Bond Issuers 6.6 60
German Bond Issuers 3.9 40
Trang 20
Exhibit 4 Currency Market Data U.S Eurozone UK
Risk free rate — One Year 0.25% 1.50% 0.90% Spot rate (£ per U.S or Euro) 0.6098 0.8929
Forward rate (&_ per U.S or Euro) 0.6137 0.8875 Kingsbridge forecast spot rate in 1 year 0.6173 0.8850
Bixby asks whether this global portfolio would benefit from including emerging market debt securities Seymour responds that returns can be attractive in emerging markets during certain periods, but risks also abound He notes the following risks:
Risk 1: Returns are frequently characterized by significant negative skewness as the potential large downside is not offset by a comparable upside
Risk 2: Emerging market countries frequently do not offer the degree of transparency, court-tested laws, and clear regulations as do developed market countries
Risk 3: Emerging market countries have limited access to secondary sources of liquidity
Finally, Seymour asks Bixby if he plans to purchase mortgaged-backed securities (MBS) in the portfolio Bixby responds, “Yes, because MBS spreads are cheap relative to historical levels, | can buy MBS, hedge the interest rate risk by shorting Treasuries, and capture the OAS By matching the dollar duration of the Treasury position with the dollar duration of the mortgage security, | will have a stable hedge.” Question 31 Based on the data in Exhibit 1, the duration of the equity in the leveraged portfolio is closest to: A 4.50 B 5.00 C 10.00 Question 32
Trang 21impact of a 100 basis point decline in U.S interest rates on the model portfolio’s value is closest to: A 3.41%
B 4.02% C 4.93%
Question 34
Based on the data in Exhibit 4, the most likely action that Kingsbridge would take to actively manage the portfolio’s currency exposure in the currency forward markets is to sell:
A USD and buy Euro B Euro and buy USD
C USD, sell Euro, and buy GBP Question 35 Seymour is least likely correct with respect to which risk regarding investing in emerging market debt? A Risk 1 B Risk2 C Risk 3 Question 36 Will Bixby’s strategy to hedge his purchases of MBS most likely be effective? A Yes
B No, because one security in the transaction amortizes and the other does not
Trang 22Sonera Endowment Fund Case Scenario
William Gatchell, CFA, is an investment analyst with the Sonera Endowment Fund Sonera is
considering hiring a new equity investment manager In preparation, Gatchell meets with Anjou Lafite, another analyst at the fund, to review a relevant part of the endowment’s investment policy statement:
“Funds will be invested in the most efficient vehicle that meets the investment objective Managers can implement either a passive or active strategy, but if active, the manager must demonstrate efficiency with which tracking error delivers active return In addition, the manager must consistently adhere to his stated style.”
Gatchell is given the task of reviewing three investment managers to hire one that is best suited to Sonera’s investment style Information about the investment managers is found in Exhibit 1 Exhibit 1 Investment Manager Data Investment Manager A B G Assets Under Management ($ millions) 1,325 3,912 524 Information Ratio -0.27 0.50 0.75
Small-Cap Value Index- Beta 0.95 0.98 1.05 Small-Cap Growth Index- Beta 0.32 0.43 0.48 Large-Cap Value Index - Beta 1.05 1.10 0.96 Large-Cap Growth Index -Beta 0.47 0.39 0.37 Manager Stated Style Value Value Growth Manager Stated Sub-style Low P/E High Yield Momentum
Gatchell is reviewing the fee structures proposed by the three investment managers He finds the following reference in the investment policy statement:
“The fee structure must be simple to understand and avoid undue complexity wherever possible Also, the fee structure must be predictable so that Sonera can reasonably forecast these costs on a yearly basis as an input to the annual budgeting process.”
He understands that there are many different fee structures and he wants to make sure that he chooses the most appropriate one for the Sonera Endowment Fund He prepares a recommendation to the investment policy committee regarding the most appropriate fee structure
Sonera has adopted an active investment style for many years Gatchell would like to make a recommendation to the investment policy committee to invest at least a portion of the funds with a passive investment style His research shows that there are a number of methods used to weight the stocks in an index, each one having its own characteristics The one key feature that he feels is important is that the method not be biased toward small capitalization stocks
Trang 23“There are a number of ways to get passive equity exposure; we can invest in equity index mutual funds, stock index futures, or a total return equity swap Stock index futures and equity swaps are low-cost alternatives to equity index mutual funds However, a drawback of stock index futures is that they have to be rolled over periodically One advantage of investing in equity mutual funds is that shares can be redeemed at market price throughout the trading day.”
Gatchell is reviewing the performance of another investment manager, Far North, who employs a value-oriented approach and specializes in the Canadian market Gatchell would like to recommend to the investment policy committee that the fund diversify geographically The information for Far North and the related returns are found in Exhibit 2 Exhibit 2 Far North — Return Information Rate of Return Far North 14%
True Active Return -1%
Misfit Active Return 5%
The investment policy committee reviews the information in Exhibit 2 and is not familiar with the terms true active return and misfit active return Gatchell responds with the following statement: “The true active return is the return Far North made above its normal benchmark return The misfit active return is the return Far North made above the investor’s benchmark return The term investor’s benchmark refers to the benchmark the investor uses to evaluate performance for a given portfolio or asset class.”
Question 37
Based on Exhibit 1, which investment manager most likely meets the criteria established in the endowment’s investment policy statement? A Manager A B Manager B C Manager C Question 38 Based on Exhibit 1, is there sufficient information for Gatchell to create and interpret the results of a style box? A Yes
Trang 24Question 39
Which fee structure is most appropriate for Sonera based on the criteria in the investment policy statement?
A Anad valorem fee structure
B A performance-based fee structure with a high water mark C A performance-based fee structure without a high water mark
Question 40
If the investment policy committee decides to accept Gatchell’s recommendation to also use passive investing, the index structure that least likely meets Gatchell’s requirement is:
A aprice weighted index B avalue weighted index C an equal weighted index Question 41 In his statement to Lafite, Gatchell is least likely correct with respect to: A cost B pricing C periodic rollover Question 42 ls Gatchell’s statement regarding true active return and misfit active return correct? A Yes
Trang 25Anna Lehigh Case Scenario
Anna Lehigh, CFA, is a portfolio manager for Brown and White Capital Management (B&W), a U.S.-based institutional investment management firm whose clients include university endowments Packer College is a small liberal arts college whose endowment is managed by B&W Lehigh is considering a number of derivative strategies to tactically shift the Packer portfolio to reflect specific investment viewpoints being discussed at a meeting with Packer’s investment committee At the meeting they review Packer’s current portfolio, whose characteristics are shown in Exhibit 1 Exhibit 1
Packer Portfolio Characteristics
Investment Amount ($§ millions) Risk Measure
Mountain Hawk, Inc stock 20 Beta: 1.30
U.S large cap stocks 30 Beta: 0.95 U.S mid cap stocks 10 Beta: 1.20 Euro large cap stocks (Unhedged, USD equivalent) 10 Beta: 1.10 S&P 500 call options (notional amount) 10 Delta: 0.50 A-rated corporate bonds 20 Duration: 5.0 Total 100
Kemal Gulen, a member of the investment committee, asks Lehigh how she manages the risk exposure of the call option investment Lehigh responds by stating that she ensures that her call option positions are delta hedged She notes, however, that at expiration the option gamma is very high and maintaining a delta hedged position becomes very difficult
Lehigh intends to synthetically modify the duration of the corporate bond component of the portfolio to a target of 3.0 in anticipation of rising interest rates Interest rate swap data are provided in Exhibit 2: Exhibit 2
Pay Fixed Interest Rate Swaps
Swap Maturity Duration A 3 years - 2.125 B 4 years - 2.875 Cc 5 years - 3.625
Lehigh expresses concern to the investment committee about the concentrated holding of Mountain Hawk stock The shares were recently donated by an alumnus who mandated that the stock not be sold for 5 years Lehigh provides three potential options strategies to use in managing the risk of Mountain Hawk’s stock price declining from its present level of $100.00:
Strategy 1: Protective put using an option with a $95.00 strike
Strategy 2: Covered call using an option with a $105.00 strike
Trang 26Exhibit 3
Premiums for Mountain Hawk Options
Strike Level Call Premium Put Premium $90.00 $15.00 $ 3.00 $95.00 $10.00 $5.00 $100.00 $5.00 $ 7.00 $105.00 $ 3.00 $12.00 $110.00 $ 2.00 $17.00
Lehigh tells the committee she believes US large cap stocks will perform well over the next year The committee agrees and wants B&W to adjust the beta of the U.S large cap part of the portfolio to a target of 1.03 by purchasing large cap futures contracts Lehigh proposes to purchase 21 contracts
For each contract, the beta is 1.00 and the unit size is $100,000
The committee is concerned that Europe’s sovereign debt crisis may lead to volatility in European stock markets and the Euro currency It considers the following three tactical hedging strategies: Strategy 4: Enter into a forward contract to sell euros and buy dollars
Strategy 5: Short euro stock market futures, sell euros and buy dollars Strategy 6: Short euro stock market futures
Finally, Lehigh discusses the committee’s view that mid cap stocks will underperform small cap stocks over the next 24 months She recommends a swap position that will capture the expected performance difference Question 43 Lehigh’s response to Gulen is most likely correct only if the option is: A _ in-the-money B at-the-money C out-of-the-money Question 44
Based on the data in Exhibit 2 and a notional amount of $11,030,000, which interest rate swap will
Trang 27have the highest value at expiration? A Strategy 1 B Strategy 2 C Strategy 3 Question 46 Will Lehigh’s purchase of U.S large cap futures contracts result in the committee’s beta objective being attained? A Yes
B No, because the beta will be lower than the target C No, because the beta will be higher than the target
Question 47
Trang 28Bud Walter Case Scenario
Bud Walter is the Chief Investment Officer of Wryte Capital Management He is meeting with TM McGourn, a prospective client, to discuss Wryte’s investment performance as presented in Exhibit 1 and subsequent disclosure notes: Exhibit 1
Wryte Capital Management US Large Cap Equity Composite
Year | Gross Benchmark Internal Number of Composite Firm Assets Return % Return % Dispersion % | Portfolios Assets ($m) | ($m) 2006 15 15 5.2 20 100 175 2007 22 20 6.1 40 200 275 2008 -20 -25 5.7 30 150 200 2009 11 10 5.2 45 225 300 2010 20 20 4.7 50 250 350
Wryte Capital Management (WCM) has prepared this report in compliance with Global Investment Performance Standards (GIPS) The US Large Cap Equity Composite has been independently verified by a qualified third party to be GIPS compliant The verification report was issued only for the Composite and not for WCM It states that during 2008, 2009 and 2010, WCM complied with all composite construction requirements for the Composite and that WCM policies are designed to calculate and present performance in compliance with GIPS standards
Notes:
1 The firm is defined as an independent investment manager, which invests exclusively in US Large Cap, US Mid Cap and US Small Cap equity securities for US resident clients WCM’s policy for valuing portfolios and calculating performance is available upon request WCM’s calculation methodology is to use time-weighted rates of return Sub-period rates of return are geometrically linked Cash equivalent instruments are included in rates of return calculations Returns are calculated quarterly, or when large external cash flows take place (as defined by WCM)
Trang 295 Internal dispersion is the equal weighted standard deviation of the annual gross returns of the five portfolios included in WMC’s Large Cap Equity Composite
McGourn asks Walter why he uses standard deviation as the measure of internal dispersion and whether there are better dispersion measures Walter responds “standard deviation has the advantage of comparability across investment firms Other measures such as the high/low range and the interquartile range are skewed by outliers.”
Finally, McGourn asks Walter about WCM’s policies regarding the valuation of its investments Walter states that WCM uses the following valuation hierarchy:
1 Observable quoted market prices for similar investments in active markets
2 Quoted prices for similar investments in markets that are not active
3 Market-based inputs other than quoted prices that are observable for the investment
4 When no quotes or other market inputs are available we use WCM estimates based on quantitative models and assumptions
Question 49
ls WCM most likely correct in claiming compliance based on the verification report?
A Yes
B No, because of the level at which verification is claimed C No, because of the timeframe for which verification is claimed
Question 50
WCM’s methodology for calculating performance, as disclosed in Note #1, is least likely consistent with GIPS standards for:
A external cash flows
B geometrically linked returns C frequency of return calculations
Question 51
ls WCM most likely compliant with GIPS required standards for composite construction as disclosed in Note #2?
A Yes
Trang 30Question 52
With respect to gross-of-fees returns, Note #4 is least likely compliant with GIPS required standards in its treatment of: A custodial fees B performance fee C trading expenses Question 53 With respect to relative merits of internal dispersion measures, Walter is least likely correct about: A high/low range B interquartile range C standard deviation Question 54 ls Walter’s response to McGourn’s regarding WCM’s valuation hierarchy most likely correct? A Yes
B No, 4 should be excluded
Trang 31Sasha Ivanov Case Scenario
Sasha lvanov and Elena Petrova are employed in the pension plan department of a multi-national corporation, Caspian Inc Caspian provides a defined benefit pension plan to its employees and the benefits are indexed to inflation lvanov and Petrova are analyzing the impact an allocation to commodities would have on the pension plan’s risk-return profile
Petrova evaluates different approaches to investing in commodities She comments, “Direct commodity investments through the cash market can be operationally complex and incur carrying and storage costs | recommend indirect commodity investment by purchasing equities of commodity-linked businesses to obtain exposure to commodity price changes This is an easy and less expensive alternative.”
lvanov reviews evidence that shows commodity investments are a good hedge against inflation The evidence indicates that inflation is best hedged with commodity classes directly related to the intensity of economic activity He shares this information with Petrova
Ivanov evaluates the return of commodity futures and concludes the return is not the same as the return on the underlying spot commodity He states that the return on a commodity futures contract is made up of three components:
1 The roll return, from replacing expiring futures contracts with new contracts over time
2 The collateral return, from investing the value of the futures contract’s underlying assets in risk-free securities
3 The price return, from the convergence of the futures price to the spot price of the underlying commodity
Petrova prepares a study on unique pricing factors associated with different commodity futures In the study she notes that the nonstorability of electricity impacts forward prices for electricity Petrova states that for electricity, supply and demand factors rather than a no-arbitrage pricing principles will determine the price
lvanov notes that the use of commodities for business reasons can influence pricing and arbitrage opportunities in commodity markets He tells Petrova, “Arbitrage, in the presence of a convenience yield, requires the forward price of the commodity to be equal to the future value of the spot price compounded at a rate equal to the sum of the interest rate and the storage costs, less the convenience yield.”
Trang 32that will minimize basis risk
Question 55
ls Petrova’s comment regarding commodity investment most likely accurate?
A Yes
B No with respect to direct commodity investment C No with respect to indirect commodity investment Question 56 Ivanov would most likely recommend which commodity class to Petrova? A Oil B Gold Cc Cattle Question 57 Ivanov is least likely correct regarding which commodity futures contract return component? A Roll return B Price return C Collateral return Question 58 Is Petrova’s statement about electricity most likely correct? A Yes
B No, she is incorrect regarding supply and demand
C No, she is incorrect regarding no-arbitrage pricing principles
Question 59
Is lvanov most likely correct about the forward price when there is a convenience yield?
A Yes
Trang 34Question 1 Correct answer: A
“Guidance for Standards | -VII,’CFA Institute
2012 Modular level III, Vol.1, pp.49-52, 59-60, 107-110
Study Session 1-2-a
Demonstrate a thorough knowledge of the Code of Ethics and Standards of Professional Conduct by interpreting the Code and Standards in various situations involving issues of professional integrity A is correct, The hedge fund manager’s trades do not represent a violation of Standard II (B) Market Manipulation because the trades would be based on material nonpublic information, thus violating Standard II (A) material nonpublic information
Question 2 Correct answer: B
“Guidance for Standards | -VII,’CFA Institute
2012 Modular level III, Vol.1, pp 85-86, 90-93
Study Session 1-2-a
Demonstrate a thorough knowledge of the Code of Ethics and Standards of Professional Conduct by Interpreting the Code and Standards in various situations involving issues of professional integrity B is correct Appropriate disclosure has been provided to indicate that simulated results have been used
Question 3 Correct answer: C
“Guidance for Standards | -VII,’CFA Institute
2012 Modular level III, Vol.1, pp.101, 136
Study Session 1-2-a
Trang 35violation of Standard VI (C), Akagi is required to disclose, at the time of a client referral, any referral fee agreement in place, including the nature and the value of the benefit Kim also is in violation of Standard IV (C) as she has a responsibility to oversee Akagi and make sure the appropriate disclosures are made
Question 4 Correct answer: B
“Guidance for Standards | -VII,’CFA Institute
2012 Modular level III, Vol.1, pp.49-52, 71-73, 131-132
Study Session 1-2-a
Demonstrate a thorough knowledge of the Code of Ethics and Standards of Professional Conduct by interpreting the Code and Standards in various situations involving issues of professional integrity B is correct, Standard VI (B) Priority of Transactions concerns investment transactions for clients and employers having priority over investment transactions in which a member or candidate is the beneficial owner Since the manager does not have beneficial ownership, this Standard has not been violated
Question 5 Correct answer: A
“Guidance for Standards | -VII,’CFA Institute 2012 Modular level III, Vol.1, pp.19-23 Study Session 1-2-a
Demonstrate a thorough knowledge of the Code of Ethics and Standards of Professional Conduct by interpreting the Code and Standards in various situations involving issues of professional integrity Ais correct Kim has not violated the Code of ethics and standard I(A) knowledge of the Law, because the manager’s efforts to influence the legislative process are legal and not a violation of any standard
Question 6 Correct answer: B
“Guidance for Standards | -VII,’CFA Institute
2012 Modular level III, Vol.1, pp.38-40, 107-110, 116-118
Trang 36Demonstrate a thorough knowledge of the Code of Ethics and Standards of Professional Conduct by interpreting the Code and Standards in various situations involving issues of professional integrity B is correct The members and candidates can rely on third-party research but must make reasonable and diligent efforts to determine that such research is sound The manager has not violated Standard V (A) Diligence and Reasonable Basis since she is very familiar with the investment advisers she hires as sub advisors and their level of diligence, she worked with these firms for many years while at the bank Question 7 Correct answer: B “Capital Market Expectations,” John P Calverley, Alan M Meder, CFA, Brian D Singer, CFA, and Renato Staub 2012 Modular level III, Vol.3, p.41 Study Session 6-18-c
Demonstrate the application of formal tools for setting capital market expectations, including statistical tools, discounted cash flow models, the risk premium approach, and financial equilibrium models
B is correct The bond-yield-plus-risk-premium method (equation (8)) sets the expected return to the yield to maturity on a long-term government bond plus the equity risk premium: 12.2% = 3.8% +8.4% Question 8 Correct answer: C “Capital Market Expectations,” John P Calverley, Alan M Meder, CFA, Brian D Singer, CFA, and Renato Staub 2012 Modular level III, Vol.3, pp.15,19 Study Session 6-18-b
Discuss in relation to capital markets expectations, the limitations of economic data, data
measurement errors and biases, the limitations of historical estimates, ex post risk as a biased
Trang 37C is correct The SCI data is an index that is not composed of the same number of firms each period due to firm failures and combinations through time, which is indicative of a survivorship bias Question 9 Correct answer: C “Capital Market Expectations,” John P Calverley, Alan M Meder, CFA, Brian D Singer, CFA, and Renato Staub 2012 Modular level III, Vol.3, pp.29-31 Study Session 6-18-c
Demonstrate the application of formal tools for setting capital market expectations, including statistical tools, discounted cash flow models, the risk premium approach, and financial equilibrium models
Cis correct Based on equation (3a) applied to a regression:
Var(M) = Var(F,)x (b,)° + Var(F,)x(b,)’ +2xb, xb, xCov(F,,F,) +Var(e)
Find the variance of the error term using values from Exhibit 2:
0.2704 = 0.0784x(1.020)* + 0.1024x(1.045)? + 2x1.020x1.045x0 + Var (e)
Var(e) = 0.0770
The adjustment is a correlation of 0.25 Change the correlation into a covariance:
Trang 38Discuss in relation to capital markets expectations, the limitations of economic data, data
measurement errors and biases, the limitations of historical estimates, ex post risk as a biased
measure of ex ante risk, biases in analysts’ methods, the failure to account for conditioning information, the misinterpretation of correlations, psychological traps, and model uncertainty Explain the use of survey and panel methods and judgment in setting capital markets expectations C is correct As stated, the projections in the survey data tended to be more volatile than the actual outcomes over the same time period This indicates that the ex post risk (i.e., the volatility of the actual data) tends to have a downward bias relative to the ex ante risk displayed by the survey data This is evidence of ex post risk being a biased measure of ex ante risk Question 11 Correct answer: B “Capital Market Expectations,” John P Calverley, Alan M Meder, CFA, Brian D Singer, CFA, and Renato Staub 2012 Modular level III, Vol.3, pp.66-67 Study Session 6-18-h
Demonstrate the use of Taylor’s rule to predict central bank behavior
B is correct Taylor’s rule (equation 12, p.66) sets the optimal short-term rate as:
neutral rate + 0.5x(GDP growth forecast - GDP growth trend) + 0.5x (inflation forecast - inflation target) Applying numbers from Exhibit 3: 2.0% = 2.5% + 0.5 x (2.0% - 1.0%) + 0.5 x (1.5% - 3.5%) Question 12 Correct answer: B “Capital Market Expectations,” John P Calverley, Alan M Meder, CFA, Brian D Singer, CFA, and Renato Staub
2012 Modular level III, Vol.3, p.69
Study Session 6-18-i
Evaluate (1) the shape of the yield curve as an economic predictor and (2) the relationship between the yield curve and fiscal and monetary policy
Trang 39Tolliver’s statement incorrect in regard to fiscal policy Question 13 Correct answer: B “Asset Allocation,” William F Sharpe, Peng Chen, CFA, Jerald E Pinto, CFA, and Dennis W McLeavey, CFA 2012 Modular Level III, Vol.3, pp 237-240 Study Session 8-21-f
Explain how loss aversion, mental accounting, and fear of regret may influence asset allocation policy B is correct Fear of regret (of having made what turns out to be the wrong decision) leads to regret avoidance, which may cause an investor to want to limit deviations from peers’ asset allocations
Question 14 Correct answer: C
“Asset Allocation,” William F Sharpe, Peng Chen, CFA, Jerald E Pinto, CFA, and Dennis W McLeavey,
CFA
2012 Modular Level III, Vol.3, pp 240-245 Study Session 8-21-i, j
Select and justify an appropriate set of asset classes for an investor
Evaluate the theoretical and practical effects of including additional asset classes in an asset allocation Cis correct Adding an asset class to a portfolio will provide a benefit if E(Riev) = Rr > E(R,)- Re =P newp Ø, new oO p
Where new is the new asset class, p is the existing portfolio, F is the risk-free asset, p is the volatility, and p is the correlation If the correlation between the new asset class and the existing portfolio is low enough, adding the new asset class will be beneficial even if its stand-alone expected return and volatility seem undesirable
Trang 40“Asset Allocation,” William F Sharpe, Peng Chen, CFA, Jerald E Pinto, CFA, and Dennis W McLeavey, CFA 2012 Modular Level III, Vol.3, pp 249-255 Study Session 8-21-n Formulate and justify a strategic asset allocation, given an investment policy statement and capital market expectations
B is correct The Black Theorum states that the optimal portfolio (lowest risk) for a given expected return is the weighted average of the adjacent corner portfolios (the two corner portfolios whose expected returns the required return falls between) such that the required return equals the weight on the adjacent corner portfolio with a higher expected return multiplied by its expected return plus one minus that weight multiplied by the expected return of the adjacent corner portfolio with the
lower expected return, or R, = wE(R,,,)+(1-w)E(R,,,) In this case, the adjacent corner
portfolios are portfolio 4 (expected return = 9.4%) and portfolio 5 (expected return = 7.7%) We calculate the weight on portfolio 4 from 9.0%=w(9.4%)+(1-w)(7.7%)>9.0%-7.7%=w(9.4%-7.7%) >w=1.3%/1.7%=0.765 So the amount of domestic bonds in the optimal portfolio = 0.765 x 23% + (1 - 0.765) x 31% = 24.9% Question 16 Correct answer: B “Asset Allocation,” William F Sharpe, Peng Chen, CFA, Jerald E Pinto, CFA, and Dennis W McLeavey, CFA
2012 Modular Level III, Vol.3, pp 270-278 Study Session 8-21-i
Discuss the strengths and limitations of the following approaches to asset allocation: mean-variance,
resampled efficient frontier, Black-Litterman, Monte Carlo simulation, ALM, and experience based
B is correct, The Black-Litterman approach starts with a global benchmark portfolio and uses the market weights to infer the market’s expected returns for each asset class Because the starting point is the global market portfolio, which is altered only to reflect the Investor’s divergent views, this approach is unlikely to result in large weights to a limited number of asset classes