2017 wiley question bank CFA l1 ethical and professional standards

Ethical and Professional Standards Reading 1: Code of Ethics and Standards of Professional Conduct Unless otherwise stated in the question, all individuals in the following questions are CFA Institute members or candidates in the CFA Program and, therefore, are subject to the CFA Institute Code of Ethics and Standards of Professional Conduct Oversight and responsibility for the CFA Institute Professional Conduct Program is maintained by the: A Board of Governors B CEO C Disciplinary Review Committee If a member or candidate does not accept the charges and proposed sanction levied by CFA Institute under the Professional Conduct Program, the matter is referred to a panel composed of A Board of Governors B Senior CFA Institute executives C Disciplinary Review Committee Sanctions that can be imposed by CFA institute under the Professional Conduct Program include all of the following except: A Public Censure B Fine C Suspension of membership Bob Hadrell, CFA, has recently joined a new firm that currently reviewing its internal code of ethics As part of this review, the firm has asked Hadrell for a summary of the CFA Institute Code of Ethics and Standards of Professional Conduct Hadrell makes the following two statements: Statement 1:”Members of CFA Institute and candidates for the CFA designation must promote the integrity of and uphold the rules governing capital markets” Statement 2:” Integrity of Capital Markets: Market Manipulation.” Hadrell should describe: A Both Statement and Statement as Standards of Professional Conduct B Statement as a component of the Code of Ethics and Statement as a Standard of Professional Conduct C Statement as a Standard of Professional Conduct and Statement as a component of the Code of Ethics “Priority of Transactions” is included as a sub-section to which CFA Institute Standard of Professional Conduct? A Duties to clients B Investment analysis, recommendations and actions C Conflicts of interest Reading 1: Code of Ethics and Standards of Professional Conduct Oversight and responsibility for the CFA Institute Professional Conduct Program is maintained by the: A Board of Governors B CEO C Disciplinary Review Committee Answer: A The CFA Institute Board of Governors maintains oversight and responsibility for the Professional Conduct Program (PCP), which, in conjunction with the Disciplinary Review Committee (DRC), is responsible for enforcement of the Code and Standards If a member or candidate does not accept the charges and proposed sanction levied by the CFA Institute under the Professional Conduct Program, the matter is referred to a panel composed of A Board of Governors B Senior CFA Institute executives C Disciplinary Review Committee Answer: C If the member or candidate does not accept the charges and proposed sanction levied by the CFA Institute under the Professional Conduct Program, the matter is referred to a panel composed of DRC members Panels review materials and presentations from Professional Conduct staff and from the member or candidate The panel’s task is to determine whether a violation of the Code and Standards or testing policies occurred and, if so, what sanction should be imposed Sanctions that can be imposed by the CFA institute under the Professional Conduct Program include all of the following except: A Public Censure B Fine C Suspension of membership Answer: B Sanctions imposed by CFA Institute may have significant consequences; they include public censure, suspension of membership and use of the CFA designation, and revocation of the CFA charter Candidates enrolled in the CFA Program who have violated the Code and Standards or testing policies may be suspended or prohibited from further participation in the CFA Program Bob Hadrell, CFA, has recently joined a new firm that currently reviewing its internal code of ethics As part of this review, the firm has asked Hadrell for a summary of the CFA Institute Code of Ethics and Standards of Professional Conduct Hadrell makes the following two statements: Statement 1:”Members of CFA Institute and candidates for the CFA designation must promote the integrity of and uphold the rules governing capital markets” Statement 2:” Integrity of Capital Markets: Market Manipulation.” Hadrell should describe: A Both Statement and Statement as Standards of Professional Conduct B Statement as a component of the Code of Ethics and Statement as a Standard of Professional Conduct C Statement as a Standard of Professional Conduct and Statement as a component of the Code of Ethics Answer: B The Code of Ethics contains six components that address general areas of Ethical behaviour The Standards of Professional Conduct are seven areas of Professional Conduct that deal with specific types of behaviour in certain situations, e.g Market Manipulation “Priority of Transactions” is included as a sub-section to which CFA Institute Standard of Professional Conduct? A Duties to clients B Investment analysis, recommendations and actions C Conflicts of interest Answer: C Standard VI(B)Conflicts of Interest relates to Priority of Transactions Reading 2: Guidance for Standards I-VII Tom Gerten is a research analyst that has reasons to believe that ongoing employer activities are in violation of CFA Institute Standards of Professional Conduct Gerten’s initial response should be to: A Report his suspicions to the relevant regulatory body B Report his suspicions to his supervisor or compliance department C Resign his position at the firm in order to dissociate from the activity Charles Baker uses internet social media platforms to communicate with clients He resides in a country with no securities laws or regulations that address social media, and his clients are located in a country with less strict securities laws and regulations regarding use of social media than the Code and Standards Baker should adhere to: A the Code and Standards B the securities laws and regulations of the location of his client C the securities laws and regulations of his residence Frank Clotti is an investment analyst working for a credit rating agency Clotti has been told by his immediate supervisor that ratings for structured products issued by a certain client should not receive a rating that is below investment grade, as it might affect the advisory relationship that the credit rating agency has with the client Clotti has already conducted his analysis and concluded that several of the structured products issued by the client should be rated as below investment grade According to the Standards, Clotti should: A Adhere to the instructions of his supervisor B Assign the structured products the lowest possible investment grade C Refuse to associate with research that assigns a rating of investment grade to the structured products he has concluded should be rated below investment grade Which of the following policies most closely adheres to the recommended procedures for compliance under Standard I(B):Independence and Objectivity regarding gifts? A Analysts should reject all gifts from clients and related parties B Analysts should disclose gifts from clients to their employer and receive only modest gifts from related parties C Analysts should disclose gifts from clients to their employer and reject all gifts from related parties Jim Wonder reads a study in a financial Journal regarding the valuation of global equity markets, and wishes to use information in the study in his own research In order to avoid violating Standard I(C): Misrepresentation Wonder should attribute the information used in his report to A The financial journal B The original author of the study C Both the financial journal and the original author of the study All of the following are considered acts of plagiarism under Standard I(C): Misrepresentation except: A Verbally repeating a quote of a leading industry expert in an online webcast without attribution B A firm using work completed by analysts that subsequently left the firm without attributing the analysts C An analyst reissuing work solely under their name that was initially completed by analysts that previously worked at the firm Which of the following actions is most likely to be considered a violation of Standard I(D): Misconduct? A A portfolio manager conducting an extra marital relationship with a member of his office B A portfolio manager not expending the necessary effort to due diligence securities that are added to client portfolios C A risk manager filing for personal bankruptcy Which of the following statements clearly conflicts with the recommended procedures for compliance with Standard I(D): Misconduct? A Firms should develop a code of ethics that makes it clear that personal behavior that reflects poorly on the individual, the institution or the industry will not be tolerated B Firms should not attempt to list potential violations and sanctions due to difficult nature of capturing the wide variety of misconduct possible at modern financial institutions C Firms should check the references of individuals to ensure they are of good character and not ineligible to work in the industry due to past misdemeanours Tom Cobo is a research analyst covering the biotechnology sector He employs an ‘expert network’ of industry contacts to stay abreast of current issues in the industry Cobo arranges a call with a scientist involved in the preliminary testing of an Alzheimer’s disease, during which the scientist discloses that it is very likely that the tests will be successful and the drug will be fast tracked through the government approval system Cobo returns to his firm and discusses this information with his colleagues, before increasing his holding in the company Cobo has A Violated Standard II(A): Material Non-Public Information B Not violated Standard II(A): Material Non-Public Information so long as procedures are in place with the expert network to deter the exchange of material non-public information C Not violated Standard II(A): Material Non-Public Information because the information was being publically disseminated by the scientist in the expert network 10 The mosaic theory states that: A Analysts should never use material non-public information B Analysts can use material non-public information as long as it is combined with material public information to reach any conclusion C Analysts can use nonmaterial non-public information 11 Which of the following is least likely to be an example of transactionbased manipulation under Standard II(B): Market Manipulation? A Issuing misleading positive information or overly optimistic projections of a security’s worth only to later sell it at an artificially high level B Crossing a single share of a security at a price that is significantly different from the last traded price in order to affect a related option expiration price C Securing a controlling, dominant position in a financial instrument to exploit and manipulate the price of a related derivative and/or the underlying asset 12 Oscar Moon is an employee at a credit ratings agency, and has created a computer model for valuation of complex asset backed securitized products The scenarios that Moon uses as the inputs for the model ignore any negative situations of deteriorating credit conditions, increasing rate and falling asset prices Due to the higher ratings that this model achieves, his valuation model becomes popular with his firm, who are keen to issue positive ratings for structured products in order to win business Moon’s firm compensates him based on the amount of structured products business the firm wins Moon has A Violated Standard II(A) Market Manipulation B Not violated Standard II(A) Market Manipulation since the scenarios used in the model accurately represent his views C Not violated Standard II(A) Market Manipulation since the Standard only relates to market transactions and publically disseminated information 13 According to Standard III(A): Loyalty, Prudence and Care, soft dollar agreements: A Violate the duty of loyalty to the client B Do not violate the duty of loyalty to the client as long as the goods and services purchased with soft dollar commissions are used to benefit the client C Never violate the duty of loyalty to the client Reading 60: Introduction to Alternative Investments Use the following information to answer Questions to 3: Tuscin Capital is a hedge fund with an initial investment capital of $100 million In its first year, the fund earns a return of 30% The fund charges a 2% management fee based on assets under management at the end of the year and a 20% incentive fee with a hurdle rate of 4% The ending values of the fund (before fees for the current year) for the first years are given below: 2009 = $130 million 2010 = $110 million 2011 = $140 million Other information: A high-water mark provision applies; and The incentive fee is based on returns in excess of the hurdle rate and is calculated net of management fee The incentive fee for 2009 is closest to: A $4.68 million B $5.48 million C $6.00 million Total fees for the year 2010 are closest to: A $2.96 million B $2.45 million C $2.2 million Investors’ effective return for 2011 is closest to: A 10.35% B 22.86% C 25.63% Investments in alternative investments that are made through special investment vehicles are least likely characterized by: A High fees B Low investment size C High use of leverage Activist strategies are most likely classified under which of the following hedge fund strategies? A Event-driven strategies B Relative value strategies C Equity hedge strategies Which of the following equity hedge strategies is most likely to have zero beta exposure to overall market risk? A Market neutral B Quantitative directional C Short bias Consider the following statements: Statement 1: The correlation between hedge fund returns and stock market returns increases in times of financial crisis Statement 2: In addition to management and incentive fees, hedge funds may also charge a fee for arranging divestures of assets Which of the following is most likely? A Only Statement is correct B Only Statement is correct C Both statements are incorrect Which of the following can most likely magnify losses for hedge funds? A Margin calls B Investor redemptions C Margin calls and investor redemptions Which of the following provisions in private equity partnership agreements ensures that the overall profit sharing ratio conforms to the initially agreed-upon profit split even if returns on portfolio companies are much higher in earlier years? A Clawback provision B Hurdle rate C High water mark 10 Which of the following is least likely a characteristic exhibited by LBO targets? A They have a significant proportion of valuable intangible assets B They have relatively low leverage C They have strong and sustainable cash flows 11 Which of the following stages of venture capital investments is most likely the first stage at which VC firms invest? A Angel investing B Seed-stage financing C Early stage financing 12 Formative stage financing is least likely provided in the form of: A Debt B Ordinary shares C Convertible preferred shares 13 Which of the following types of financing is most likely provided to prepare a company to go public? A Early-stage financing B Mezzanine-stage financing C Later-stage financing 14 When a PE firm sells a portfolio company to another PE firm, it is most likely referred to as a(n): A Trade sale B Associate sale C Secondary sale 15 Which of the following valuation approaches is least likely used to value real estate properties? A Comparable sales approach B Direct capitalization approach C Asset-based approach 16 Consider the following statements: Statement 1: Fluctuations in commodity spot prices are driven primarily by fluctuations in supply rather than in demand Statement 2: Commodity returns have exhibited a higher standard deviation than stocks and bonds over the last 20 years Which of the following is most likely? A Only Statement is correct B Only Statement is correct C Both statements are incorrect 17 Which of the following is most likely? A Futures price = Spot price + Interest costs – Storage costs – Convenience yield B Futures price = Spot price + Cost of carry – Convenience yield C Futures price = Spot price + Interest costs – Storage costs + Convenience yield 18 Which of the following is not a relative value hedge fund strategy? A Convertible arbitrage fund B Merger arbitrage fund C Multistrategy 19 Generally speaking, what is the aggregate fee structure of a hedge fund of funds? A 1% plus 10% of profits B 2% plus 20% of profits C 3% plus 30% of profits 20 For highly illiquid or nontraded alternative investments, what is the most likely method used for valuing them alongside other fund assets? A Fund’s best estimate B Book value at time of investment C Statistical modeling 21 Scott is running a multi-billion-dollar pension fund with a 40% allocation to alternative investments and a 60% allocation to equities that have just fallen 50% in value, whereas the alternative investments have gone up 20% He wants to rebalance the portfolio to take advantage of the huge discount in equities What type of risk is Scott going to experience in trying to this? A Rebalancing risk B Illiquidity risk C Liquidation risk 22 Which of the following metrics uses downside deviation as opposed to standard deviation as a measure of risk? A Value-at-risk B Shortfall or safety first measures C Sortino ratio 23 Which of the following items would not be included as part of a risk management due diligence review for a hedge fund? A Fund risk policies B Fund leverage C Fund structure Reading 60: Introduction to Alternative Investments Use the following information to answer Questions to 3: Tuscin Capital is a hedge fund with an initial investment capital of $100 million In its first year, the fund earns a return of 30% The fund charges a 2% management fee based on assets under management at the end of the year and a 20% incentive fee with a hurdle rate of 4% The ending values of the fund (before fees for the current year) for the first years are given below: 2009 = $130 million 2010 = $110 million 2011 = $140 million Other information: A high-water mark provision applies; and The incentive fee is based on returns in excess of the hurdle rate and is calculated net of management fee The incentive fee for 2009 is closest to: A $4.68 million B $5.48 million C $6.00 million Answer: A Management fee = 130 million × 0.02 = $2.6 million Incentive fee = [130 – 100 – (100 × 0.04) – 2.6] × 0.20 = $4.68 million Total fees for the year 2010 are closest to: A $2.96 million B $2.45 million C $2.2 million Answer: C Total fee in 2009 = Management fee + Incentive fee = 2.6 million + 4.68 million = $7.28 million Therefore, beginning capital position in 2010 = 130 million – 7.28 million = $122.72 million Ending value of the fund in 2010 = $110 million Since the fund has declined in value, no incentive fee will be paid Management fee = 110 million × 0.02 = $2.2 million Investors’ effective return for 2011 is closest to: A 10.35% B 22.86% C 25.63% Answer: C Total fee paid in 2010 = $2.2 million Therefore, beginning capital position in 2011 = 110 million – 2.2 million = $107.8 million Ending value of the fund in 2010 = $140 million Management fee = 140 million × 0.02 = $2.8 million Incentive fee = [140 million – 122.72 million – 2.8 million – (0.04 × 140 million)] × 0.20 = $1.776 million (High water mark applies) Total fee = 2.8 million + 1.776 million = $4.576 million Investor’s effective return = (140 – 4.576 – 107.8) / 107.8 = 25.63% Investments in alternative investments that are made through special investment vehicles are least likely characterized by: A High fees B Low investment size C High use of leverage Answer: B Investments in alternative investments that are made through special investment vehicles require relatively large investment amounts Activist strategies are most likely classified under which of the following hedge fund strategies? A Event-driven strategies B Relative value strategies C Equity hedge strategies Answer: A Activist strategies (that focus on purchasing sufficient equity in a company to be able to influence its policies and strategic direction) are categorized as event-driven strategies Which of the following equity hedge strategies is most likely to have zero beta exposure to overall market risk? A Market neutral B Quantitative directional C Short bias Answer: A Quantitative directional strategies may have positive or negative beta exposure depending on their expectations regarding future market direction Short bias strategies have negative beta exposure to the overall market Consider the following statements: Statement 1: The correlation between hedge fund returns and stock market returns increases in times of financial crisis Statement 2: In addition to management and incentive fees, hedge funds may also charge a fee for arranging divestures of assets Which of the following is most likely? A Only Statement is correct B Only Statement is correct C Both statements are incorrect Answer: A In addition to management and incentive fees, LBO firms may also charge fees for (1) arranging divestures of assets and (2) arranging buyouts of companies Which of the following can most likely magnify losses for hedge funds? A Margin calls B Investor redemptions C Margin calls and investor redemptions Answer: C Margin calls can magnify losses if the hedge fund is forced to liquidate certain positions immediately Redemptions usually occur when the fund is performing poorly They can also force the fund to close certain positions quickly Which of the following provisions in private equity partnership agreements ensures that the overall profit sharing ratio conforms to the initially agreed-upon profit split even if returns on portfolio companies are much higher in earlier years? A Clawback provision B Hurdle rate C High water mark Answer: A A clawback provision prevents the GP from earning more than its share of profits if incentive fees are paid on profits earned over time and the fund’s profits are relatively high in early years but decline later 10 Which of the following is least likely a characteristic exhibited by LBO targets? A They have a significant proportion of valuable intangible assets B They have relatively low leverage C They have strong and sustainable cash flows Answer: A LBO targets typically have a relatively high proportion of tangible physical assets, which can be used by the LBO firm to collateralize the loans taken to finance the buyout 11 Which of the following stages of venture capital investments is most likely the first stage at which VC firms invest? A Angel investing B Seed-stage financing C Early stage financing Answer: B Seed-stage financing is typically the first stage at which VC firms invest in companies At the angel stage, capital is primarily provided by individuals (friends and family) 12 Formative stage financing is least likely provided in the form of: A Debt B Ordinary shares C Convertible preferred shares Answer: A Debt financing is typically provided in later stage financing when the company has commenced commercial operations and has the cash flows required to service debt 13 Which of the following types of financing is most likely provided to prepare a company to go public? A Early-stage financing B Mezzanine-stage financing C Later-stage financing Answer: B Mezzanine-stage financing is provided to prepare a company to go public Later-stage financing (expansion venture capital) is provided after the company has begun commercial operations but before any IPO 14 When a PE firm sells a portfolio company to another PE firm, it is most likely referred to as a(n): A Trade sale B Associate sale C Secondary sale Answer: C A trade sale occurs when a company is sold to a strategic buyer A secondary sale occurs when a company is sold to another PE firm or group of investors 15 Which of the following valuation approaches is least likely used to value real estate properties? A Comparable sales approach B Direct capitalization approach C Asset-based approach Answer: C Asset-based approaches are used to compute REIT NAVs They are not used to value individual properties 16 Consider the following statements: Statement 1: Fluctuations in commodity spot prices are driven primarily by fluctuations in supply rather than in demand Statement 2: Commodity returns have exhibited a higher standard deviation than stocks and bonds over the last 20 years Which of the following is most likely? A Only Statement is correct B Only Statement is correct C Both statements are incorrect Answer: B Fluctuations in commodity spot prices are driven more by fluctuations in demand than in supply as supply is relatively inelastic over the short run 17 Which of the following is most likely? A Futures price = Spot price + Interest costs – Storage costs – Convenience yield B Futures price = Spot price + Cost of carry – Convenience yield C Futures price = Spot price + Interest costs – Storage costs + Convenience yield Answer: B Futures price = Spot price (1 + r) + Storage costs – Convenience yield Interest costs and storage costs together are known as the cost of carry 18 Which of the following is not a relative value hedge fund strategy? A Convertible arbitrage fund B Merger arbitrage fund C Multistrategy Answer: B The merger arbitrage funds fall under the category of event-driven, not relative value, strategies 19 Generally speaking, what is the aggregate fee structure of a hedge fund of funds? A 1% plus 10% of profits B 2% plus 20% of profits C 3% plus 30% of profits Answer: C Direct hedge funds normally charge a fee of 2% plus 20% of profits, and the hedge fund of funds adds on a 1% management fee plus 10% of profits 20 For highly illiquid or nontraded alternative investments, what is the most likely method used for valuing them alongside other fund assets? A Fund’s best estimate B Book value at time of investment C Statistical modeling Answer: C For highly illiquid or nontraded investments where reliable market value data is unavailable, values are estimated using statistical models 21 Scott is running a multi-billion-dollar pension fund with a 40% allocation to alternative investments and a 60% allocation to equities that have just fallen 50% in value, whereas the alternative investments have gone up 20% He wants to rebalance the portfolio to take advantage of the huge discount in equities What type of risk is Scott going to experience in trying to this? A Rebalancing risk B Illiquidity risk C Liquidation risk Answer: B Illiquidity risk will be Scott’s primary enemy in trying to rebalance his portfolio This is because virtually all alternative investments are illiquid to various degrees For example, most hedge funds only offer quarterly liquidity and private equity funds cannot be liquidated, except on secondary markets for a discount to intrinsic value 22 Which of the following metrics uses downside deviation as opposed to standard deviation as a measure of risk? A Value-at-risk B Shortfall or safety first measures C Sortino ratio Answer: C The Sortino ratio measure of downside risk uses downside deviation as opposed to standard deviation for a measure of risk 23 Which of the following items would not be included as part of a risk management due diligence review for a hedge fund? A Fund risk policies B Fund leverage C Fund structure Answer: C Fund structure is part of the legal review process when conducting due diligence on a hedge fund WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley’s ebook EULA ... Ethics and Standards of Professional Conduct Unless otherwise stated in the question, all individuals in the following questions are CFA Institute members or candidates in the CFA Program and, ... Statement and Statement as Standards of Professional Conduct B Statement as a component of the Code of Ethics and Statement as a Standard of Professional Conduct C Statement as a Standard of Professional. .. summary of the CFA Institute Code of Ethics and Standards of Professional Conduct Hadrell makes the following two statements: Statement 1:”Members of CFA Institute and candidates for the CFA designation