CFA 2018 level 3 schweser practice exam CFA 2018 level 3 question bank 06 asset allocation questions

ASSET ALLOCATION QUESTION IS COMPOSED OF TWO PARTS (A, B) FOR A TOTAL OF 10 MINUTES Seth Batten, CFA, is working with two different clients The first, Client A, is a high net worth individual subject to a marginal tax rate of 50% (combined federal and state) on ordinary income and a 20% capital gains tax rate Client A has a risk aversion factor of The second account, Client B, is a tax-exempt institution having a risk aversion factor of Both clients have long time horizons Clients A and B are each considering hiring one of the separate account managers profiled in Figure All three managers use the S&P 500 as their index benchmark The S&P 500 is expected to average a 9.0% annual return over the next 10 years Figure 1: Manager Comparison Data Expected Portfolio Expected Annual Standard Manager Total Return Deviation X 10.1% 15.1% Y 10.6% 15.3% Z 9.5% 14.9% Expected Annual Management & Turnover Trading Costs 50% 100% 15% 0.40% 0.70% 0.20% A Calculate which portfolio manager Client A would choose based on utility adjusted return Show your work (4 minutes) B i Based on the risk aversion factors only, identify which client is more likely to exhibit a low tolerance for shortfall risk ii Based on tax considerations only, identify which client is more likely to have higher turnover Justify your responses Consider each issue in isolation Answer Part B in the template provided (6 minutes) Template for Part B Behavior i Low tolerance for shortfall risk Client Most Likely to Exhibit Behavior (circle one) Reason Client A Client B Client A ii Higher turnover Client B QUESTION HAS THREE PARTS (A, B, C) FOR A TOTAL OF 13 MINUTES Jane Lo is responsible for strategic asset allocation with Global Asset Management (GAM) Lo is looking at a domestic equity portfolio and considering adding either international bonds or equity to the portfolio Either is acceptable to the client, and Lo’s primary focus is improving the Sharpe ratio of the portfolio She reviews the historical data and expects the international bonds will have lower correlation with the existing portfolio than international equity will have She also makes the following projections: Existing portfolio International bonds International equity Investor’s domestic rf E(R) 7% 4% 8% 1% 8% 5% 11% A Based only on the information provided, determine whether Lo will recommend adding international equity or bonds, or determine there is insufficient date to make a decision Support the determination with two reasons (5 minutes) Lo next turns her attention to one of the firm’s existing global asset allocation funds The fund manager is looking to add value through currency allocation and the carry trade The manager treats currency as an asset class Lo collects information on current 1-year interest rates and projected change in currency value versus the fund’s domestic currency Fund’s Domestic Country Country B Country C Country D 1-Year Rate 1.0% 3.5% 3.8% 2.0% Change in Currency Na –2.0% +1.0% +3.0% B Based on Lo’s data and expectations, determine and explain the optimal carry trade Lo will recommend Calculate the approximate percent return the trade would net per unit of the fund’s domestic currency (4 minutes) Six months have passed and Lo now projects a significant and generally unexpected increase in currency volatility The same manager wants to profit from this view In addition to his existing carry trade, the manager is considering either a straddle, strangle, or collar option trade C Assuming Lo is highly confident in her volatility opinion: i Explain what the manager should with the existing carry trade ii Explain which of the option trades being considered the manager should select (4 minutes) ... Client A ii Higher turnover Client B QUESTION HAS THREE PARTS (A, B, C) FOR A TOTAL OF 13 MINUTES Jane Lo is responsible for strategic asset allocation with Global Asset Management (GAM) Lo is looking... firm’s existing global asset allocation funds The fund manager is looking to add value through currency allocation and the carry trade The manager treats currency as an asset class Lo collects... Fund’s Domestic Country Country B Country C Country D 1-Year Rate 1.0% 3. 5% 3. 8% 2.0% Change in Currency Na –2.0% +1.0% +3. 0% B Based on Lo’s data and expectations, determine and explain the optimal