CFALEVEL III PRACTICE QUESTIONS (LOS # 27) Question - #91779 An asset manager says he has perfectly hedged an equity portfolio that is denominated in a foreign currency by only using forward currency contracts We know then that the: A) asset manager is not telling the truth B) number of contracts used is equal to that used on a comparable equity position C) number of contracts used is greater than that used on a comparable equity position Question - #91447 If a manager plans to use currency forwards to hedge a long position in foreign equities, then which of the following would represent a strategy that would prevent over-hedging? A) Short an amount that is more than the current equity position B) Short an amount that is less than the current equity position C) Go long an amount that is more than the current equity position Question - #92301 If the value of a stock portfolio equals 16 times the futures price of the appropriate equity index contract and beta of the equity portfolio and futures price were equal, how many contracts would it take to reduce the beta of the equity index to zero? A) A long position in contracts B) A short position in 16 contracts C) A long position in 16 contracts Question - #91799 With respect to the practice of using forward contracts to eliminate the exchange-rate risk associated with a receiving a future payment in a foreign currency, which of the following is correct? A firm that expects to receive a foreign-currency payment is: A) “long” the currency and should short the forward contract on the foreign currency B) “short” the currency and should go long the forward contract on the foreign currency C) “short” the currency and should short the forward contract on the foreign currency Question - #91565 Redden Capital Management manages an intermediate, high-quality bond portfolio with a value of $12 million dollars The modified duration of the portfolio is 4.4 years with a yield beta of 1.0 Scott Stuart, the manager of the portfolio is concerned about rising interest rates over the next few months and wants to make a tactical adjustment and cut the duration of the portfolio in half Stuart asks Amy Swemba, a junior portfolio manager with Redden, to accomplish this task Swemba is aware that a Treasury bond futures contract exists with a value of $102,000, with a modified duration of 8.2 years Swemba replies to Stuart’s comments with the following statements: Statement 1: The fastest and most cost-effective way to reduce the duration of the portfolio by half would be to sell $6 million dollars worth of the actual bonds in the portfolio Statement 2: The portfolio’s duration could also be adjusted by selling 40 of the Treasury bond futures contrac After listening to Swemba’s statements, Stuart should: A) disagree with Statement 1, but agree with Statement B) disagree with both Statement and Statement C) agree with Statement 1, but disagree with Statement Question - #91570 The performance of a synthetically reallocated portfolio, e.g., a synthetic adjustment from stocks to bonds, would not exactly match the target position for all of the following reasons EXCEPT: A) the risk free rate is not zero B) rounding of the number of contracts used C) duration is not constant Question - #92351 A manager of a $20,000,000 portfolio wants to decrease beta from the current value of 0.9 to 0.5 The beta on the futures contract is 1.1 and the futures price is $105,000 Using futures contracts, what strategy would be appropriate? A) Long 69 contracts B) Short 19 contracts C) Short 69 contracts Question - #92304 A manager wants to synthetically convert to cash $45 million of a diversified stock portfolio for three months The manager will use the CME E-mini S&P stock index futures contract, which has a multiplier equal to $50, and the price of the three month contract is 1610.50 The dividend yield on the portfolio is 2.4% The risk-free rate is 4.04% The number of contracts the fund needs to use is closest to: A) 564 B) 588 C) 532 Question - #92225 The practice of taking long positions in futures contracts to create an exposure that converts a yet-to be received cash position into a synthetic equity or bond position is: A) called leveraging down B) illegal C) called pre-investing Question 10 - #92404 To synthetically create the risk/return profile of an underlying common equity security: A) Sell short the corresponding futures contract and invest in a T-bill B) Buy the corresponding futures contract and invest in a T-bill C) Buy the corresponding futures contract and borrow at the risk-free rate Question 11 - #91569 If a manager shorts a forward currency contract to hedge the expected value of a foreign-equity portfolio in one year The worst-case scenario is if the portfolio’s return is: A) less than the expected value and the currency depreciates B) less than the expected value and the currency appreciates C) greater than the expected value and the currency appreciates Question 12 - #91762 When investing in foreign equity assets, the exchange-rate dimension of the investment generally: A) diversifies the position and thus lowers risk B) increases the total risk C) can be completely hedged Question 13 - #91571 When hedging the exchange-rate risk of a foreign currency-denominated equity portfolio, a manager must recognize that the position has: A) exchange-rate risk only B) equity risk only C) both equity risk and foreign exchange risk Question 14 - #93166 Robert Zorn, CFA, manages an equity portfolio with a current market value of $150 million The beta of the portfolio is 1.23 and Zorn is forecasting a short-term market adjustment that will significantly lower equity values and will occur in the near future Zorn has decided to use S&P 500 futures, currently trading at 1260, to reduce the portfolio’s systematic risk exposure by 30 percent The multiplier is 250 What is the number of futures contracts, rounded up to the nearest whole number, that will be needed to achieve Zorn’s objective? A) Buy 182 B) Sell 176 C) Sell 169 Question 15 - #91672 An investor has a $100 million stock portfolio with a beta of 1.2 He would like to alter his portfolio beta using S&P 500 futures contracts The contracts are currently trading at 596.90 The futures contract has a multiple of 250 Which of the following is the CORRECT trade required to double the portfolio beta? A) Sell 804 contracts B) Buy 1608 contracts C) Buy 804 contracts Question 16 - #91573 A manager has a 70/30 stock and bond portfolio To synthetically create a portfolio that is 60 percent stock and 40 percent bonds, the manager should: A) go long both bond futures and stock index futures B) go long the bond futures and short the stock index futures C) short the bond futures and go long the stock index futures Question 17 - #92002 Derivatives are most often used to hedge which type of exchange-rate risk? A) Transaction exposure B) Translation exposure C) Economic exposure Question 18 - #92054 When expecting to make a future payment in a foreign currency, a firm should take a: A) short forward position in the currency to hedge an appreciation of that currency B) long forward position in the currency to hedge an appreciation of that currency C) long forward position in the currency to hedge a depreciation of that currency Question 19 - #92286 An investor has an $80 million stock portfolio with a beta of 1.1 He would like to partially hedge his portfolio using S&P 500 futures contracts The contracts are currently trading at 596.70 The futures contract has a multiple of 250 Which of the following is the CORRECT trade to reduce the portfolio beta by 50 percent? A) Sell 590 contracts B) Sell 295 contracts C) Buy 295 contracts Question 20 - #92801 A manager has a position in Treasury bills worth $175 million with a yield of 2% For the next months, the manager wishes to have a synthetic equity position approximately equal to this value The manager chooses S&P 500 index futures, which has a dividend yield of 3% The futures price is 1,050 and the multiplier is $250 How many contracts will this take? A) 673 contracts B) 655 contracts C) 421 contracts Question 21 - #92428 Which of the following statements about portfolio hedging is least accurate? For a fixed portfolio insurance horizon, using put options generally requires less rebalancing A) and monitoring than with the use of futures contracts To synthetically create the risk/return profile of an underlying common equity security, buy B) the corresponding futures contract, sell the common short, and invest in a T-bill C) Futures contracts have a symmetrical payoff profile Question 22 - #92525 A manager of a $10,000,000 portfolio wants to increase beta from the current value of 0.9 to 1.1 The beta on the futures contract is 1.2 and the futures price is $245,000 Using futures contracts, what strategy would be appropriate? A) Long 11 contracts B) Short contracts C) Long contracts Question 23 - #91572 In order to perfectly hedge an investment in foreign equities, a manager would most likely have to use: A) currency forwards only B) both currency futures and equity forwards C) both currency forwards and equity futures Question 24 - #91999 The risk associated with a fall in demand for a firm’s product caused by an appreciation of the home currency of the firm is called: A) translation exposure B) economic exposure C) transaction exposure Question 25 - #92172 A portfolio manager knows that a $10 million inflow of cash will be received in a month The portfolio under management is 70% invested in stock with an average beta of 0.8 and 30% invested in bonds with a duration of The most appropriate stock index futures contract has a price of $233,450 and a beta of 1.1 The most appropriate bond index futures has a duration of and a price of $99,500 How can the manager pre-invest the $10 million in the appropriate proportions? Take a: A) long position in 22 of the stock futures and 25 of the bond futures B) short position in 25 of the bond futures and 22 of the stock futures C) long position in 25 of the stock futures and 28 of the bond futures Question 26 - #91683 A manager has a $100 million portfolio that consists of 50% stock and 50% bonds The beta of the stock position is The modified duration of the bond position is The manager wishes to achieve an effective mix of 60% stock and 40% bonds The price and beta of the stock index futures contracts are $277,000 and 1.1 respectively (The futures price includes the effect of the index multiplier.) The price, modified duration, and yield beta of the futures contracts are $98,000, 6, and respectively What is the appropriate strategy? A) Short 85 bond futures and go long 33 stock index futures B) Go long 53 bond futures and go long 40 stock index futures C) Short 40 bond futures and go long 106 stock index futures Question 27 - #92463 An investor has a $100 million stock portfolio with a beta of 1.1 He would like to hedge his portfolio using S&P 500 futures contracts, which are currently trading at 596.70 The futures contract has a multiple of 250 Which of the following is the CORRECT trade required to create a synthetic T-bill? A) Sell 670 contracts B) Sell 737 contracts C) Buy 670 contracts Question 28 - #92057 A maker of large computers has just received an order for some of its products The agreed upon price is in British pounds: ₤8 million The firm will receive the pounds in 60 days The current exchange rate is $1.32/₤ and the 60-day forward rate is $1.35/₤ If the firm uses the forward contract to hedge the corresponding exchange rate risk, how many dollars will it expect to receive? A) $10,800,000 B) $10,560,000 C) $5,925,926 Question 29 - #92033 The exchange-rate risk associated with falling asset values in foreign subsidiaries caused by currency fluctuations is called: A) economic exposure B) translation exposure C) transaction exposure Question 30 - #92440 An investment of $240,000,000 in T-bills earning percent is combined with 886 stock index futures that have a price of 1,100 and a multiplier of 250 In three months, when the futures mature and the index value is 1,120, what will be the value of the position at that time? A) $243,650,000 B) $246,210,097 C) $248,080,000 Question 31 - #91845 An S&P500 index manager knows that he will have $60,000,000 in funds available in three months He is very bullish on the stock market and would like to hedge the cash inflow using S&P 500 futures contracts The S&P 500 futures contract stands at 1100.00 and one contract is worth 250 times the index Which of the following is the most accurate hedge for this portfolio? A) Buy 218 contracts B) Sell 218 contracts C) Buy 284 contracts Question 32 - #92361 A manager wants to synthetically convert to cash $12 million of a diversified stock portfolio for three months The manager will use the CME E-mini S&P stock index futures contract, which has a multiplier equal to $50, and the price of the three month contract is 1598.80 The dividend yield on the portfolio is 2.8% The risk-free rate is 3.96% To accomplish this, the best choice would be to: A) take a long position in 152 contracts B) take a short position in 156 contracts C) take a short position in 152 contracts Question 33 - #92382 An investor has a cash position currently invested in T-Bills but would like to "equitize" it by using S&P futures contracts Which of the following trades will create the desired synthetic equity position? A) Selling the T-Bills and buying S&P 500 futures contracts B) Buying S&P 500 futures contracts C) Selling S&P 500 futures contracts short Question 34 - #91834 Jackson Inc is a multi-national company based in the U.S that makes freight cars One third of Jackson’s freight car sales occur in the Netherlands To manufacture the cars, the firm must import approximately one half of their raw materials from Canada Heretofore, Jackson’s CFO Pete Moore ignored exchange rate risk, figuring that currency fluctuations even out over time However, Jackson is doing more and more business abroad, and Moore is beginning to rethink his position In addition, Moore believes that exchange rates have become more volatile, thus hedging currency exposure might make sense Given his new mindset, Moore decides to hedge some of the company’s currency exposure Two months from now, Jackson plans to sell freight cars to a Dutch firm for 15 million To protect the company from any adverse moves in exchange rates, Moore enters into a 15 million forward contract due in 60 days Moore also enters into a 60-day forward contract to lock in 8.5 million Canadian dollars which will be used to purchase steel from a Canadian supplier to be delivered in months The current Euro-to-U.S dollar exchange rate is 0.79/$, while the Canadian dollar-to-U.S dollar exchange rate is C$1.30/$ The 60-day forward Euro-to-U.S dollar exchange rate is 0.80/$, while the 60-day forward Canadian dollar-to-U.S dollar exchange rate is C$1.33/$ At the end of two months, the actual Euro/U.S dollar exchange rate is 0.90/$ and the actual Canadian dollar/U.S dollar rate is C$1.20/$ In addition to his duties at Jackson, Moore is a Level III CFA Candidate To assist with his studies and gain insights that will help him with Jackson’s hedging strategy, Moore has put together the following two tables Table 1: Types of Exchange Rate Risks Types of Definition Exposure The risk that exchange rate fluctuations will Economic make contracted future cash flows from foreign Exposure trade partners’ decrease in domestic currency value The risk that multinational corporations might Translation see a decline in the value of their assets that are Exposure denominated in foreign currencies when those foreign currencies depreciate It is the loss of sales that a domestic exporter Transaction might experience if the domestic currency Exposure appreciates relative to a foreign currency Table 2: Hedging Currency Positions Currency Exposure Position Action Receiving foreign Long Buy forward contract currency Paying foreign currency Short Sell forward contract Up to now, Moore has used only forward contracts to hedge the foreign currency exposure However, after reading about futures contracts, he thinks futures may be appropriate To help him decide, Moore makes a list of the advantages and disadvantages of using futures contracts Pros & Cons of Futures vs Forwards Futures contracts are standardized contracts, forward contracts are not Futures contracts are less regulated than forward contracts, and thus have higher default risk Forward contracts can be established for any settlement date, futures contracts have a limited number of available settlement dates Part 1) With respect to Table 1, which of the following statements is most accurate? The definition for: A) economic exposure is correct; the definition for transaction exposure is correct B) translation exposure is correct; the definition for transaction exposure is incorrect C) translation exposure is incorrect; the definition for transaction exposure is incorrect Part 2) When hedging their exchange rate risk on the freight car sale, Moore used a forward contract to: A) sell 15 million in exchange for $18.75 million B) buy 15 million in exchange for $18.75 million C) sell 15 million in exchange for $16.67 million Part 3) To hedge the foreign exchange risk relative to the Canadian dollar, Jackson should: A) buy a forward contract to exchange $7,083,333 for CAD 8.5 million B) buy a forward contract to exchange $6,390,977 for CAD 8.5 million C) sell a forward contract to exchange $6,390,977 for CAD 8.5 million Part 4) In regard to Table 2, which of the following is CORRECT? The: A) receiving foreign currency position is incorrect; the action is also incorrect B) receiving foreign currency position is correct; the action is incorrect C) paying foreign currency position is correct; the action is correct Part 5) Regarding the advantages of futures contracts, which statement is least accurate? A) Statement B) Statement C) Statement Part 6) All of the following are advantages of using futures and forward contracts to hedge risk in a portfolio, relative to adjusting the actual debt and equity positions, EXCEPT: the manager gets a leverage effect with futures because the only required “investment” is the A) margin deposit liquidity, at least for shorter maturity contracts, is often greater in the futures market than in B) the underlying market C) it is typically less expensive to use derivatives than to adjust the actual portfolio Question 35 - #91936 A manager of $30 million in mid-cap equities would like to move half of the position to an exposure resembling small-cap equities The beta of the mid-cap position is 1.0, and the average beta of small-cap stocks is 1.6 The betas of the corresponding mid and small-cap futures contracts are 1.05 and 1.5 respectively The mid and small-cap futures prices are $260,000 and $222,222 respectively What is the appropriate strategy? A) Short 17 mid-cap futures and go long 17 small-cap futures B) Short 55 mid-cap futures and go long 72 small-cap futures C) Short 17 small-cap futures and go long 17 mid-cap futures Question 36 - #92159 A portfolio manager has a net long position in both stocks and bonds and no cash When pre-investing a future cash inflow, to replicate the existing portfolio, using bond and stock futures, which of the following statements is most accurate? The manager will: A) go long both stock and bond futures B) go long the stock futures but short the bond futures C) have to choose a single futures contract and net the bond and stock position Question 37 - #92559 Michael Hallen, CFA, manages an equity portfolio with a current market value of $78 million and a beta of 0.95 Convinced the market is poised for a significant upward movement, Hallen would like to increase the beta of the portfolio by 40 percent, using S&P 500 futures currently trading at 856 The multiplier is 250 What is the number of futures contracts, rounded up to the nearest whole number, that will be needed to achieve Hallen’s objective? A) 143 B) 139 C) 144 Question 38 - #93144 George Kaufman, portfolio manager and CEO of Kaufman Co., is extremely busy He has a number of important issues that must be dealt with before the end of the week The portfolio Kaufman manages consists of $40 million in bonds and $60 million in equities The modified duration of the bond portfolio is 6.3 The beta of the equity portfolio is 1.25 The holding period for each is year Kaufman also has the authority to borrow up to $25 million which may be invested on a short-term basis to earn the spread between the borrowing rate and the investing rate Kaufman is afraid that interest rates will rise 25 basis points in the near future and would like to decrease the duration of the bond portion of the portfolio to 5.0 for a short period of time He prefers to use futures contracts to this since it is a temporary change and he does not want to actually sell bonds in the portfolio Kaufman is considering using a Treasury bond futures contract that has a modified duration of 4.2, a yield beta of 1.1, and a price (including the multiplier) of $245,000 Kaufman would like to borrow money three months from today so he can invest at the expected higher interest rates However, he would like to lock in today’s interest rates for the loan To this he is considering locking in a loan rate using a forward rate agreement (FRA) A cash settlement will be made based on the actual interest rate three months from now, relative to the FRA interest rate If Kaufman decides on this strategy, he would borrow $20 million at percent for months The loan date would start three months from today The equity portion of the portfolio has performed extremely well over the recent past and Kaufman must decide on one of the following two strategies: Equity Strategy 1: Kaufman could hold on to his current profits for the next six months which should make the reported annual return rank in the top one percentile of similar portfolios Again, Kaufman prefers to use futures contracts instead of selling stocks to lock in the profits The portfolio is composed of the same stocks and sector weightings as the S&P 500 The contract on the index is at 2000 (with a multiplier of 250), and it expires in months The risk free rate is percent and the dividend yield on the index is percent Equity Strategy 2: Kaufman believes there is a chance the market may move significantly over the next six months To benefit from the expected move in the market, Kaufman could increase the equity portion of the portfolio from its current beta of 1.25 to 1.4 by using equity index futures The appropriate equity index futures contract that Kaufman is considering using has a beta of 0.90 and a price (including the multiplier) of $335,000 Finally, Kaufman Co is expecting a $6 million cash inflow in months and would like to pre-invest the funds to create the same exposure to the bond and stock market that is found in the original portfolio The most appropriate stock index futures contract for accomplishing this has a total price (including the multiplier) of $315,650 and a beta of 1.10 The most appropriate bond index futures contract has a total price of $115,460, a yield beta of 1.05 and an effective duration of 6.2 Part 1) Assume Kaufman Co uses a FRA to hedge the loan rate If interest rates are 4.85 percent at expiration of the FRA, the settlement payment is closest to: A) $21,710, with the bank paying Kaufman the settlement B) $28,739, with Kaufman paying the bank the settlement C) $21,710, with Kaufman paying the bank the settlement Part 2) The value of the bond portfolio given a 25 basis point increase is closest to: A) $39,580,000 B) $39,370,000 C) $37,480,000 Part 3) The number of Treasury bond futures contracts that Kaufman would need to reduce the duration of the bonds in the portfolio is closest to: A) buy 269 contracts B) sell 56 contracts C) sell 51 contracts Part 4) Kaufman is interested in increasing the beta of the equity portfolio to 1.4 for a brief period of time Kaufman is expecting a(n): increase in the market; a long position in approximately 27 contracts will accomplish this A) target increase in the market; a long position in approximately 30 contracts will accomplish this B) target decrease in the market; a short position in approximately 72 contracts will accomplish this C) target Part 5) How many S&P index futures contracts would Kaufman need to buy or sell to create a six-month synthetic cash position? A) Buy approximately 121 contracts B) Sell approximately 400 contracts C) Sell approximately 121 contracts Part 6) The most appropriate strategy to pre-invest the anticipated $6 million inflow would be to: A) buy 21 bond futures contracts and buy 35 stock futures contracts B) buy 22 bond futures contracts and sell 13 stock futures contracts C) buy 22 bond futures contracts and buy 13 stock futures contracts Question 39 - #92256 A portfolio holds $20 million of its assets in an index fund that mimics the return of the Dow Jones Industrial Average (DJIA) The dividend yield on the DJIA index is 2.8% The manager of the portfolio would like to synthetically convert half of the position to cash for a one month period The futures contract on the DJIA that expires in a month is priced at 14520.01 It has a multiplier equal to $10 The risk-free rate is 3.85% The number of contracts the fund needs to use is closest to: A) 66 B) 72 C) 69 Question 40 - #92389 When using stock index futures contracts and cash to create a synthetic stock index, the larger the index multiplier: A) the fewer the number of needed contracts B) there is no such thing as an index multiplier C) the greater the number of needed contracts Question 41 - #92423 To create a synthetic cash position: A) sell short the common equity, buy the corresponding futures contract, invest in a T-bill B) buy the common equity and sell short the corresponding futures contract C) buy the common equity, sell short the corresponding futures contract, invest in a T-bill Question 42 - #91460 A manager wishes to make a synthetic adjustment of a mid-cap stock portfolio The goal is to increase the beta of the portfolio by 0.5 The beta of the futures contract the manager will use is one If the value of the portfolio is 10 times the futures price, then the futures contract position needed is a: A) long position in 20 contracts B) short position in contracts C) long position in contracts Question 43 - #93174 Tom Corser is the manager of the $140,000,000 Intrepid Growth Fund Corser’s long-term view of the equity market is negative, and as a result, his portfolio is allocated defensively with a beta of 0.85 Despite his negative long-term outlook, Corser thinks the market is temporarily mispriced, and could rise significantly over the next few weeks Corser has implemented tactical asset allocation measures in his fund sporadically over the years, and thinks now is another time to so Because he likes his long-term holdings, he decides to use a futures overlay rather than trading assets to implement his view of the market Corser decides he wants to increase the beta of his portfolio to 1.25 The appropriate futures contract has a beta of 1.03 and the total futures price is $310,000 What is the appropriate tactical allocation strategy for Corser to accomplish his objective? A) Buy 373 equity futures contracts B) Sell 175 equity futures contracts C) Buy 175 equity futures contracts ... both equity risk and foreign exchange risk Question 14 - # 931 66 Robert Zorn, CFA, manages an equity portfolio with a current market value of $150 million The beta of the portfolio is 1. 23 and... adjust the actual portfolio Question 35 - #91 936 A manager of $30 million in mid-cap equities would like to move half of the position to an exposure resembling small-cap equities The beta of the... contracts C) take a short position in 152 contracts Question 33 - #9 238 2 An investor has a cash position currently invested in T-Bills but would like to "equitize" it by using S&P futures contracts Which