CFA 2018 level 3 schweser practice exam v2 exam 2 afternoon

Question #1 of 60 Questions 1-6 relate to Ethical and Professional Standards Theresa Bair, CFA, a portfolio manager for Brinton Investment Company (BIC), has recently been promoted to lead portfolio manager for her firm's new small capitalization closed-end equity fund, the Horizon Fund BIC is an asset management firm headquartered in Holland with regional offices in several other European countries After accepting the position, Bair received a letter from the three principals of BIC The letter congratulated Bair on her accomplishment and new position with the firm and also provided some guidance as to her new role and the firm's expectations Among other things, the letter stated the following: "Because our firm is based in Holland and you will have clients located in many European countries, it is essential that you determine what laws and regulations are applicable to the management of this new fund It is your responsibility to obtain this knowledge and comply with appropriate regulations This is the first time we have offered a fund devoted solely to small capitalization securities, so we will observe your progress carefully You will likely need to arrange for our sister companies to buy and sell Horizon Fund shares between themselves and at no risk over the first month of operations This will artificially support the price of the shares to allow the fund to trade closer to its net asset value, giving the perception that our fund is more desirable than other small-cap closed-end funds." Bair heeded the advice from her firm's principals and collected information from qualified advisors on the laws and regulations of three countries: N, S, and D Assume all of the investors in the Horizon Fund will be from these areas Based on her research, Bair has determined:    N allows crossing trades in the fund between firm clients even though this is prohibited between clients in D BIC will internally match buy and sell orders between clients in N whenever possible, but not in D This will reduce costs for clients in N whose orders are crossed and lower total fund expenses for all clients, which will benefit the fund's overall performance For clients located in D, account statements that include the value of the clients' holdings, number of trades, and average daily trading volume will be generated on a monthly basis as required by D's securities regulators Clients in N will only receive such reports quarterly as consistent with that country's requirements For clients located in S, the fund will not disclose differing levels of service that are available for investors based upon the size of their investment This policy is consistent with the laws and regulations in N D's securities regulations not cover this type of situation Three months after the inception of the fund, its market value has grown from $200 million to $300 million, and Bair's performance has earned her a quarter-end bonus It is now the end of the quarter, and Bair is participating in conference calls with companies in her fund Bair calls into the conference number for Sunrise Petroleum The meeting doesn't start for another five minutes, however, and as Bair waits, she hears the CEO and CFO of Sunrise discussing the huge earnings restatement that will be necessary for the financial statement from the previous quarter The restatement will not be announced until the year's end, six days from now Bair does not remind the officers that she can hear their conversation Once the call has ended, Bair rushes to BIC's compliance officer to inform him of what she has learned during the conference call Bair ignores the fact that two members of the firm's investment banking division are in the office while she is telling the compliance officer what happened on the conference call The investment bankers then proceed to sell their personal holdings of Sunrise Petroleum stock After her meeting, Bair sells the Horizon Fund's holdings of Sunrise Petroleum stock Do the suggestions in the letter from the principals of BIC violate any CFA Institute Standards of Professional Conduct? A) Yes, the principals are pressuring Bair to perform B) Yes, the suggested trades are intended to manipulate market data in order to attract investors for the fund C) No, even though Bair is responsible for knowing the laws, the compliance officer is responsible for making sure the firm is in compliance Question #2 of 60 With regard to the treatment of clients in N and D, the policies that Bair has selected regarding crossing trades and client statements for the Horizon Fund violate any CFA Institute Standards of Professional Conduct? N A) No B) Yes C) No D Yes No No Question #3 of 60 With regard to the treatment of clients in S, does the policy that Bair has selected regarding levels of service for the Horizon Fund violate any CFA Institute Standards of Professional Conduct? A) Yes, Bair's policy will violate Standard III(B) Fair Dealing B) No, because disclosure in S would disadvantage clients residing in other countries C) No, because disclosure in any country would break the confidentiality that Bair owes to her clients Question #4 of 60 After her conference call with Sunrise Petroleum, Bair should have: A) included the information in a research report to make it public before selling the holdings from the Horizon Fund B) attempted to have Sunrise publicly disclose the earnings restatement before informing the compliance officer of the information C) informed the compliance officer and then publicly disclosed the information in a research report before selling the Sunrise stock Question #5 of 60 By selling their personal holdings of Sunrise Petroleum, did the employees of BIC's investment banking division violate any CFA Institute Standards of Professional Conduct? A) Yes, because they breached their fiduciary duty and were disloyal to Sunrise B) Yes, because they were front running the information by trading for their own benefit before BIC's clients C) Yes, because they knowingly traded on information that, if it had been publicly known, would have affected the price of Sunrise stock Question #6 of 60 By selling the Horizon Fund's shares of Sunrise Petroleum, did Bair violate any CFA Institute Standards of Professional Conduct? A) Yes, Bair violated Standard II Integrity of Capital Markets B) No, because she ensured public dissemination of the earnings restatement information before she traded the shares C) Yes, because waiting to trade the stock would severely disadvantage investors in her fund and would have violated her duty of loyalty to her clients Question #7 of 60 Questions 7-12 relate to Ethical and Professional Standards Johnny Bracco, CFA, is a portfolio manager in the trust department of Canada National (CNL) in Toronto CNL is a financial conglomerate with many divisions In addition to the trust department, the firm sells financial products and has a research department, a trading desk, and an investment banking division Part of the company's operating procedures manual contains detailed information on how the firm allocates shares in oversubscribed stock offerings Allocation is effected on a pro rata basis based upon factors such as the size of a client's portfolio, suitability, and previous notification to participate in IPOs Additionally, company policy discloses to clients that any trade needs to meet a minimum transaction size in an effort to control trading costs and to comply with best execution procedures One of Bracco's trust accounts is the Carobilo family trust, which contains a portion of nondiscretionary funds managed by Stephen Carobilo Carobilo has a friend who runs a brokerage firm called First Trades, to which Carobilo tells Bracco to direct trades from the nondiscretionary accounts Bracco has learned that First Trades charges a slightly higher trading fee than other brokers providing comparable services, and he discloses this to Carobilo Due to high prices and limited supplies of oil, Bracco has been following companies in the energy sector He believes this area of the economy is in turmoil and should present some mispricing opportunities One company he has been researching is the Stiles Corporation, which is working on a new type of hydrogen fuel cell that uses fusion technology to create energy To date, no one has been able to successfully sustain a fusion reaction for an extended period of time Bracco has been in close contact with Stiles' pubic relations department, has toured their laboratories, and has thoroughly researched fusion technology and Stiles' competitors Bracco is convinced from his research, based upon various public sources, that Stiles is on the verge of perfecting this technology and will be the first firm to bring it to the marketplace Jerry McNulty, CFA and vice president of the investment banking division of CNL, has been working with Stiles to raise new capital via a secondary offering of Stiles common shares One day Bracco happened to be in a stall in the bathroom when McNulty and a colleague came in and discussed the fact that Stiles had perfected the fuel-cell technology, which will greatly increase the price of Stiles' stock A routine audit by the quality control department at CNL discovered trading errors in several of Bracco's accounts involving an oversubscribed IPO Some accounts received shares they should not have and others did not receive shares they should have Bracco and his supervisor Jaime Gun, CFA, are taking responsibility to reverse the incorrect trades Bracco told Gun, "I'll correct the trades based on our clients' investment policy statements, previous notification of intent, and according to the company's formula for allocating shares on a pro rata basis In so doing, we will fairly allocate shares so even small accounts that did not meet minimum size requirements will receive some shares of the IPO." Gun adds that we must go further and credit short-term interest back to the accounts that should not have received the shares That evening, Bracco and his wife attended the company holiday party for CNL employees and their spouses Jerry McNulty, whose wife was ill and could not come to the party, arrived drunk from a meeting with Stiles' upper management During the party McNulty made inappropriate advances toward many of the female employees and joked about the inadequacies of Stiles' managers While cleaning up after the party, a janitor found McNulty's pocket notebook that he apparently dropped accidentally during the party In the notebook, McNulty wrote the recommended amount and date of the secondary offering as well as several details on the nature of the new product Not knowing exactly what to with the notebook, the janitor gave it to Burt Sampson, CFA, a trader at CNL Later that night, Sampson called many of his relatives and friends and told them about the upcoming offering First thing the following Monday morning, McNulty submitted an order to buy the stock for his personal portfolio Has Bracco violated any soft dollar standards regarding the Carobilo family trust? Bracco has: A) violated soft dollar standards because he did not satisfy the requirement of best execution B) violated the soft dollar standards because client brokerage is to be used only for research purposes to benefit the client C) not violated any soft dollar standards since Carobilo requested that the trades be sent to a specific broker Question #8 of 60 If after overhearing McNulty's conversation in the bathroom Bracco placed trades to purchase shares of the Stiles Corporation for some of his clients, would Bracco have violated any of the Standards of Professional conduct? A) No, because the information regarding the Stiles Corporation was not acquired in a breach of confidence B) No, because he did not base the trade solely on the information he overheard C) Yes, because he is not allowed to trade on material, nonpublic information Question #9 of 60 Regarding the statements made by Bracco and Gun on how to correct the trading errors: A) only Gun's statement is correct B) only Bracco's statement is correct C) both are correct or both are incorrect Question #10 of 60 Did McNulty's behavior at the holiday party violate the: Code of Ethics? A) B) C) Standards of Professional Conduct? Yes No Yes Yes Yes No Question #11 of 60 Based solely on the information provided in the last paragraph, determine whether McNulty and/or Sampson violated the Code and Standards A) B) C) McNulty Sampson No Yes No No Yes Yes Question #12 of 60 Under the provision of the Asset Manager Code (AMC), in order to minimize the likelihood of some of the recent problems, CNL must all of the following except: A) establish written policies to ensurer fair and equitable trade allocation B) appoint a qualified compliance officer C) prohibit employees from trading in securities in which the firm has positions or investment banking relationships Question #13 of 60 Questions 13-18 relate to Behavioral Finance Krista Duchene, CFA, is an investment advisor for U.S clients Below, she summarizes some recent conversations with her clients Jonathan: Jonathan faces mandatory retirement from his unionized job in five years He has a relatively small portfolio and will be highly dependent on it in retirement His only other asset will be a modest pension He wants to avoid all international equities in his portfolio because he read in a few online news stories that many of them have performed poorly in the past year, despite having performed well for many years before that Jonathan's portfolio consists primarily of investment grade bonds that he inherited from his father He feels that his father was a knowledgeable investor, so it will be good to hold the bonds Duchene plans to apply behaviorally modified asset allocation (BMAA) to Jonathan's situation Seth: Seth attended his bachelor party in Las Vegas last week where he gambled and lost $5,000 Afraid to come home and share the news with his future spouse, he accepted a proposal with a 50% chance of losing another $5,100 (therefore, losing $10,100 in total) or a 50% chance of winning $5,000 (therefore, losing $0 in total) Being sure his luck would turn, he won and ended up breaking even overall Leah: Leah played a coin tossing game with her son They tossed a quarter 10 times and it came up heads every time Given that the long-term mean must be 50% heads and 50% tails, Leah said that the probability of tails turning up on the 11th loss is much more likely than heads Micah: After careful analysis, Micah purchased 200 shares of Ruby Corp (Ruby) several months ago at $25 per share The share price fell shortly thereafter due to an unexpected antitrust court ruling that increased competition in Ruby's industry The current share price is $20 and reliable analyst reports suggest that price properly reflects the new situation Micah says he may consider selling his shares when the price rises above $25 Stacey: Stacey owns 6% of the outstanding voting common stock of a private company She has no involvement in the company and has considered selling the shares in the past but has not found the time to so Also, because Stacey is independently wealthy, she would have no need for the funds anyways In applying BMAA to Jonathan's situation and his desire to avoid international equity and hold the bonds, the most appropriate action would be to: A) mitigate both his requests and have him invest in international equity and sell the investment grade bonds B) accommodate his request to hold the investment grade bonds C) accommodate his request not to invest in international equities Question #14 of 60 Seth's behavior in accepting the 50/50 proposal is best described as: A) risk averse B) risk neutral C) risk seeking Question #15 of 60 Leah's description of the coin toss is best described by which of the following cognitive errors? A) Anchoring and adjustment bias B) Confirmation bias C) Gambler's fallacy Question #16 of 60 Which bias best describes Micah's actions with regard to his holdings of Ruby shares? A) Anchoring and adjustment bias B) Confirmation bias C) Conservatism bias Question #17 of 60 Which bias is Stacey most likely exhibiting? A) Endowment bias B) Regret aversion bias C) Status quo bias Question #18 of 60 Which of the following models least likely assumes that investors satisfice rather than maximize utility? A) Behavioral asset pricing B) Behavioral portfolio theory C) Adaptive markets hypothesis Question #19 of 60 Questions 19-24 relate to Private Wealth Management and Asset Allocation Michael Berkovsky, CFA, is a senior portfolio manager who has a wide range of institutional investment clients, including pension plans, foundations, property and casualty insurance, and life insurance He also maintains a few high net worth individual clients One of those clients, Kathleen Penny, age 50, is a successful corporate lawyer Her son, Adam, age 15, will be going to college in a few years Kathleen established a separate college fund for him when he was born She selected a specific asset allocation at the time to minimize the volatility of the fund The cost of tuition has been rising steadily for many years and is expected to be about $25,000 per year for four years when Adam is ready to attend Kathleen wants to be certain that his tuition costs will be fully covered by the college fund because the remainder of her funds have been set aside for retirement and philanthropic reasons Kathleen is subject to marginal tax rates of 40%, 35%, and 25% on interest, dividends, and capital gains, respectively Her income tax rate is expected to decrease in the coming years as she gradually decreases her working hours to part-time in preparation for retirement Her total investment portfolio consists of taxable, tax-deferred and tax-exempt accounts Kathleen is interested in adding five-year coupon bonds to her investment portfolio, subject to the maximum allowable amounts applicable to the accounts Berkovsky's assistant is looking at circumstances in which asset allocations change when there are changes to investment objectives, constraints, or both She makes the following two statements: Statement 1: A large cash inheritance that leads a client to accelerate retirement plans will result in a change in constraints Statement 2: Moving through the business cycle will usually trigger a change in goals for both institutional and individual portfolios One of Berkovsky's clients is a large foundation that awards annual scholarships to music students in need From time to time, he applies tactical asset allocation strategies to the foundation's portfolio after examining data such as bond yields and credit spreads, GDP growth, and sentiment indicators for the past year Another of Berkovsky's clients is an insurance company that uses the same asset allocation strategy in its employee pension plan assets as it does for its insurance assets The pension assets are invested 85% in investment grade bonds with a duration of 10.3 and 15% in domestic and global equities The duration of the pension liabilities is about 17 years The pension plan is currently overfunded and the insurance company is capable of keeping it that way However, as part of a corporate cost-cutting strategy, the company has two objectives, (1) to reduce future cash contributions to the pension plan and (2) maintain minimal risk to the funded status In response, Berkovsky has formulated three proposals to attempt to meet the insurance company's objectives: Proposal 1: Maintain the status quo on the asset allocation and the portfolio's duration Proposal 2: Maintain the status quo on the asset allocation but increase the portfolio's duration Proposal 3: Increase the equity allocation and increase the portfolio's duration Which group of Michael's clients would most likely have the lowest liquidity needs? A) Banks B) Life insurance C) Property and casualty insurance (P&C) Question #20 of 60 Which of the following asset allocations would Penny most likely have chosen for the college fund for her son? A) 100% equity B) 100% bonds and cash C) 60% equity and 40% bonds Question #21 of 60 In which investment account would it be most appropriate for Penny to add the coupon bonds? A) Taxable B) Tax-exempt C) Tax-deferred Question #22 of 60 How many of the statements made by Berkovsky's assistant are most likely correct? A) None B) One C) Two Question #23 of 60 Which of the following tactical asset allocation approaches or strategies is Michael most likely using for the foundation's portfolio? A) Discretionary B) Momentum C) Value Question #24 of 60 Which of the following asset allocation proposals for the insurance company's pension plan is most appropriate for Berkovsky to consider? A) Proposal B) Proposal C) Proposal Question #25 of 60 Questions 25-30 relate to Asset Allocation - Currency Management James Sanderson is an analyst with Barnard Capital Management (BCM), a U.K.-based investment management company All results are reported in GBP Many of the funds offered by BCM include substantial foreign currency-denominated positions and Sanderson is involved both in hedging decisions and in active currency position decisions The BCM Global Alpha Fund takes aggressive currency bets based on a variety of active management approaches Different strategies are used at different times, depending on perceived opportunities Sanderson is currently interested in opportunities for the Mexican peso He checks and finds six-month GBP and MXN interest rates are 0.29% and 6.71% The spot exchange rate is 23.6554 (MXN per GBP) He sees a potential advantage in undertaking a carry trade He has talked through his thoughts on the carry trade opportunity with Annette Fischer, a colleague at BCM, who has made two comments: Comment 1: "I'm projecting low volatility for the MXN/GBP rate over the next six months, and thus, the carry trade would be an appropriate strategy to undertake." Comment 2: "My projection is that the Mexican peso will depreciate by no more than 3% over the next six months, so your carry trade looks profitable (before trading costs)." Sanderson is also considering a speculative position in the MXN only He checks his technical indicators and sees the 10-day moving average of the exchange rate has just crossed and is now above the 200-day moving average of 23.5512 MXN per GBP BCM's European Industrials Fund hedges its currency exposures The fund has just acquired Swiss franc-denominated stock in a manufacturing company, costing CHF1.5 million, and Sanderson plans to use a static forward contract-based hedge for the first six months that the stock is held, after which the position and the appropriateness of the hedge will be reviewed The GBP per CHF is 0.8095, while the six-month forward rate is 0.8143 The BCM Nordic Equity Fund invests in a number of Scandinavian markets Among the fund's holdings is a NOK11 million exposure to the OBX index (based on the 25 most liquid stocks on the Oslo stock exchange) Sanderson is concerned that a naïve currency hedge will ignore the potential implicit hedge between the market and the currency He believes a minimum-variance hedge will deliver better performance Sanderson examines five years of historic data for the NOK and the stock index (the OBX) He concludes they are negatively correlated Stephanie Swann, a client of BCM, is lunching with Andrew Baker, the portfolio manager who runs her account In the course of their conversation, Swann asks for some advice regarding currency exposures faced by Swann Pacific, her U.K.-based import/export business Swann mentions to Baker that she has heard that there is such a thing as a nondeliverable forward contract (NDF) She does not understand this and cannot see how these can be useful if there is no exchange of currency at maturity Baker confesses that he is not up-to-speed on NDFs, but calls in Sanderson, who spends five minutes explaining to Swann the basics of NDFs through an example While Sanderson is in the room, Swann also asks about the use of forward contracts to hedge a yen-denominated liability that she expects will be outstanding for about two months Ideally, she would like Swann Pacific to be fully protected against adverse movements of the currency and retain the benefit from favorable movements Swann states that a forward contract would inflexibly remove both the costs and benefits deriving from the position, but that an option-based strategy could give Swann the two objectives she seeks What is the best description of Fischer's comments on the carry trade between the peso and sterling? A) Both comments are accurate B) Comment is accurate, but comment is inaccurate C) Comment is inaccurate, but comment is accurate Question #26 of 60 Based on the MXN/GBP moving average data, Sanderson would most likely: A) close out his carry trade B) take long positions in the MXN C) take short positions in the MXN Question #27 of 60 For the static currency hedge of the Swiss stock, if the value of the stock two months after the hedge was established is CHF1.58 million, and the spot rate is 0.8114; then Sanderson should: A) nothing B) buy CHF80,000 four months forward C) sell CHF80,000 four months forward Question #28 of 60 If Sanderson hedges the Nordic Equity Fund's NOK11 million exposure to the OBX using a minimum-variance hedge ratio, the most likely short position in GBP/NOK futures is: A) more than NOK11 million B) NOK11 million C) less than NOK11 million Question #29 of 60 Which of the following statements regarding NDFs is most accurate? A) The credit risk of an NDF is typically lower than for a standard forward contract B) The price of NDFs should be the same as for a standard forward contract C) Selling the foreign currency forward using an NDF when the foreign currency depreciates will most likely result in a positive margin cash flow Question #30 of 60 Regarding Swann Pacific's yen liability, the most appropriate strategy for Sanderson to suggest using options on the currency would be buy: A) 50-delta puts on the GBP B) 50-delta calls on the GBP C) 50-delta puts and sell 30-delta puts on the GBP Question #31 of 60 Questions 31-36 relate to Alternative Investments for Portfolio Management William Bliss, CFA, runs a hedge fund that uses both managed futures strategies and positions in physical commodities He is reviewing his operations and strategies to increase the return of the fund Bliss has just hired Joseph Cantori, CFA, to help him manage the fund because he realizes that he needs to increase his trading activity in futures and to engage in futures strategies other than passively managed positions Cantori is a registered commodity trading advisor (CTA) who generally uses a contrarian strategy to manage futures Bliss also hired Cantori because of Cantori's experience with swaps, which Bliss hopes to add to his choice of investment tools Bliss explains to Cantori that his clients pay 2% on assets under management and a 20% incentive fee The incentive fee is based on profits after having subtracted the risk-free rate, which is the fund's basic hurdle rate, and there is a high water mark provision Bliss is hoping that Cantori can help his business because his firm did not earn an incentive fee this past year This was the case despite the fact that, after two years of losses, the value of the fund increased 14% during the previous year That increase occurred without any new capital contributed from clients Bliss is optimistic about the near future because the term structure of futures prices is particularly favorable for earning higher returns from long futures positions Cantori says he has seen research that indicates inflation may increase in the next few years He states this should increase the opportunity to earn a higher return in commodities and suggests taking a large, margined position in a broad commodity index This would offer an enhanced return that would attract investors holding only stocks and bonds Bliss mentions that not all commodity prices are positively correlated with inflation, so it may be better to choose particular types of commodities in which to invest Furthermore, Bliss adds that commodities traditionally have not outperformed stocks and bonds either on a risk-adjusted or absolute basis Cantori says he will research companies who business in commodities because buying the stock of those companies to gain commodity exposure is an efficient and effective method for gaining indirect exposure to commodities Bliss and Cantori next discuss some of the issues that may affect client decisions to invest in Bliss's fund Cantori states that if they begin marketing to sophisticated institutional portfolios, they can expect increased due diligence questions They may be questioned on the portfolio's risk management procedures   Bliss states they must tighten up their risk budgeting process and impose tighter limits on the amount of futures trades they with each dealer while implementing payment netting across all futures positions Cantori states that this will be even more important in commodity swaps where the fund receives a commodity return and pays LIBOR because maximum potential credit risk exposure typically continues up to swap expiration Bliss points out that sophisticated investors in the hedge fund will be more focused on risk adjusted performance ratios such as Sharpe, Sortino, and Treynor Given the information, the most likely reason that Bliss's firm did not earn an incentive fee in the past year was because: A) of a high water mark provision B) the return did not exceed the risk-free rate C) the 2% asset-under-management fee is greater than the risk-free rate Question #32 of 60 Assuming Cantori continues to follow a contrarian futures trading strategy, his strategy can best be described as a: A) market trading strategy B) discretionary trading strategy C) systematic trading strategy Question #33 of 60 Bliss is optimistic about the near future because the term structure of futures prices is particularly favorable for earning higher returns from long positions This would be the case if the term structure is: A) in contango B) relatively flat C) in backwardation Question #34 of 60 The points made by Cantori and Bliss during their discussion of commodity returns given high inflation expectations were correct with the exception of: A) Cantori's assertions concerning the indirect method of investing in stocks to gain commodity exposure B) Bliss's assertion that not all commodities are positively correlated with inflation C) Cantori's assertion that a broad index would benefit from inflation Question #35 of 60 Regarding the statements made by Bliss and Cantori on risk budgeting: A) both are correct B) only Cantori is correct C) both are wrong Question #36 of 60 Regarding Bliss's comments on return ratios, the ratio least appropriate to the hedge fund is likely to be the: A) Sharpe B) Sortino C) Treynor Question #37 of 60 Questions 37-42 relate to Fixed Income Portfolio Management Yuvraj Avraham is a senior portfolio manager with Kalyani Capital Partners (KCP) a multimanager investment firm based out of Mumbai, India KCP specializes in efficient multimanager combinations Avraham asks Vinod Piramal, an equity analyst with KCP, to review a multimanager portfolio for a large institutional client GXP Holdings Piramal compiles the following data shown below in Exhibit Exhibit 1: GXP Holdings Multimanager Portfolio Data (in USD) Allocation Portfolio active returns* Manager Manager Manager W X Y 25% 45% 30% 2.25% 1.75% 0.75% Management fees and expenses (%) 2.85% 0.60% 3.45% Weighted average market cap (billions) $50.75 $53.62 $54.91 P/E 11.60 16.25 19.83 EPS long-term projected growth 7.20% 10.50% 13.90% Dividend yield 3.05% 1.58% 0.98% Portfolio active risk * 3.85% 2.45% 2.35% * Active return and risk are assumed to be uncorrelated Avraham asks Piramal to analyze the performance and styles of the managers using the data in Exhibit They also suggest removing Manager Y from the GXP Holdings Portfolio and placing those funds in a passive index fund with Manager Z Later, they plan to meet with Mohinder Suresh, a new high net worth private client of KCP Suresh is looking for dynamic investment solutions and has identified three strategies to present to the client: Strategy 1: Equity Market Neutral Strategy 2: 130/30 Short Extension Strategy 3: Strategy + Long Equity Futures Overlay At the client presentation, Suresh asks about using alpha and beta separation strategies and requests additional performance data on KCP's small-cap equity performance Data for that composite (SSCO) is shown in Exhibit Exhibit 2: KCP Performance Data-Strategic Small Cap Opportunities (SSCO) Composite Risk & Return Data (previous 12 months) Annual % Investor's benchmark return 12.2% Manager's normal portfolio return 13.7% KCP SSCO portfolio return 12.8% KCP SSCO total active risk 5.75% KCP SSCO misfit active risk 4.15% After looking at the data for the SSCO composite, Suresh asks how he can identify the true value added by KCP during the 12-month period Using the GXP Holdings Data in Exhibit 1, which of the following managers is most likely to be following a value style? A) Manager W B) Manager X C) Manager Y Question #38 of 60 Using the GXP Holdings Data in Exhibit 1, Manager Y could most likely be classified as: A) contrarian B) high yield C) momentum Question #39 of 60 Assuming Avraham and Piramal make the proposed change and replace Manager Y with Manager Z in the GXP Holdings Portfolio, estimate the new portfolio information ratio A) 0.63 B) 0.92 C) 0.96 Question #40 of 60 Which of the three strategies presented to Suresh is most clearly a form of alpha and beta separation? A) Strategy B) Strategy C) Strategy Question #41 of 60 If Suresh states that he requires full exposure to the benchmark and a portfolio beta near 1, which of the three strategies will least likely meet this constraint? A) Strategy B) Strategy C) Strategy Question #42 of 60 The true information ratio of the SSCO composite is: A) -0.23 B) -0.33 C) -0.43 Question #43 of 60 Questions 43-48 relate to Fixed Income Portfolio Management Rebecca Bradley is a fixed-income specialist at Boyds Bank with particular experience in devising liability funding strategies It is October 2018, and she is meeting with Jeremy Wilson of Qual-Mart plc Qual-Mart is a major supermarket chain, and due to an extensive expansion of their stores across the United Kingdom, Qual-Mart has a large amount of debt outstanding Wilson is concerned this is depressing the stock price The company's liabilities are in various forms and maturity For ease of discussion, Bradley has set up groups of liabilities so they can discuss potential strategies to deal with the debt Group is GBP12 million market value of liabilities that will be due for payment between and 10 years from now Some key features of these liabilities are detailed in Exhibit 1: Exhibit 1: Qual-Mart Liabilities Cash flow yield: 2.92% Basis point value (BPV): 7,496 Duration: 6.34 Convexity: 47.75 Bradley has identified four possible AAA-rated portfolios that might be used to immunize these liabilities Details of the immunizing portfolios are given in Exhibit The first block of data for each portfolio discloses the bonds in that portfolio For example, portfolio P is made up of bonds due in five years with a coupon of 2.6% and bonds due in eight years with a coupon of 3.6% Exhibit 2: Potential Immunizing Portfolios Portfolio: P Q R S Bonds (term, coupon) years, 2.6% years, 2.4% 3.5 years, 2.3% years, 2.1% years, 3.6% 6.5 years, 3% years, 3.5% 13.5 years, 5% 10 years, 4.1% 11 years, 4.6% Cash flow yield 3.20% 3.26% 3.59% 3.02% BPV 7,476 7,215 7,474 7,471 Duration 6.33 6.11 6.34 6.32 Convexity 46.03 47.60 47.89 68.34 Group of Qual-Mart's liabilities has already been immunized Due to a recent reshaping of the yield curve, the BPV of the immunizing portfolio has decreased from 31,678 to 29,324, while the liability BPV fell to 31,207 Bradley suggests that bond futures contracts could be used to close this duration gap She determines that the CTD bond for the long gilt future (a futures contract on U.K government bonds) has a BPV of 90.57 per contract (100,000 par), with a conversion factor of 1.1346 Qual-Mart's treasury department has reported to Wilson that the company's cash holdings are so sufficiently large that some debt liabilities could be retired Wilson has identified a group of liabilities where this would be possible, but he believes it will be more cost effective to defease these liabilities by purchasing U.K government bonds Both the liabilities and the bonds purchased could be removed from the reported balance sheet The company's accountants have determined that this will require a cash flow matching strategy to cover the principal and interest payments on the liabilities Exhibit details the payments due on these group liabilities: Exhibit 3: Debt Payments to be Defeased March 2019 2,470,000 September 2019 1,780,000 March 2020 3,150,000 September 2020 2,675,000 March 2021 2,980,000 Exhibit lists the U.K gilts that are being considered for purchase The gilts pay interest semiannually in September and March It can be assumed that the payment dates for the gilts fall on or before the payments due on the debt to be defeased and that this is acceptable to qualify for balance sheet defeasement Exhibit 4: Gilts Available for Purchase Annual Coupon Maturity 1.98% March 2019 2.05% September 2019 2.25% March 2020 2.48% September 2020 2.70% March 2021 Finally, Wilson seeks advice regarding a GBP22 million of fixed-to-floating rate note issued by Qual-Mart one year ago The notes were issued with a 10-year maturity, paying a quarterly coupon of 4.1% for the first three years, then LIBOR plus 1.1% over the remaining period to maturity Of the immunizing portfolios in Exhibit 2, which has the greatest structural risk relative to the liabilities in Exhibit 1? A) Portfolio P B) Portfolio R C) Portfolio S Question #44 of 60 Which of the portfolios in Exhibit would be most appropriate to immunize the liabilities in Exhibit 1? A) Portfolio P B) Portfolio Q C) Portfolio R Question #45 of 60 Assume that the Exhibit liabilities were immunized by an investment in portfolio S and that 6.32 is the modified duration If the portfolio is fully funded with GBP12 million to match the present value of the liabilities, what is the effect on the surplus (asset PV - liability PV) of an immediate 1.5 percentage point decrease in all yields? A) There will be no change in the surplus B) The surplus will turn positive C) The surplus will turn negative Question #46 of 60 How many long gilt futures contracts must be purchased to eliminate the duration gap in the immunized group liabilities? A) 18 B) 21 C) 24 Question #47 of 60 If a cash matching portfolio is built using the gilts in Exhibit to defease the debt payments in Exhibit 3, which of the following is closest to the par value that will be purchased of the September 2020 gilt? A) 2.675 million B) 2.642 million C) 2.603 million Question #48 of 60 Bradley should classify the Qual-Mart fixed-to-floating rate notes as: A) type I liabilities B) type II liabilities C) type III liabilities Question #49 of 60 Questions 49-54 relate to Execution of Portfolio Decisions: Monitoring and Rebalancing Somerset Investment Limited is a Singapore-based money management firm that is conducting an appraisal of its investment performance Cameron Li, CFA, has been charged with conducting the appraisal and is to report back to upper management with his findings Li is convinced that trade executions play a substantial role in overall portfolio performance, particularly for funds that have a relatively high level of turnover during the year As a result, he is seeking methods that will allow him to evaluate the quality of trade executions He knows that the firm's traders use both market and limit orders, and he is wondering if a framework can be developed to ensure that the best order type is used under the specific circumstances for each trade When he consults with the firm's head trader, Rick Gleeson, Gleeson tells him that market orders have price uncertainty but no execution uncertainty, while limit orders eliminate price uncertainty but have execution uncertainty According to Gleeson, rebalancing and liquidity-motivated trades should use limit orders while valuemotivated and information-motivated trades should use market orders Li knows that bid-ask spreads are a major component of trading costs and asks Gleeson for some recent trade data that he can use for analysis and presentation to management He receives the following data relating to a series of buy trades for Sumatra Natural Resources (SNR), with all currency values in Singapore dollars: Trades of Sumatra Natural Resources Execution Shares Time Bid Price Ask Price Price Bought 10:30 $22.18 $22.36 $22.33 900 11:15 $22.23 $22.43 $22.43 600 13:45 $22.29 $22.48 $22.47 700 15:00 $22.37 $22.63 $22.65 800 Gleeson also tells Li that the portfolio manager had originally made the decision to purchase 5,000 SNR at 10:00 a.m when the price was $22.36 The closing price for the day was Gleeson's last trade at $22.65, at which point the order for the remaining 2,000 shares was cancelled Which of the following correctly summarizes Gleeson's comments concerning the differences between market and limit orders? A) He is correct concerning the nature of uncertainty; he is correct concerning when the order types should be used B) He is correct concerning the nature of uncertainty; he is incorrect concerning when the order types should be used C) He is incorrect concerning the nature of uncertainty; he is correct concerning when the order types should be used Question #50 of 60 Concerning the Sumatra Natural Resources price and execution data, the average effective spread and weighted average effective spread are closest to: Average effective spread A) B) C) 0.1957 0.0971 0.1975 Weighted average effective spread 0.1975 0.0908 0.1957 Question #51 of 60 Assume that the four trades in Sumatra Natural Resources are the only trades in the security for the day Determine which of the following statements concerning the volume weighted average price (VWAP) is most correct A) The VWAP for the day is 22.470, and the trader's goal would be to have an average cost that is less than the VWAP B) The VWAP for the day is 22.468, and the trader's goal would be to have an average cost that is greater than the VWAP C) The VWAP for the day is 22.468, and the trader's goal would be to have an average cost that is less than the VWAP Question #52 of 60 Calculate the implementation shortfall assuming total commissions paid by Gleeson when he purchased the 3,000 SNR were $210 A) 0.303% B) 0.996% C) 2.027% Question #53 of 60 Which of the following statements concerning implementation shortfall and VWAP is incorrect? A) Implementation shortfall is greater than zero if any portion of the original order goes unfilled and is cancelled B) For small trades in non-trending markets, VWAP is more appropriate than implementation shortfall C) Implementation shortfall can be adjusted to accurately account for movements in the general market Question #54 of 60 Determine which of the following statements concerning an algorithmic trading strategy is most incorrect An algorithmic trading strategy: A) ensures that the portfolio does not become over-concentrated (in specific assets or sectors) because it is based on quantitative rules B) involves the use of automated processes based on quantitative measures, such as the ratio of the trade size to average daily volume, to guide trading decisions C) known as simple logical participation, breaks trades into small pieces to avoid detection and to minimize market impact costs Question #55 of 60 Questions 55-60 relate to Risk Management Application of Derivatives Suzanne Sheffield is the head of risk management at Elm Court Advisors (Elm) Elm is an investment management firm headquartered in Burlington, Vermont She is meeting with George Harris, a portfolio manager at Elm In preparation for the meeting, Sheffield prints out the information in Exhibit for options on BIM stock BIM is a major financial software consultancy The stock is trading at USD154.10 and the tables show a range of option expirations and strike prices for both calls and puts The put data includes each option's price and its delta Harris has two large clients Sheffield wants to discuss Both are retired senior executives of BIM He has consulted with Elm's compliance group and determines neither client is considered an insider Also, both insiders are free to trade in the stock or its options without legal restriction Client has a favorable view of BIM and holds a large block of the stock with a large unrealized capital gain Harris is considering two strategies for client In both strategies he is ignoring the long position in the stock which the client wants to retain and looking only at the performance of the options Strategy A: This is a speculative single option position to generate additional profits if the stock appreciates before the year's end (December) He will buy an at-the-money 154 December option Strategy B: Harris wants to take a position that will generate premium income if the stock price is stable for the next 14 days but without substantial downside risk in the option position Client has sold his shares of BIM and has a very negative opinion on the stock Strategy C: Harris will use a bear spread constructed with September 150 and 158 calls Exhibit 1: Options Data for BIM Inc (all values in USD1) Calls (premium) Expiration: June September December (14 days) (105 days) (196 days) Strike price: 150 6.15 12.95 17.26 152 4.88 11.87 16.21 154 3.79 10.85 15.21 156 2.87 9.89 14.26 158 2.12 9.00 13.35 Puts (premium, and associated deltas) June September December (14 days) (105 days) (196 days) Strike price: 150 1.80, -0.324 7.01, -0.435 9.73, -0.453 152 2.53, -0.408 7.90, -0.467 10.64, -0.477 154 3.43, -0.496 8.85, -0.500 11.60, -0.501 156 4.51, -0.583 9.87, -0.532 12.60, -0.524 158 5.76, -0.665 10.95, -0.563 13.65, -0.547 The current price of BIM stock is $154.10 Expiration: Harris has another client (client 3) where he has been using option strategies for a couple of years The client recently observed that it appears more of the strategies have involved long rather than short positions Harris responds that is often true and that it is just human nature that we all like positive skew and buying options can have a large payoff with limited down side risk The client asked how that can work "Doesn't there have to be an option seller?" Harris admitted he was stumped by this and now asks Sheffield to explain it Sheffield states that dealers will take the other side of the trade and typically accumulate net short positions in the options Then, they use delta hedging to offset the risk For example, a dealer might accumulate a short position in September puts on 10,000 shares of BIM at a strike price of 152 The dealer can hedge this with shares of BIM It then it gets complicated because the hedge must be rebalanced and there are second order issues that can affect the performance of the hedge Sheffield promises to follow up with Harris and provide more details later Right now, Harris wants help with a more immediate problem Client is a large retail enterprise with extensive money market investments and is considering making a loan to one of its suppliers It will be a 180-day loan at LIBOR plus 3.6% All principal and interest will be repaid at the end of the 180 days The problem is that the loan won't be made for another 60 days, and the client wants to hedge the risk that LIBOR can decline before the loan is made Sheffield says it can be done with a put on LIBOR at a strike rate of 4.5%, the current level of LIBOR The client will still benefit if LIBOR goes up but will have a floor on the effective annual rate (EAR) it will earn on the loan After the meeting, Harris realizes he forgot to ask the obvious question, "What is that EAR"? The breakeven stock price for the option in strategy A is closest to: A) 15.21 B) 154.00 C) 169.21 Question #56 of 60 The most appropriate option position to achieve Strategy B is: A) a September straddle using only the 154 strike price B) a June butterfly using strike prices of 150, 154, and 158 C) a December reverse butterfly using strike prices of 152, 154, and 156 Question #57 of 60 The max gain for the bear spread using call options in strategy C is closest to: A) 3.95 B) 4.05 C) 12.95 Question #58 of 60 The initial shares of BIM required to hedge the 10,000 short September puts with a strike price of 152 is closest to: A) short 4,080 share B) long 4,670 shares C) short 4,670 shares Question #59 of 60 Rebalancing the hedge on the 10,000 short September puts with a strike price of 152 is most likely to produce an immediate net profit if the: A) BIM stock price increases and expected volatility decreases B) BIM stock price increases and expected volatility increases C) BIM stock price decreases and expected volatility increases Question #60 of 60 Ignoring any differences in day count or compounding conventions for various types of interest rates, the minimum EAR for client 4's future loan transaction is: A) 8.1% B) less than 8.1% C) more than 8.1%  ... Time Bid Price Ask Price Price Bought 10 :30 $22 .18 $22 .36 $22 .33 900 11:15 $22 . 23 $22 . 43 $22 . 43 600 13: 45 $22 .29 $22 .48 $22 .47 700 15:00 $22 .37 $22 . 63 $22 .65 800 Gleeson also tells Li that the... years, 2. 6% years, 2. 4% 3. 5 years, 2 .3% years, 2. 1% years, 3. 6% 6.5 years, 3% years, 3. 5% 13. 5 years, 5% 10 years, 4.1% 11 years, 4.6% Cash flow yield 3. 20 % 3. 26 % 3. 59% 3. 02% BPV 7,476 7 ,21 5 7,474... Annual Coupon Maturity 1.98% March 20 19 2. 05% September 20 19 2. 25% March 20 20 2. 48% September 20 20 2. 70% March 20 21 Finally, Wilson seeks advice regarding a GBP 22 million of fixed-to-floating rate