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CFA 2018 level 3 schweser practice exam v2 exam 2 afternoon

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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

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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 do 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

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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

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

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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

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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 do 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?

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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? Standards of Professional Conduct?

Under the provision of the Asset Manager Code (AMC), in order to minimize the likelihood

of some of the recent problems, CNL must do 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

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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 anti-trust 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 do 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

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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) 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

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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

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

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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 1

B) Proposal 2

C) Proposal 3

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)."

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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 nạve 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 deliverable 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

non-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 1 is accurate, but comment 2 is inaccurate

C) Comment 1 is inaccurate, but comment 2 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

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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

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