CFA Level III Mock Exam – Questions (AM) FinQuiz.com CFA Level III Mock Exam June, 2018 Revision Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) FinQuiz.com – 2nd Mock Exam 2018 (AM Session) Questions Topic Minutes Portfolio Management – Individual Investors 32 Portfolio Management – Behavioral Finance 18 30 Portfolio Management – Institutional Investors Portfolio Management – Individual Investors/Asset Allocation Portfolio Management – Equity Investments Portfolio Management – Fixed-Income Investments 19 Portfolio Management – Risk Management 17 Portfolio Management – Monitoring and Rebalancing Portfolio Management – Performance Evaluation and Attribution 13 Total: FinQuiz.com © 2018 - All rights reserved 24 21 180 CFA Level III Mock Exam – Questions (AM) QUESTION HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 32 MINUTES Michael and Andy Seinfeld are married and live in Minneapolis, Minnesota Michael, 45 years old, is a physician working in the North Memorial Hospital in Minneapolis The Seinfelds have two children; Ryan, a college student in the State University of New York, and Rebecca, a marketing specialist working for a multinational firm, with headquarters in Boston The Seinfelds are in excellent health and have sufficient medical insurance Michael earns a current salary of $150,000 annually which is taxed as income at 25% Andy earns $75,000, and her income is taxed at a rate of 20% Both Michael and Andy expect their salaries to grow at the inflation rate of 3.5% In addition, the Seinfelds are obligated to pay Ryan’s tuition fee, which equals $50,000 per year Ryan expects to specialize in economic studies in a university in Boston, a year from now The admission fee will equal $25,000, which would be paid at the beginning of the next year, and the annual tuition fee will equal that he pays currently—this fee will remain constant till he graduates in about seven years’ time Rebecca is independent and her salary sufficiently covers her living expenses The Seinfelds fully own and live in a well furnished home in Minneapolis with a current price of $1,800,000 The family also owns a small side business of home furnishing that they plan to sell by next year Michael has received an offer of $5,000,000 for his business, and if he decides to sell, the entire amount will be taxed at a capital gains tax rate of 17% Exhibit displays information about the Seinfelds personal assets as of today Exhibit Stock holdings $950,000 Fixed-Income holdings $850,000 Cash and cash Equivalents $550,000 Real Estate $1,800,000 Michael just hired Jay Peck, a financial advisor and portfolio manager, to manage their personal portfolio During a conversation with Michael, Peck discovered that the average living expenses of the family equal $155,000 a year that will increase at 3.5% annually, the U.S inflation rate Peck also found out that both Michael and Andy (who is currently 43 years old) want to retire in about ten years time after which they want to fulfill their lifelong dream of travelling around the globe They believe that by that time, Ryan would also be independent and earning FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) To make sure that their portfolio allows for the achievement of their goals, Michael often reads financial journals to gain information on what trading strategies would reap the most profit Most of his investments were based on research of several analyst recommendations and market information Andy believes that investing should be done after careful analysis to minimize the probability of the loss of principal Her past experience has shown her that rushing into investments can cause unexpected losses Peck is in the process of developing an appropriate investment policy statement for the Seinfelds A Assuming that the market value of the current portfolio remains unchanged and Michael sells the family business, calculate the after-tax nominal rate of return that is required by the Seinfelds for year Show your calculations (12 minutes) B Prepare the following portions of Seinfelds’ Investment Policy Statement, after the sale of the furnishing business: i ii Risk tolerance Time horizon Answer Question 1-B in the template provided on page (8 minutes) C Characterize Michael and Andy Seinfeld as cautious, individualistic, methodical, or spontaneous investors Justify your selection with two reasons each Answer Question 1-C in the template provided on page (4 minutes) FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Five years have passed and Michael and Andy Seinfeld have incomes that just cover their current expenses Their joint after-tax salary equals $350,000 and both their incomes and expenses grow at the inflation rate of 5.0% The Seinfelds current investment portfolio includes stocks, corporate bonds and short-term instruments and has a current market value of $3,500,000 Ryan and Rebecca are each financially independent and earn competitive salaries in their respective fields Both Michael and Andy plan to retire in five years time, after which they want their portfolio to provide sufficient income to cover their expenses Neither of the two has participated in a pension plan Peck has continued to be their financial advisor and the Seinfelds have explained to him that a real after-tax return of 4.5% would be adequate to meet their objectives, while instructing him to take on only those risks with their portfolio that are absolutely necessary to meet their return requirement They also mentioned that they would like to maintain their current standard of living during retirement and have no further goals or objectives The Seinfelds are now taxed at a rate of 30% The U.S inflation rate will continue to be 5.0% even after their retirement D i Prepare the current return objectives portion of the Seinfeld’s IPS ii Assuming the market value of the current portfolio remains unchanged, calculate the after-tax nominal rate of return that will be required by the portfolio during the first year of retirement Show your calculations (8 minutes) FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Template for Question 1-B Prepare the following portions of Seinfelds’ IPS i Risk tolerance ii Time horizon FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Template for Question 1-C Circle the type that best describes them Explain your choice with two justifications each Cautious Methodical Andy Individualistic Spontaneous Cautious Methodical Michael Individualistic Spontaneous FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) QUESTION HAS THREE PARTS (A, B, C) FOR A TOTAL OF 18 MINUTES Secure Capital Investments (SCI) is a financial advisory firm headed by Lucy Appleby, the firm’s chief portfolio manager and head of the advisory department Appleby has been introducing a number of new concepts and techniques toward an improved management of clients’ capital One such change has been the application of behavioral finance in the development of clients’ investment policy statements, and in implementing portfolio investment strategies During a conversation with a member of the portfolio management team, Appleby mentioned the following client behaviors reflecting deviations from perfect rationality: Client A: “I regularly follow the recommendations of the most successful analysts in the field to ensure that the right decisions are made Popular investments are likely to return positive returns since everyone must be investing in them for a reason.” Client B: “These last few years, my portfolio experienced a number of ups and downs Most of my gains resulted from my accurate prediction for the telecommunications sector However, last year my portfolio’s value dropped by 15%, primarily due to the unanticipated turn of economic events in Canada and Europe.” A Identify the biases inherent in each of the above statements Give one reason each for their existence Answer Question 2-A in the template provided on page 11 (4 minutes) FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Appleby is currently managing the investment portfolio for Chris Moss, a civil engineer working as a consultant for a number of construction companies in the U.S He is 50 years old, is not married, and has no children Moss earns a salary of $175,000 annually and has living expenses well within his annual income (net of tax) However, Moss spends a considerable amount on travelling and entertainment, and so, frequently spends more than his net income Due to a comprehensive retirement savings and investment plan at his firm, Moss has managed to accumulate a portfolio worth $2,500,000, invested mostly in international and domestic equities Over the past few years the equity allocation of his portfolio had an 18% annual return, primarily due to some successful bets made by him on oil stocks Appleby noticed that Moss’s equity allocation is concentrated in the stocks of a few oil companies In addition, Moss frequently traded in and out of investments based on his predictions since he believes they have helped him earn high returns in the past Appleby also observed an investment in the stock of Lions Enterprises (LEN) that had been performing poorly for the past two years When he recommended liquidating the investment, Moss stated that he would hold it for another year until the stock price reaches his purchase price When Appleby asked him about his retirement goals, Moss mentioned that he would not like to compromise his current spending for future consumption He believed in ‘living in the present’ B i Identify three biases that Moss is most likely subject to Justify your response for each bias (6 minutes) ii Determine whether to adapt to, moderate, or adapt to and moderate Moss’s biases Justify your response (4 minutes) FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Roger Wong is a financial advisor at SCI Wong has been assigned the responsibility to work with Jasmine Arcus, a 35-year old successful entrepreneur who owns a fashion boutique in Chicago, USA Arcus has an investment portfolio worth $5,000,000 that is invested 55% is stocks, and 45% in bonds She manages to make an annual profit from her boutique that comfortably covers her living expenses and also contributes to her savings Arcus is convinced about the future prospects of the U.S automobile sector and has invested 25% of her equity allocation in automobile stocks When Wong suggested diversifying part of the holding due to a deterioration of the industry’s fundamentals, Arcus disagreed, and stated that his predictive model validated the industry’s positive outlook Arcus also mentioned that most of the companies within the auto industry had high P/E multiples which confirmed that her investment in the industry is of good value When Wong asked her how she gathered the information about the P/E multiples, Arcus mentioned that she read in most of the best selling financial journals about how high P/E multiples for companies within the industry prove that their stocks have growth potential and can yield high returns for investors C Determine whether to adapt to, moderate, or adapt to and moderate Arcus’s biases Justify your response (4 minutes) FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Template for Question 5-A Circle the indexed portfolio that would be most suitable to meet McGrath’s objectives Determine for each indexed portfolio not selected, one reason why it is not appropriate Euro-equity Index Mutual Fund with more than 20 shareholders Questa Investor Right ETF indexed to a broad based local equity market index Indexed Equity Shares managed as pooled accounts Euro-equity Index Futures FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Template for Question 5-B(i) Determine the investment style followed by Wells in the management of her portfolio Justify your response with four reasons FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) QUESTION HAS THREE PARTS (A, B AND C) FOR A TOTAL OF 19 MINUTES Graham Kelly works for Multiple Investment Management (MIM), a capital management firm that serves as a comprehensive financial solution provider Kelly is in charge of managing the MIMF Short Duration Fixed Income Fund that invests only in investment grade fixed-income securities with effective durations of or less The fund’s mandate gives Kelly the flexibility to alter the fund’s duration as long as it stays within ±0.50 of the benchmark duration of Exhibit displays the fund’s current composition Exhibit 1: MIMF Short Duration Fixed Income Fund Beginning % Total Maturity Coupon Price Effective Market Duration Value year 1.70 100 0.976 2% year 1.99 100 1.930 10% year 2.45 100 2.700 20% year 2.78 100 2.861 70% Kelly strongly believes that the yield curve will experience an upward parallel shift of 50 bps within the next year Given the confidence in his forecast, he plans to alter the fund’s composition to reap maximum benefits from the change in yields Consequently, Kelly requests MIM’s research department to work with him towards estimating expected returns for each maturity A Given the forecast yields, estimate the total expected return for each maturity given in Exhibit Based on your calculations, justify an appropriate strategy to maximize returns over the next year Give two reasons to support your answer (6 minutes) When working with the research department of MIM, Kelly met with Ian Jackson, a yield curve specialist that has been working with the firm for over ten years As the discussion on the future discourse of interest rates progressed, Jackson mentioned that his department had developed several scenarios detailing the changes in yields in the imminent future He presented the following views: Scenario 1: “Short-term rates are expected to fall as monetary policy aims to help the economy reach the target growth rate However, long-term rates are expected to remain stable.” FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Scenario 2: “Even though the economy lags the long-term target, a rise in inflation will encourage monetary policy setters to raise short-term interest rates; with the rise being greater than the rise in long-term rates.” Scenario 3: “Future volatility of interest rates is likely to be much less than that reflected in current prices Neither short-term nor long-term rates are expected to change much owing to a stable economic environment.” B State a suitable strategy for each of the interest rate scenarios presented by Jackson Support your answer by explaining why each strategy is appropriate Use the template on page 28 to answer the question (6 minutes) Jackson has been exploring numerous investment opportunities in international markets and has been particularly interested in German bonds He has constructed a portfolio that tracks the German Government Bond Index, with a part of the portfolio being fully invested in 15-year German bonds The rest of the portfolio is constructed so as to match the duration of the benchmark index Jackson expects German interest rates to be considerably volatile next year due to uncertainties surrounding the amount of private and public investment in the country He anticipates interest rates to move by at least 2% in either direction Exhibit presents information that Jackson’s research team has accumulated about German notes and bonds Security Exhibit 2: German Sovereign Securities Effective Effective YTM Duration Convexity Coupon Rate 6-month bill 2.07% 0.555 0.004 5.00% 5-year note 4.10% 4.709 0.301 7.50% 15-year bond 5.49% 11.965 1.740 7.00% 30-year bond 5.73% 14.950 2.890 4.50% C Suggest one way Jackson could alter the part of the portfolio that is fully invested in 15-year German bonds to take advantage of the move in interest rates Construct the new portfolio and show its convexity and yield State one risk factor of the suggested alteration (7 minutes) FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) B Most Suitable Strategy Scenario Scenario Scenario FinQuiz.com © 2018 - All rights reserved Justification CFA Level III Mock Exam – Questions (AM) QUESTION HAS THREE PARTS (A, B, C) FOR A TOTAL OF 17 MINUTES Total Asset Management is an investment firm in the U.S that invests funds for high networth private wealth clients TAM specializes in excess return and risk management strategies involving traditional asset classes as well as alternative investments and derivatives Recently, the firm launched the “Global Equity Fund’, an investment vehicle that invests in foreign markets Marc Fishman is part of the portfolio management team for the fund, and is responsible for managing investments made in the euro-zone The high growth in the region, development in the services sector, and the removal of barriers to foreign capital inflow has caused Fishman to believe that the euro market would be an attractive inclusion to the Global Equity Fund Based on his research, Marc has determined that a $39,550,000 investment in an equity portfolio of European stocks with a beta of 1.27 would be appropriate The fund will make this investment for a year, starting from 31 January 2009, till 31 January 2010 TAM, however, does not yet specialize in currency risk management In addition, Fishman is uncertain about the future movements in the pound-dollar exchange rate For these reasons, Fishman wants to fully hedge the currency risk associated with the investment and not base his hedge on estimates or uncertain expectations For this purpose, Marc approached a currency risk dealer, who gave him the following quotes: • • A stock index futures contract on a euro-denominated index trades at €259,394 and has a beta of 1.10 A currency forward contract based on the $/€ exchange rate has a price of $1.1742/€ In addition, Fishman determined that the euro-zone risk free rate is 4.67% and the dollar risk free rate is 2.95% Both these rates are annually compounded rates Also, the current spot exchange rate is $1.1938 A Determine and explain the hedging strategy that Fishman should implement to achieve his objective Show your calculations (5 minutes) FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) A year has passed, and the Global Equity Fund has performed well TAM’s upper management has decided to continue the fund and expand its scope to include stocks from other regions as well Jeff Glave, an international portfolio manager, has been assigned the task of investing part of the fund’s assets in British stocks Glave allocates £2.5 million to British stocks and assigns Matha Walters, an independent currency specialist, to devise a solution for hedging currency exposure Walters establishes a twomonth short forward position equal to the amount of the investment Two months later the market value of the GBP denominated assets increases to £2.8 million and Walters expects the GBP to depreciate Walters informs Glave that she intends to rebalance and rollover the forward position using a foreign currency (FX) swap The USD/GBP spot rate and the three-month forward points (scaled by 10,000) at the time of the rollover is 1.6621/1.6639 and -14/-12 respectively B Determine: i the type of FX swap used to rebalance the hedged position and ii whether the size of the hedged position should be increased, decreased, or remain constant (2 minutes) iii Determine the rates at which the spot and forward legs of the FX swap are transacted Show your calculations (2 minutes) (4 minutes) Melissa Bretherton is part of the research management team at Total Asset Management, and is analyzing the performance of her equity portfolio under different possible scenarios As part of her research, Bretherton executes the following analysis: • • • Bretherton has developed a multifactor model to explain the returns on her portfolio The model includes factors that she believes explain the majority of returns to her portfolio After every six months, she determines the combined effect of the risk factors on her portfolio assuming they move in the most unfavorable way Based on her probability models and expectations, Bretherton determines the worst possible return outcome for her portfolio, one that she expects has some probability of occurring She then compares this return to her threshold return requirement Every year, Bretherton creates scenarios based on certain investment fears she has, and then analyzes how her portfolio would react to such events She knows that such scenarios have an extremely small or maybe even a zero probability of occurring, but she still feels it is necessary to remove any uncertainties FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Bretherton has worked with Fishman on several assignments, for the past many years Recently, Fishman took the task of managing an institutional fund worth $10 million owned by Orange Enterprises (OE) OE has instructed Fishman to use the funds provided to manage the risk of their foreign transactions, and the risk of their bond portfolio Marc has decided to use forward contracts to meet OE’s objectives related to risk management C i Identify the risk management approaches used by Bretherton in the management of her portfolio Justify your response for each approach Answer Question 7-C (i) in the template provided on page 32 Note: Consider each approach independently (6 minutes) ii Determine why Fishman might have preferred the use of forwards over futures and options for meeting Orange Enterprises’s risk management objectives Answer Question 7-C (ii) in the template provided on page 33 (2 minutes) FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Template for Question 7-C(i) Identify the risk management approaches used by Bretherton in the management of her portfolio Justify your response for each approach Note: Consider each approach independently Bretherton has developed a multifactor model to explain the returns on her portfolio The model includes factors that she believes explain the majority of returns to her portfolio After every six months, she determines the combined effect of the risk factors on her portfolio assuming they move in the most unfavorable way Based on her probability models and expectations, Bretherton determines the worst possible return outcome for her portfolio, one that she expects has some probability of occurring She then compares this return to her threshold return requirement Every year, Bretherton creates scenarios based on certain investment fears she has, and then analyzes how her portfolio would react to such events She knows that such scenarios have an extremely small or maybe even a zero probability of occurring, but she still feels it is necessary to remove any uncertainties FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Template for Question 7-C(ii) Determine why Fishman might have preferred the use of forwards over futures and options for meeting Orange Enterprises’s risk management objectives Futures Contracts Option Contracts FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) QUESTION HAS TWO PARTS (A, B) FOR A TOTAL OF 13 MINUTES Anthony Reyna is responsible for the implementation of portfolio management decisions made by the research and management department at his investment firm Recently, Reyna was instructed to buy 1,500 shares of W-Tech Corporation, a company specializing in high-tech security equipment In the process of selecting the best broker, Reyna searched the market and decided to select the Chicago Brokers for the execution of the order Reyna ordered Chicago Brokers to buy 1,500 shares of W-Tech stock on Monday, with a benchmark price of $56 On the same day, Chicago Brokers managed to purchase 750 shares at a price of $56.703/share To trade these shares, Reyna had to pay commissions of $55 No more shares were purchased that day, and the stock closed at a price of $55.302/share On Tuesday, 300 more shares were purchased at $57.923/share, and the commissions on the trade were $25 The closing price for the stock that day was $56.201 The remaining shares could not be purchased, and Reyna cancelled the order on Wednesday, the day when W-Tech stock closed at $57.034 Reyna’s employer just launched an investment product that invests in emerging and developing markets, including Brazil, Russia and India Reyna knows that although these markets offer attractive return and diversification opportunities, they also have inherent risks One of the risks is the absence of an established and well-organized market structure, one that encourages secondary trades To examine the quality of Brazil’s capital market, Reyna gathered the following information A The Crossover Clearing House has recently been established to serve as an intermediary to capital market transactions The entity is subject to financial and ethical standards imposed by the Brazilian government B The market offers attractive opportunities to investors who can identify mispricings before others, especially in the small-cap sector Those who act early can earn significant gains Reyna is working with Sam Walter, a portfolio manager, towards setting the appropriate corridor width for asset classes within the Brazilian market The asset classes include Brazilian corporate bonds, Brazilian equities, and Brazilian government bonds Walter has determined the following about the asset c lasses: • • The volatility of Brazilian government bonds and equities has increased over the past few years The correlation of Brazilian equities with Brazilian corporate bonds is higher than their correlation with Brazilian government bonds FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) A Calculate the components of the implementation shortfall for the trade of W-Tech Stock Show your calculations separately for each component (5 minutes) B i Determine whether the Brazilian market information suggests an increase or a decrease in the quality of the Brazilian market Identify the market quality factor that each affect Justify your response with one reason each Note: Consider each point independently Answer Question 8-B (i) in the template provided on page 37 (4 minutes) ii Evaluate the effect of the information Walter gathered, on the optimal corridor width of Brazilian corporate bonds Justify your response with one reason each Note: Use an all-else equal assumption in each case Answer Question 8-B (ii) in the template provided on page 38 (4 minutes) FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Template for Question 8-B(i) Determine whether the Brazilian market information suggests an increase or a decrease in the quality of the Brazilian market The Crossover Clearing House has recently been established to serve as an intermediary to capital market transactions The entity is subject to financial and ethical standards imposed by the Brazilian government The market offers attractive opportunities to investors who can identify mispricings before others, especially in the small-cap sector Those who act early can earn significant gains FinQuiz.com © 2018 - All rights reserved Identify the market quality factor that each affect Justify your response with one reason each CFA Level III Mock Exam – Questions (AM) Template for Question 8-B(ii) Evaluate the effect of the information Walter gathered, on the optimal corridor width of Brazilian corporate bonds Justify your response with one reason each Note: Use an all-else equal assumption in each case The volatility of Brazilian government bonds and equities has increased over the past few years The correlation of Brazilian equities with Brazilian corporate bonds is higher than their correlation with Brazilian government bonds FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) QUESTION HAS ONE PART FOR A TOTAL OF MINUTES Hugh Ross is a fixed income analyst at White Stripes Investment Management, a firm that offers bond portfolio management services Ross has managed more than twenty portfolios over the course of his career, some for institutional investors, and others for private wealth clients Recently, Larry Kemp, the chief investment officer at White Stripes, instructed Ross to analyze the performance of a bond portfolio managed by one of his subordinates, Anne Couk While evaluating the portfolio’s performance, Ross calculated the impact of the following on the portfolio’s total return: • • • The sector/quality effect The security selection effect The trading effect A Determine for each of the effects mentioned how Ross might have calculated their impact on the portfolio’s total return Note: No calculations are necessary (6 minutes) FinQuiz.com © 2018 - All rights reserved ... of: i ii The Towers Foundation, and Shining Star Endowment (6 minutes) FinQuiz. com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) C i ii iii iv Identify two factors that... each Cautious Methodical Andy Individualistic Spontaneous Cautious Methodical Michael Individualistic Spontaneous FinQuiz. com © 2018 - All rights reserved CFA Level III Mock Exam – Questions... template provided on page (4 minutes) FinQuiz. com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (AM) Five years have passed and Michael and Andy Seinfeld have incomes that just