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CFA Level III Mock Exam – Questions (PM) 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 (PM) FinQuiz.com – 3rd Mock Exam 2018 (PM Session) Questions Topic Minutes 1-12 Ethical and Professional Standards 36 13-18 Alternative Investments 18 19-30 Risk Management 36 31-36 Risk Management Application of Derivatives 18 37-42 Portfolio Execution 18 43-48 Equity Investments 18 49-54 Global Investment Performance Standards 18 55-60 Fixed Income 18 Total 180 FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions through relate to Ethical and Professional Standards GemStar Associates Case Scenario GemStar Associates, a U.S based firm, provides investment advisory services to domestic and international private wealth and institutional clients It houses two portfolio management teams, A and B, comprising of three managers each Team A manages traditional investment vehicles while Team B manages alternative investments This year, one of the firm’s objectives is to gain full compliance with the Global Investment Performance Standards (GIPS) Susan Marcus, CFA, is a member of Team A who is exploring small-cap high growth equities in the emerging market country of Lipa To aid her selection process, she is using a statistical model, which uses factor-based models and regression analysis In her monthly communication with clients she describes the model Description: To aid the selection of equity securities in Lipa, a statistical model is being used which employs complex methodologies Details on the model are available on request Damien Rupert is another portfolio manager and member of Team A He is following Mono Corporation, a manufacturer of skin care products, the owner of which is a close friend of Rupert’s During a casual lunch, Monroe’s friend shares his long-term business plans He intends to launch a line of organic skin care products; the launch will depend on Mono’s success following the IPO Following their meeting, Rupert purchases Mono stock for a majority of his clients’ portfolios To avoid any conflict of interest, he does not invest in the stock for his personal portfolio Rupert devotes some of his time to charities as a volunteer At some charities, he participates in the policy making progress while at others he serves as a junior volunteer He has not disclosed these involvements to GemStar Terry Peters is GemStar’s senior portfolio manager and member of Team B Due to his successful performance record and significant expertise with alternative investments, he has been invited by Abascus Associates, a newly incorporated investment advisory firm, to offer wealth management guidance to its portfolio managers His meeting with the firm’s CEO is scheduled at an offsite company lodge Upon arriving at the lodge, the CEO invites Peters to a famous skiing spot, which he accepts Although he had notified his employer about the visit to the lodge, he reports the remaining trip details upon his return FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) In order to bring GemStar into compliance with the GIPS standards, senior compliance officer Jerry Walsh plans to undertake verification for its equity composites, which have recently been brought into compliance, from Tray Inc, a firm providing verification services Walsh intends to take the following actions to further comply with the standards: Action 1: Present each account’s performance net of trading expenses The amount of trading expenses will be disclosed upon request Action 2: Include terminated accounts within the relevant composite’s historical performance record for a three year period with details of termination dates clearly disclosed By providing a description of the model she employs, has Marcus violated any CFA Institute Standards of Professional Conduct? A No B Yes, she has not described the model adequately C Yes, she has not used an adequate communication channel Has Rupert violated any standards by purchasing Mono’s stock for his clients’ portfolios? A No B Yes, he has acted on material nonpublic information C Yes, he has not determined the suitability of the investment Has Rupert violated Standard IV (A) Loyalty by failing to disclose his charity involvements to GemStar? A Yes, with respect to his role as policy maker B Yes, with respect to his role as policy maker and junior volunteer C No FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Has Peters violated any Professional Conduct Standards during his trip? A Yes, by visiting the offsite company lodge B Yes, by visiting the skiing spot C No Walsh’s decision to undertake verification is: A appropriate B inappropriate, verification must be firm wide C Inappropriate, with respect to the independence of the verifier Which of the following actions violate the CFA Institute Standards of Professional Conduct? A Action B Action C Both Actions and FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions through 12 relate to Ethical and Professional Standards Martinez Advisory Case Scenario Martinez Advisory is a U.S based multinational investment management firm founded by the Martinez brothers, Jose and Juan Its U.K division, Holton Advisory (HA), currently manages a £45 million investment fund and is being headed by Jeremy Walsh, CFA Portfolio investments include U.K Treasuries, corporates, gilts, municipals, hedge funds, private equity, and emerging and developed market equities A strong believer of maintaining good relationships with clients, Walsh instructs HA’s portfolio managers to report hedge fund performance on a semi-annual basis and the performance of the other asset classes on a quarterly basis To justify the difference in the reporting policies, HA’s performance report includes a disclosure to clients Disclosure: All our hedge fund investments are structured with lock-up periods; therefore their performance cannot be ascertained with 100% accuracy before the scheduled reporting date Therefore, it is HA’s utmost responsibility to ensure reported performance is fair, accurate and complete HA’s private wealth clients are of various financial backgrounds To ensure equitable dealings with clients, portfolio managers allocate trades based on needs assessment Trades are first allocated to those accounts which management believe require immediate allocation Any remaining portion of the trade is allocated to the accounts of those clients expressing an interest HA’s risk management head, Harold White, has retired after serving a 30 year period Upon his retirement he recommends Jack Lee, senior risk manager, for his position After lengthy discussions and decision making by the board, Lee is appointed as the risk management head Upon his appointment, Lee formulates a plan to automate HA’s centralized risk management system The system will have the added function of generating automated performance reviews of the firm’s portfolio managers To ensure performance being reported to clients complies with HA’s policies, the most experienced portfolio managers undertake a review of individual client account information Due to the complexity of institutional accounts, a joint audit is undertaken by HA’s internal audit department head and a renowned external audit firm Valuing private equity holdings has been a challenge for HA’s portfolio managers To aid its portfolio managers, Walsh has introduced a self-developed valuation model whereby FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) fund investments are valued using statistical methodologies With the exception of hedge funds investments and emerging market equities, which are valued using a ad hoc error approach, all other asset classes are valued using the most recent asset prices Are HA’s performance reporting policies consistent with both the required and recommended standards of the CFA Institute Asset Manager Code of Professional Conduct? A Yes B No, the procedures regarding hedge funds are not C No, the procedures regarding all asset classes are not Is HA’s trade allocation policy consistent with both the required and recommended standards of the Asset Manager Code? A Yes B No, trades should be allocated based on suitability C No, trades should not be allocated to the accounts of clients expressing an interest In order to adhere to the requirements and recommendations of the Asset Manager Code with respect to the changes at the risk management department, HA’s best course of action is to: A nothing B disclose to clients details regarding the risk management head replacement only C disclose to clients details regarding the risk management head replacement and the automation of the risk management system 10 Are HA’s performance review policies consistent with requirements and recommendations of the Asset Manager Code? A No B Only with respect to private wealth client accounts C Only with respect to institutional client accounts FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) 11 Which of the following asset classes are valued using a methodology, which is inconsistent with the Asset Manager Code? A Private equity B All other asset classes C Hedge funds investments and emerging market equities 12 Which of the following statements is most likely correct with respect to the CFA Institute Code of Ethics? Members and candidates: A are encouraged to adhere to the Code B are required to respect client confidentiality C are required to respect their fellow investment professionals FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions 13 through 18 relate to Alternative Investments Caroline King Case Scenario Caroline King is the chief investment officer for the Ray Foundation (RF), a small-sized recently established foundation RF’s portfolio is invested 60% in equity and 40% in bonds King has selected Jeremy Brown, a consultant, for recommending the addition of alternative investments to RF’s portfolio To hire Brown, King had conducted a lengthy search process which was based on several key criteria According to King, “Such criteria ensure that we select the best advisor” During his first meeting with King, Brown proposes that RF allocate its portfolio to indirect real estate, particularly REITs He justifies his proposal with the following statement: Statement 1: “Given RF’s limited funds and small size, investing in REITs is more appropriate compared to a direct real estate investment.” King responds by stating that she has heard that the evaluation of REIT investments is complicated by the low volatility bias often associated with the NAREIT index Brown assures King that he intends to use a benchmark corrected for this bias After their meeting concludes, Brown decides to explore commodity investments He is particularly interested in the diversification potential the asset class can bring to RF’s portfolio He has read in an article that this potential arises from the low correlation between commodities and stock and bond returns For RF’s portfolio, Brown would like to invest in commodity futures He has chosen futures over an indirect investment in the commodity producing companies with the intention of providing maximum exposure to the underlying commodities He collects data on three 3-month oil futures contracts with different expiration dates (Exhibit 1) Brown notices that many oil producers participating in the futures market hold real production options FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Exhibit Oil Futures Contract Prices ($) Contract Maturity Futures Price as of May 2011 Futures Price as of April 2011 Change in spot price June 2011 45.10 44.71 0.80 September 2011 46.55 45.88 0.80 December 2011 46.99 46.02 0.80 Finally, King requests Brown to consider hedge funds for RF’s portfolio King identifies three conditions which need to be satisfied before making a final selection: Condition 1: Enhance risk-adjusted portfolio returns Condition 2: Minimize the momentum effect in returns Condition 3: Sensitivity of the index to the direction of the underlying stock and bond markets should be minimal Brown collects data on three hedge fund indices (Exhibit 2) The funds underlying each index are collectively managed using a distinct strategy The Treasury bill rate is 4.0% Exhibit Data Concerning Three Hedge Fund Indices Index Annual Return (%) Annual Standard Deviation (%) Correlation with the S&P 500 Correlation with the Lehman Gov./Corp Value/ Equal Weighted Equity Hedge 9.5 7.8 0.65 0.10 Equal Equity market neutral 11.2 10.7 0.04 0.24 Equal Long-only 14.4 12.1 0.26 0.30 Value FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Solutions (PM) 31 If the stock price rises to $55, the profit on the covered call strategy with the highest initial inflow is closest to: A $945,000 B $985,000 C $1,000,000 32 Is Sparks correct with respect to the statements made to the investment officer? A Yes B Only with respect to Statement C Only with respect to Statement 33 The breakeven asset price of Mackintosh’s proposed strategy is closest to: A $133 B $137 C $153 34 In light of HC’s expectations, Sparks is correct with respect to his proposal concerning: A the butterfly strategy only B the box spread strategy only C neither of the two strategies 35 Should Sparks implement a box spread strategy for HC, he will most likely conclude that the box spread is: A overpriced B fairly priced C underpriced 36 With regard to the two statements to be included in his article, Sparks is most likely incorrect with respect to: A both statements B Statement only C Statement only FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) Questions 43 through 48 relate to Portfolio Execution David Miller Case Scenario David Miller, CFA, works as an analyst with U.S based ZM Asset Management Firm Miller is currently exploring how portfolio execution costs can be minimized when fulfilling trade orders Miller is considering various price benchmarks with the intention of selecting the most appropriate benchmark Various price benchmarks are available such as quotation midpoint, volume weighted average price (VWAP), opening price, closing price and implementation shortfall Miller selects VWAP because he considers it a more satisfactory benchmark compared to quotation mid-point William Banner is another analyst at ZM He agrees with Miller with respect to the use of VWAP However, he makes the following statements regarding the limitations of VWAP Statement 1: “VWAP is not free from limitations because it can be ‘gamed’.” Statement 2: “To deal with the gaming problem associated with VWAP, a more reliable measure of VWAP can be obtained by measuring VWAP over multiple days instead of a single day.” Banner is evaluating market quality He gathers necessary information and observes that quoted and effective spreads are high and investors not have easy access to accurate and reliable information about quotes and trades In addition, parties to trades not stand behind their quotes Based on this information, he concludes that the market has low quality Based on this conclusion, Banner decides to use implementation shortfall as a price benchmark due to its various advantages over other price benchmarks Banner mentions two advantages of implementation shortfall Advantage 1: Implementation shortfall incorporates both explicit and implicit costs and is not vulnerable to gaming Advantage 2: Implementation shortfall can be used for all types of assets due to its inherent quality of capturing all elements of transaction costs FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) Miller is analyzing a transaction involving Saving Life Drugs Company (SDC) (Exhibit 1) Exhibit Saving Life Drugs Company Transaction (SDC) Benchmark Price: On Monday, April 2nd, SDC closed at $23.05 a share Tuesday Morning: Before market opens, a portfolio manager at ZM decides to buy 1,100 shares of SDC using a limit order at $22.95 Tuesday Close of Trading: • Price of SDC does not fall below $23.00 and no part of the order is filled on Tuesday, it expires • It closes at $23.10 Wednesday: • Limit order is revised to a new limit of $23.11 • The order is partially filled on Wednesday, buying 750 shares incurring commission costs of $15 • The stock closes at $23.15 and order for the remaining 350 shares is cancelled After analyzing various trades, Miller concludes that the implementation shortfall is always positive for buy orders Banner is analyzing a trade of Angels Clothing Company (ACC) He has computed an implementation shortfall of 23% The expected return on ACC’s stock is 25% Miller is also managing a separate fund for a client His client is very concerned about minimizing trading costs Therefore, Miller decides to discuss the issue with head of the trading desk, Abraham Ryan Ryan makes the following two comments: Comment 1: Both explicit and implicit costs are part of total trading costs and explicit costs constitute a major part of total trading cost Comment 2: Trading aggressively often leads to the most expensive trade due to higher market impact Therefore, trading costs can be reduced by avoiding aggressive trades FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) 37 With respect to the use of VWAP as a price benchmark and the two statements made by Banner, which of the following is most likely correct? A Banner is correct in agreeing with Miller; Banner is incorrect with respect to both Statements and B Banner is correct in agreeing with Miller; Banner is correct with respect to both Statements and C Banner is correct in agreeing with Miller; Banner is correct with respect to Statement only 38 With regard to Banner’s conclusion regarding market quality and use of implementation shortfall as a price benchmark, which of the following is most likely correct? A Banner is correct with respect to market quality and correct with respect to the use of implementation shortfall B Banner is incorrect with respect to market quality and incorrect with respect to the use of implementation shortfall C Banner is correct with respect to market quality but incorrect with respect to the use of implementation shortfall 39 With regard to the two advantages of implementation shortfall: A Advantage is correct; Advantage is incorrect B Advantage is correct; Advantage is correct C Advantage is incorrect; Advantage is correct 40 Using the data provided in Exhibit 1, the implementation shortfall and delay costs are, respectively, closest to: implementation shortfall: A 0.373% B 0.375% C 0.316% delay costs: 0.446% 0.148% 0.069% FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) 41 With respect to Miller's conclusion regarding implementation shortfall and Banner's analysis of the adjusted implementation shortfall (IS) measure for ACC, respectively, which of the following is most likely correct? A B C Miller is: Incorrect Correct Correct The adjusted IS is: – 2% + 2% – 2% 42 With regard to the comments made by Ryan on trading costs, which of the following is most likely correct? A Comment is correct; Comment is incorrect B Comment is correct; Comment is correct C Comment is incorrect; Comment is incorrect FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) Questions 49 through 54 relate to Equity Investments Amanda Gary and Harrod Dickson Case Scenario Amanda Gary, CFA and Harrod Dickson, CFA are senior analysts at Wealth Management Associates (WM) WM provides portfolio management services and investment advice to wealthy individuals and institutional clients Gary and Dickson discuss the fundamental law of active management and its application in evaluating managers’ performances During their discussion, Gary makes two statements Statement 1: “In the fundamental law of active management, investor’s breadth represents the number of independent active decisions made each year This implies that the greater the size of the investor’s research universe, the greater the breadth and consequently the greater the information ratio.” Statement 2: “A manager’s style of investing can be identified using two approaches with one based on analyzing the characteristics of overall individual security holdings while the other based on analyzing the characteristics of the overall portfolio.” Dickson has gathered some data on three portfolio managers at WM Macklin holds a long position in S&P 500 Futures contracts and a cash position He focuses on generating alpha by altering the duration of his cash position Correlation between Macklin’s forecasted returns and actual returns is 0.04 Carter holds a long-short portfolio which involves 500 stocks in the S&P 500 index and uses a stock-based semi-active strategy to generate active returns Correlation between Carter’s forecasted returns and actual returns is 0.07 Bernard holds a long-only portfolio consisting of 500 stocks of the S&P 500 index and focuses on generating active returns through over- or under weighting individual stocks based on his expectations for those stocks Correlation between Bernard’s forecasted returns and actual returns is 0.04 Walter Tobler, Dickson’s subordinate, is concerned about the effects of a long-only constraint on investing activities In response to those concerns, Dickson states: Statement 3: “A long-only constraint only limits an investor’s ability to take advantage of negative information This indicates that in case of a long-only constraint, the investor has an asymmetric opportunity set.” FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) On hearing that, Tobler asks Dickson about the types of risks long-only investors are exposed to James Chan, WM’s client, indicates that he might invest a total of USD 100 million While having a discussion with Robert Andrew, CFA, a portfolio manager at WM, Chan says: Statement 4: “Although I am highly risk averse, I am interested in taking a systematic risk exposure along with the opportunity to earn skill-based active returns.” In response to Chan, Andrew says the strategy that best serves Chan’s interest is an equitized market neutral long-short strategy Andrew is also analyzing different funds to pursue a core-satellite approach for Chan Relevant data on these funds is given in Exhibit Exhibit Potential Funds for the a Core-Satellite Approach Expected α Expected Tracking Risk Total Investment Fund A 0% Fund B 5% Fund C 0% Fund D 3% Fund E 2% 0% 9% 0% 6% 5% $50 million $10 million $15 million $40 million $45 million Andrew is also working with another client, Rainbow Foundation (RF) RF seeks to achieve two specific objectives Objective 1: To earn skill-based active returns along with beta exposure but without altering the strategic asset allocation of our portfolio Objective 2: To capture value added from active management along with matching overall portfolio’s risk to its benchmark FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) 43 Is Gary correct with regard to Statement and with regard to Statement 2: which style analysis would result in greater need for buffering? A Yes; holdings-based analysis B No; composition-based analysis C No; return-based analysis 44 With regard to the data provided on the three portfolio managers, which of the following statements is most likely incorrect? A Macklin will have a higher information ratio than Bernard B Carter will have a higher information ratio than Bernard C Macklin will have a lower information ratio than Carter 45 With regard to Statement and Dickson’s response to Tobler, respectively, which of the following is most likely correct? A Statement is correct; long-only investors are exposed to both systematic and unsystematic risk B Statement is incorrect; long-only investors are exposed to both systematic and unsystematic risk C Statement is incorrect; long-only investors are exposed to systematic risk only 46 Is Andrew’s proposed strategy appropriate for Chan? A Yes B No; the most appropriate strategy is an alpha-beta separation strategy C No; the most appropriate strategy is a short extension strategy 47 Based on Exhibit and Statement 4, in order to pursue the core-satellite approach, which of the following funds would be most appropriate for Chan as a core investment? A Fund A B Fund C C Fund E FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) 48 In order to meet RF’s objectives, the most appropriate investment approach is: A short-extension strategy for objective 1; completeness fund for objective B equitized market neutral long-short strategy for objective 1; bias control fund for objective C short-extension strategy for objective 1; portfolio indexed to broad market for objective FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) Questions 55 through 60 relate to Global Investment Performance Standards Eleanor Moser Case Scenario Eleanor Moser, portfolio manager at Boise Securities, an asset management firm, has been hired by Adrian Gustov Gustov represents Maritime Corp’s pension plan’s investment portfolio and has approached Moser based on Boise’s advertised claim of compliance to the Global Investment Performance Standards (GIPS) During her first meeting with Gustov, Moser states, “Compliance with the GIPS standards is entirely voluntary Once a firm claims compliance, it must apply the standards with the goal of full disclosure and fair representation.” Gustov is particularly interested in Boise’s international equity composite and asks Moser to demonstrate how the composite’s performance complies with the standards Moser responds by stating, “All composite returns are calculated by multiplying individual portfolio returns by the beginning composite assets held in each portfolio and summing the results.” Next, Moser collects data concerning the international equity composite’s assets and related external cash flow activity (Exhibit 1) Exhibit International Equity Composite Assets and External Cash Flows Cash flow weighting factor Beginning assets (March 31) Portfolio ($ 000) A B C 91.5 124.8 140.0 External Cash flows April 0.933 –4.0 + 5.0 + 2.0 10 April 0.667 + 3.8 + 6.0 + 4.0 27 April 0.100 + 5.0 –1.2 + 3.6 96.9 135.0 150.8 Ending assets (April 30) *The composite has a beginning total assets and weighted cash flows of $400,000 FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) Boise’s international equity composite was constructed on January 1, 2006 Composite policies did not meet the requirements of the GIPS standards at that time Boise’s chief compliance officer, Ramon Martin, drafted three policies on December 31, 2006 These policies were intended to ensure that composites fairly and accurately reflected the performance of the underlying portfolios Policy 1: All foreign emerging and developed market equities are included in the composite To capture active returns, the former category is managed using a core-satellite approach while the latter is managed using a short-extension strategy Policy 2: If a portfolio’s total asset value falls by at least $2 million for two consecutive periods, it will be removed from the composite along with its performance record Portfolio B belongs to a risk-averse client who exhibits home bias with respect to his investments His entire portfolio is invested in foreign equities The client has requested Moser to dispose his foreign stock allocation and avoid further foreign trades 49 With respect to the statement made during her meeting with Gustov, Moser is most likely: A correct B incorrect, compliance with the GIPS standard is compulsory C incorrect, full disclosure cannot be made in performance situations where a standard does not exist 50 Is Boise’s composite return calculation policy in compliance with the requirements of the GIPS standards? A Yes B No, composite returns must be time-weighted C No, composite returns must be weighted according to beginning asset values and external cash flows FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) 51 Using the data in Exhibit 1, the proportion of portfolio B relative to the composite’s beginning assets and weighted cash flows is closest to: A 31.20% B 33.34% C 35.89% 52 With respect to Policy 1, has Boise complied with the GIPS standards by including developed and emerging equities in one composite? A Yes B No, they each represent distinct geographical segments C No, they are each managed using a distinct investment strategy 53 Is Policy consistent with the GIPS standards? A Yes B No, the historical performance record must not be removed C No, portfolios falling below the minimum threshold should be withdrawn at the end of the first period 54 In order to comply with the GIPS standards, Boise’s best course of action with respect to client B’s portfolio is to: A remove the portfolio from the composite B transfer the portfolio to a more suitable composite C retain the portfolio but provide adequate disclosure FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) Questions 55 through 60 relate to Fixed Income Defense Insurance Providers (DIP) Case Scenario Defense Insurance Providers (DIP) is a life and casualty insurance firm based in Wisconsin, USA The firm not only provides life insurance, but also protection against most risks to property including fire, weather damage, and theft DIP manages its risk at an enterprise level by diversifying its liabilities over a large client base, and by offering specialized insurance including flood insurance, earthquake insurance and fire insurance Nathan Bowen heads the risk management and finance department at the firm, which includes a team of risk managers, portfolio managers, research and finance analysts, and economists Bowen has instructed Alyson Moore, a fixed-income analyst, to manage a cash liability of $7.5 million due in five years Moore has constructed three bond portfolios to immunize this liability Exhibit displays the features and characteristics of each of these portfolios Exhibit 1: Bond Portfolios Portfolio A Portfolio B Portfolio C Macaulay Duration 4.98 4.99 5.03 PV $7.50 $7.60 $7.65 Convexity 55.69 64.21 69.20 Cash flow yield 3.55% 3.57% 3.60% In addition to this, Bowen also assigns Moore the task of immunizing a set of liabilities with a value of $20,029,650 and a cash flow yield of 4.520%, stated on a semiannual basis The duration and convexity of the debt portfolio are years and 56.90 respectively The dispersion equals 9.55 Moore presents Bowen with the following four portfolios as options for this purpose FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) Exhibit 2: Multiple Liability Immunization Bond Portfolios Portfolio A Portfolio B Portfolio C Portfolio D Cash Flow Yield 4.53% 3.79% 3.88% 4.99% PV $20.029648 $20.890129 $20.030333 $20.000120 Convexity 58.00 56.32 57.00 57.03 Dispersion 11.40 10.90 12.10 8.20 Macaulay Duration 7.01 6.98 6.80 7.00 When talking to Bowen about the attractiveness of each portfolio, Moore makes the following comments: Comment 1: “Since the present value of Portfolio B is greater than the present value of the liability portfolio, we will have considerable surplus to pursue contingent immunization.” Comment 2: “To immunize with Portfolio C, we would need to go long a certain number of futures contracts The greater these contracts are spread out across the yield curve, the lower the structural risk.” During the discussion, Bowen inquired about how model risk could affect the ultimate effectiveness of the immunization strategy Moore agreed that such a risk is always inherent in these situations especially if portfolio duration is measured using a weighted average of the individual durations of the bonds He added that using futures contracts would also add spread risk to the liability driven investment strategy Bowen decided to further this discussion the next day 55 Which of the bond portfolios given in Exhibit is most likely the correct immunizing portfolio for the single liability? A Portfolio A B Portfolio B C Portfolio C FinQuiz.com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) 56 Which of the bond portfolios given in Exhibit is most likely the correct immunizing portfolio for the set of liabilities? A Portfolio A B Portfolio B C Portfolio C 57 In Exhibit 2, structural risk will most likely be highest for: A Portfolio B B Portfolio C C Portfolio D 58 Moore is most accurate with respect to: A Comment only B Comment only C Both comments and 59 Moore’s concern about model risk will least likely be mitigated if: A the underlying yield curve is flat B future cash flows are concentrated in a particular segment of the yield curve C cash flow yield is used to discount the future coupon and principal payments 60 Spread risk in derivatives overlay liability driven investing most likely arises from: A a large duration gap between the asset portfolio and the liability portfolio B Not incorporating short-term rates and accrued interest in the determination of the futures BPV C The fact that yields on high-quality bonds are less volatile than on moreliquid government bonds FinQuiz.com © 2018- All rights reserved ... risks i Operations risk ii Model risk iii Settlement risk iv Regulation risk v Legal risk vi Taxes vii Accounting risk FinQuiz. com © 2018 - All rights reserved CFA Level III Mock Exam – Solutions... Performance Standards 18 55-60 Fixed Income 18 Total 180 FinQuiz. com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions through relate to Ethical and Professional Standards... incorrect FinQuiz. com © 2018- All rights reserved CFA Level III Mock Exam – Solutions (PM) Questions 49 through 54 relate to Equity Investments Amanda Gary and Harrod Dickson Case Scenario Amanda
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