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 – 4th Mock Exam 2018 (PM Session) Questions Topic Minutes 1-6 Ethical and Professional Standards 18 7-12 Ethical and Professional Standards 18 13-18 Economic Analysis 18 19-24 Economic Analysis 18 25-30 Risk Management Application of Derivatives 18 31-36 Risk Management Application of Derivatives 18 37-42 Equity Portfolio Management 18 43-48 Fixed-Income Portfolio Management 18 49-54 Alternative Investments 18 55-60 Alternative Investments 18 Total FinQuiz.com © 2018 - All rights reserved 180 CFA Level III Mock Exam – Questions (PM) Questions through relate to Ethical & Professional Standards A&J Case Scenario Matt Beckner is a chemical engineer who works for an oil exploration firm in Ohio, USA Beckner is 55 years old and has an investment portfolio worth $75,000 consisting of stocks, bonds and T-bills In the past, Beckner has been managing his portfolio himself However, he now believes that getting professional expertise and financial advice for his portfolio’s management would be prudent Consequently, he selects Alfred & Jack Associates (A&J) to be his capital management firm During his visit at the firm, Beckner meets Robin Flynn, an investment analyst at A&J As part an introductory presentation to Beckner, Flynn presents him with the performance of a number of A&J’s internally managed funds Beckner observes that many of these funds, especially the ones that relied on complex derivative strategies, lacked an associated benchmark presentation In addition, when presenting the value of the firm’s real estate investments, Flynn states that independent, third party valuations were used since fair values were not easily available He provides Beckner with a list of third party firms that were hired Beckner notices that in the past two years, A&J switched among ten firms for obtaining valuations for their real estate investments While presenting to Beckner, Flynn also displays a list of the funds that the firm offered its clients and prospects Beckner discovers that the firm offered a total of fifteen funds ranging from completely conservative, to very aggressive The presentation then makes the following comment: “A&J has achieved excellent returns for its investors The Aggressive Growth Fund, for example, has had returns that exceeded its peer group benchmark by more than 12% for the past fifteen years.” Beckner was satisfied with the performance history of A&J’s funds He now wanted to know about the procedures and methods used by the managers at the firm for stock picking In seeking such information, Beckner approaches Gina Melton, the chief portfolio manager at A&J Melton tells Beckner that A&J paid a firm that served as an intermediary in connecting analysts and investors with market experts Many of these experts have followed a single industry for over five to seven years, and are thus, privy to much of the industry’s internal workings Melton adds that A&J uses the insights of such experts in making investment choices He then makes the following comment: FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) “Whenever a portfolio manager is uncertain about the appropriate course of action with respect to a specific client, the manager makes the decision as if it were affecting him/her If in doubt, the manager discloses the matter to the client and obtains client approval.” Beckner then asks Melton about the trading procedures at A&J and the related policies in place Melton states that many a times they get unsolicited trade requests from clients that are unsuitable for them In such cases, the manager updates the client’s investment policy statements so that he or she can clearly understand the potential effect of the requested trade on his or her current goals After meeting with several other portfolio managers and employees at the firm, Beckner is satisfied with his decision to opt for A&J to manager his portfolio Before his departure, Melton provides Beckner with the ID of his facebook account that she maintained only for professional purposes She states that this makes it easier for her to separate her personal contacts from her professional ones In Flynn’s presentation, which of the following is most likely a red flag with regards to a violation of the CFA Institute Standards of Professional Conduct? A The lack of benchmarks B The third party valuations C Both the lack of benchmarks and the third party valuations In his comment about The Aggressive Growth Fund, has Flynn most likely violated the CFA Institute Standards of Professional Conduct? A Yes B No, since Flynn is allowed to state outperformance as long as it is correct C No, since Flynn has stated a fact and used a sufficiently long time horizon to justify its accuracy In using the services of the intermediary firm, A&J has most likely: A not violated any Standards B violated the Standards, since it is requesting or acting on confidential information C violated the Standard, since the compensation provided may result in a conflict of interest FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) With regards to Melton’s comment, are the managers at A&J most likely in compliance with the CFA Institute Standards of Professional Conduct? A Yes B No, since clients are not financial experts and decisions should not be based on their approval C No, since managers are required to seek approval from their compliance department first With regards to the handling of unsolicited trade requests, to be in compliance with the Standards, portfolio managers should adopt A&Js policy: A under no circumstances B only for clients agreeing with the policy C only for trades that have a material impact on the portfolio If Melton decides to leave A&J and join another firm, to be in compliance with the CFA Institute Standards of Professional Conduct, before leaving she should most likely: A delete her professional facebook account or transfer it B keep her facebook accounts since they are her property C keep her facebook accounts only if A&J approves of it FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions through 12 relate to Ethical & Professional Standards DIM Case Scenario Delta Investment Management (DIM) is a capital management firm in New York, USA DIM initiated its operations as a small firm comprising of only a few portfolio managers With hard work and disciplined efforts, DIM has managed to increase its investable asset base considerably To ensure that asset managers within the firm fulfill their ethical responsibilities with respect to the management of client assets, Brad Lowman, the CEO of DIM is considering compliance with the Asset Manager Code of Professional Conduct Lowman plans to work in alliance with a team of ethical experts headed by Thomas Hahn to research the procedures within DIM and determine the ones that need to be altered for assuring compliance At their first meeting, Lowman makes the following comment: “As part of holding clients’ interest paramount, at DIM, we have established policies that guide portfolio managers with regards to the acceptance of gifts from clients Our policy limits the acceptance of cash gifts by specifying the amount per time period per vendor Usually the items accepted are of minimal value.” He continued with the following comment: “Also, to preserve independence and objectivity, the managers at DIM are not allowed to maintain multiple business relationships with a client as it can result in significant conflicts of interests.” As their discussion continued, Lowman mentioned that DIM offered certain financial products that were made available only to certain qualifying clients Also, additional services were provided to only those clients who expressed an interest in getting them and paid additional fees In addition, managers at DIM engaged in ‘tag-along’ arrangements with certain clients for whom the opportunity was suitable Hahn was interested in knowing about the financial products offered by DIM One such product, The International Growth Investment Fund, particularly caught his attention The Fund earned a return of more than 18% last year, which was very impressive given the performance of similar funds On further research, Hahn discovered that the Manager of the fund would occasionally diverge slightly from the stated strategy to take advantage of changing financial circumstances This was disclosed to clients in the course of normal client reporting FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) When researching the policies regarding the allocation of initial public offerings, Hahn was surprised to learn that the firm allowed employees to participate in IPOs for their personal accounts In justifying this policy, Lowman stated that all employees who wished to invest in IPOs for their personal accounts needed to seek prior approval and were not allowed to forerun client trades In addition, employees were required to provide the compliance officer with copies of trade confirmations each quarter, along with a statement of personal holdings As Lowman talked about the various risks faced by Managers at DIM, Hahn inquired a little further about the risk management processes at DIM Lowman stated that all risk management activities were outsourced because a separate risk management firm was not cost-effective or feasible Hahn was confused how the managers at DIM ensured that risk management complemented the investment management processes at DIM instead of competing with it Before the meeting concluded, Hahn scrutinized the performances of DIM’s private wealth accounts Hahn noticed that when presenting the performance of their accounts, portfolio managers at DIM disclosed the actual management fees, incentive fees, and other costs charged to them However, since future trading expenses, including commissions and bid/ask spreads were uncertain, estimated or expected expenses were not disclosed to prospective clients The firm did, however, mention in all presentations to prospects, that fees and other costs would be assessed to investors With respect to the comments made by Lowman, are DIM’s policies regarding the acceptance of gifts and multiple business relationships most likely in compliance with the Asset Manager Code of Professional Conduct? A No B Yes C Only with respect to multiple business relationships FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) In offering additional services and products to only a few clients, and engaging in tag-along arrangements, has DIM violated the Asset Manager Code of Professional Conduct? A Yes B Only with respect to tag-along arrangements and not with respect to additional services and financial products C No, as long as the arrangements are disclosed and made available to all clients and opportunities are fairly allocated With regards to the International Growth Investment Fund, DIM has most likely: A violated the Asset Manager Code of Professional Conduct B not violated the Asset Manager Code of Professional Conduct C not violated the Asset Manager Code of Professional Conduct, only if the divergence occurs less than twice a year 10 Is Hahn’s concern about the participation by DIM’s employees in IPOs for their personal accounts most likely valid? A No, because the justifications provided Lowman assure compliance B No, as long as the statements of personal holdings are provided annually instead of quarterly C Yes, because to ensure best practice, firms should prohibit employees from participating in IPOs for their personal accounts 11 To be in compliance with the Asset Manager Code of Professional Conduct, can DIM outsource the risk management functions? A Yes B No, since risk needs to be analyzed and managed as part of a comprehensive risk management process for portfolios, investment strategies, and the firm C No, because risk management functions involve the use of confidential information about specific portfolios that can and should not be shared with outside consultants FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) 12 With regards to performance presentation, has DIM violated the Asset Manager Code of Professional Conduct? A Yes B No, because actual, and not estimated, expenses are to be disclosed C No, because the Code instructs such presentations to be made only to clients and not to prospects FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions 13 through 18 relate to Economic Analysis AGIA Case Scenario The Analytical Group of Investment Advisors (AGIA) is a small, U.S based financial advisory firm that offers research and investment services covering a wide range of domestic and international asset classes Ryan Porter is a finance manager at AGIA and is currently working with Douglas Bell, a research analyst, to set capital market expectations for the coming future Bell has researched and collected the data displayed in Exhibit Exhibit 1: Asset Class (U.S Real Estate) Standard deviation 18.50% Correlation with the GIM Portfolio 0.55 Lock-up period years MPSR @ ICAPM required return of 14% 0.20 MPSR @ expected return of 23% 0.32 In addition, Bell also provides Porter with the following correlation matrix: Exhibit 2: Correlation Matrix Correlation U.S Equities Real Estate U.S Equities 1.0 Real Estate - 1.0 GIM 0.75 0.55 FinQuiz.com © 2018 - All rights reserved GIM 1.0 CFA Level III Mock Exam – Questions (PM) McGill performs certain calculations to determine an appropriate response to Dunn’s query After he concludes his computations, Dunn talks about the opportunities that existed for managing risk using futures and forwards He knew that there were a number of differences between forwards and futures that made one or the other more appropriate in certain situations McGill makes Dunn note the following pointers: Forward contracts are the preferred vehicle for the risk management of foreign currency because of the deep liquidity in the forward market The Eurodollar futures contract is one of the most active of all futures contracts even though most corporations not use this market to hedge their floating-rate loans The risk of equity portfolios tends to be managed using futures rather than forwards Before his meeting with McGill concludes, Dunn tells him that he holds a position in the stock of Ticker Products Incorporated Dunn expects a fall in the price of his stock holding and wanted to hedge this risk McGill provides him with the options given in Exhibit Exhibit 1: Call Options Call Options Exercise Call Price Price Call A $125 $55.50 Call B $115 $57.80 Call C $105 $61.00 Dunn asks McGill to structure a strategy that would give him more room for gain on the upside The current stock price equals $100 31 The overall return on the $35 million fixed income portion of institutional fund after the yield change is closest to: A 0.70% B 1.50% C 1.75% FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) 32 For the synthetic index fund, the money that UBEM is synthetically depositing in risk-free bonds is closest to: A $100,000,000 B $100,011,495 C $100,104,398 33 Which of the following best describes the underlying concern of Dunn regarding the synthetic stock position? A The transaction will not capture the dividends that would be earned if one held the underlying stocks directly B The futures contract could expire later than the desired date C The futures contract may not be correctly priced 34 Assuming the conversion is for six months, the best response to Dunn’s question is that the number of stocks would be closest to: A 2,856 B 2,857 C 2,895 35 With respect to the differences between the use of forwards and futures for risk management purposes, McGill is most accurate with respect to: A Point only B Points and only C Points 1, and 36 If McGill structures an appropriate strategy involving Dunn’s holding of Ticker Products Inc stock, the maximum profit to his position will be closest to: A $66.00 B $72.80 C $80.50 FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions 37 through 42 relate to Equity Portfolio management Tom Holzinger Case Scenario Tom Holzinger, an equity portfolio manager and advisor, is responsible for overseeing the performance of the equity portion of three large pension funds managed by his investment firm In reviewing their annual performance, Holzinger gathers information about the expected alphas and tracking risk of the pension funds’ managers Exhibit displays this data Exhibit 1: Portfolio Managers’ Characteristics Pension Fund X Manager A Manager B Manager C Manager D Pension Fund Y Pension Fund Z Allocation Expected Alpha Allocation Expected Allocation Alpha Expected Alpha 22% 0% 0% 0% 35% 0% 10% 0.5% 54% 0.5% 0% 0.5% 30% 2% 26% 2% 40% 2.5% 38% 4% 20% 4% 25% 4.0% As he continued with his review Holzinger discovered that for the most recent year Pension Fund X reported the highest active return To confirm the accuracy of the reported figures, Holzinger collected the following additional facts: • • • Manager C is a growth oriented manager The MSCI World ex-US Index, the MSCI World ex-US growth index and Manager C earned a return of 15%, 19% and 17% respectively Manager C’s risk relative to the MSCI World ex-US Index is 6.5% The manager’s ‘misfit’ risk is 4% annually Holzinger was also concerned with the risk factors that the pension funds were exposed to To properly understand the risk exposures, Holzinger planned to perform an absolute and a relative analysis of the risk biases inherent in the portfolios He unfolded the details given in Exhibit FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Exhibit 2: Funds’ Risk Exposures (Historical) Pension Pension Fund Y Fund X Portfolio return Stock Selection Process Pension Fund Z 20% 24% 22% Bottom up Top down Bottom up Misfit risk 0% 0% 2% Overall style return 0% 3% 5% After a comprehensive performance appraisal, Holzinger concluded that a few of the pension fund managers needed to be replaced due to below average performance and inferior stock picking capabilities In his attempt to replace an equity manager for Pension Fund Z, Holzinger shortlisted three equity portfolio managers Exhibit displays data about the managers’ performance Exhibit 3: Manager Details Manager A Manager B Manager C Historical Alpha 2.5% 1.2% 3.5% Tracking Risk 3.5% 2.7% 6.5% IC 0.04 0.09 0.06 Number of stocks followed 290 250 300 In addition to the above information, Holzinger also found out the following: • • • Managers A and B attempt to pick up active return through equity insights Manager B evaluates every investment relative to the benchmark Manager A carries out absolute analysis Manager C generates active return from investments other than equity He also follows changes in the yield curve very closely Holzinger also found out that Manager A invested some of the funds in a tracking portfolio to gain exposure to a specific segment of the market In addition, he also FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) invested in a long-short portfolio to generate alpha Holzinger found this strategy very interesting and easy to use 37 Which of the portfolios mentioned in Exhibit most likely represents the structure of a core satellite portfolio? A Pension Fund X B Pension Fund Y C Pension Fund Z 38 Using an appropriate measure of the manager’s stock selection ability, Manager C’s information ratio will be closest to: A 0.31 B -0.39 C -1.00 39 Using the information given in the vignette, which of the following pension funds is most likely utilizing a completeness fund? A Pension Fund X only B Pension Fund X and Y only C Pension Fund X and Z only 40 Which of the following managers should Holzinger most likely select to manage the pension fund? A Manager A B Manager B C Manager C 41 Which of the following managers most likely follows a stock-based semiactive strategy? A Manager A B Manager B C Manager C FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) 42 Manager A is most likely managing his portfolios using the: A short-extension strategy B alpha and beta separation strategy C equitizing a long-short portfolio strategy FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions 43 through 48 relate to Fixed Income Portfolio management Amy Wulfing Case Scenario Amy Wulfing is a portfolio analyst who manages a fifteen million dollar fixed-income portfolio invested in US-based corporate bonds Wulfing manages credit risk separately from interest rate risk and uses the Z-spread as a close approximation of the credit spread of a security Wulfing is currently evaluating the attractiveness of four corporate bonds each with a different credit rating Exhibits and display relevant information for all the four bonds Exhibit 1: Expected Credit Loss Expected recovery rate Expected probability of default Yield Bond A 60% 0.55% 4.5% Bond B 45% 1.38% 5.7% Bond C 25% 5.77% 9.5% Bond D 35% 2.90% 6.4% Exhibit 2: Bond Characteristics Spread Duration Z-Spread (today) Z-spread (at the end of the holding period) Holding period Bond A 2.5% 2.75% months Bond B 2.7% 3.00% months Bond C 4.4% 4.90% months Bond D 3.5% 3.70% months Wulfing derives the following conclusions from her appraisal of the corporate bonds: Conclusion 1: “The evaluation of spread risk and credit migration risk will bear more importance in the assessment of Bond A than the assessment of Bond C.” Conclusion 2: “If interest rates rise in the near future, Bond C is likely to experience the highest % change in its price.” FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Conclusion 3: “If default losses are expected to be low, and credit spreads to be relatively tight, Bond C’s interest rate sensitivity is likely to increase.” Wulfing is planning to construct a portfolio composed of bonds that span a broad range of the credit spectrum The ratings of the bonds will vary from Aaa to Caa2 In addition, the portfolio’s mandate will emphasize a focus on long-term returns, so only intermediate to long-term bonds will be a part of the asset allocation To accurately assess the credit quality of this portfolio, Wulfing will use the following approaches: The arithmetical weighting of each credit rating category assigned A market-value weighted OAS of each of the component bond’s individual OAS Even though this portfolio would include only domestic bonds, Wulfing is evaluating the possibilities of expanding the investment universe to include international bonds After a comprehensive analysis, Wulfing has shortlisted European Corporates as a plausible option Using these bonds, Wulfing develops the following two investment strategies: Strategy 1: Buying credit securities in the European market and selling credit securities in the US market Strategy 2: Borrowing in the euro market and investing in the US market Wulfing bases these strategies on the following market expectations: Expectation 1: “Euro interest rates are expected to fall and US interest rates are expected to rise.” Expectation 2: “Euro bond prices are expected to rise more than the rise in US bond prices.” Expectation 3: “The euro/dollar exchange rate is expected to fall.” Wulfing is also using the G-spread to estimate the price change of a bond issued by The Eon Group (TEG) The bond has an interest rate of 6.94% and a duration of 8.0 FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) 43 Which bond is most likely to experience the greatest credit loss? A Bond A B Bond B C Bond D 44 Which of the following conclusion(s) is (are) most accurate? A Conclusion only B Conclusions and only C Conclusions 1, and 45 Wulfing’s suggested methods of assessing the credit quality of the bond portfolio are most likely to: A Overestimate credit quality B Underestimate credit quality C One method will overestimate credit quality, whereas the other will underestimate it 46 Which of the following market expectations are most likely to affect Strategy negatively? A Expectations and only B Expectation and only C Expectations 1, and 47 Which of the following market expectations are most likely to affect Strategy positively? A Expectation only B Expectations and only C Expectations 1, and 48 What advantage would Wulfing gain, if instead of the G-spread, she uses the Ispread to measure the price change of the TEG bond? A The I-spread more accurately reflects supply and demand B The swap curve is less disjointed than the government bond curve C The I-spread more accurately represents a credit risk-free rate FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions 49 through 54 relate to Alternative Investments Connon Carey Case Scenario Connon Carey is a wealthy entrepreneur who holds an investment portfolio worth ten million US dollars Carey’s portfolio is invested in US stocks, US corporate bonds, and T-bills During a recent meeting with Kasey Kreft, his portfolio manager, Carey informed her about an expected influx of $100,000 in cash in the coming six months Keeping the probability of receiving this inflow in mind, Kreft recommended Carey to invest a certain portion of his portfolio in alternative investments She presented the following options: Equity market neutral hedge funds Systematic managed futures Hedged equity hedge funds Event driven hedge funds Fixed-income arbitrage Carey agreed with the suggestion to add alternative investments to his portfolio but was still contemplating which investment would be most appropriate for him, given his circumstances He was particularly interested in hedge funds but was also concerned with the issues in selecting and using hedge fund indices Kreft shared his concern, and stated that survivorship bias was often raised as a major concern for investors in hedge funds However, she added that such a bias could be reduced by conducting superior due diligence In addition, Kreft mentioned the following additional concerns related to the creation of hedge fund indices: • • • Age effects make it difficult to compare the performance of hedge funds However, as the time horizon increases, age effects generally decrease in importance Lack of security trading leads to the stale price bias which causes volatility to be understated and measured correlations to be lower than expected Value-weighted indices overweigh the performance of the best-performing hedge funds over a given time period As their discussion on hedge funds continued, Carey mentioned the difficulties in appraising the performance of a hedge fund investment Kreft stated that the most extensively used measure for hedge fund appraisal has been the Sharpe Ratio However, she added that such a ratio could easily be gamed In trying to further elucidate her point, Kreft presented the following examples: FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Example 1: Many hedge funds take on excessive amounts of exposure to a specific risk factor to improve the mean or standard deviation of a particular investment Example 2: A hedge fund can enter a total return swap where it pays the best and worst returns for its benchmark index each year, and the counterparty pays a fixed cash flow Example 3: Many FOFs combine funds in such a way that reduces negative skewness For example, global macro funds with high volatility and kurtosis are often combined with equity market-neutral funds that tend to act as volatility and kurtosis reducers When the discussion concluded, Kreft altered Carey’s portfolio’s asset allocation by investing 10% of the portfolio in hedge funds While reviewing his portfolio’s revised asset allocation, Carey instructed Kreft to diversify his alternative investments by including another asset class Kreft advised Carey to invest in distressed securities, given the economic forecasts and expected long-term financial trends Carey agreed, though he stated some conditions as expressed in the following comment: “I not want to take on an influential position by becoming the target’s major creditor or by owning most of its stock In addition, I would like to gain certain protection under either scenario: the target’s prospects worsening, or the target’s prospects improving.” Carey then posed the following question: “Which risk should I be least worried about when investing in distressed securities?” 49 In order to achieve maximum diversification, which of the following fund options presented by Kreft should Carey least likely invest in? A hedged equity and event driven hedge funds B fixed-income arbitrage and systematic managed futures C systematic managed futures and event driven hedge funds FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) 50 To minimize the concern of survivorship bias, Carey should least likely invest in: A Currency funds B Hedged equity C Funds of funds 51 Kreft is most accurate with respect to which of the following concerns regarding hedge funds? A Age effects and value-weighting effect only B Stale price bias and value-weighting effect only C Age effects, stale price bias and value-weighting effect 52 Which of the examples given by Kreft least likely represents a gaming of the Sharpe ratio? A Example B Example C Example 53 Given Carey’s conditions as presented in his comment, the most appropriate distressed investment strategy for him would be: A private Equity B prepackaged Bankruptcy C distressed Debt Arbitrage 54 The most appropriate response to Carey’s question is: A event risk B market risk C market liquidity risk FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions 55 through 60 relate to Alternative Investments Ted Smith Case Scenario Ted Smith, a portfolio manager and research analyst, owns and operates an investment management firm in the U.S Smith’s firm specializes and deals mainly in the more traditional asset classes, that is, stocks and bonds However, recently, Smith hired a group of financial managers who were experts in managing funds in non-traditional asset classes; ones that had risk and return characteristics very different from those of stock and bond investments This branch of Smith’s firm attracted many high-net worth private wealth clients as well as institutional funds Martha Long is the head of this department and is contemplating investment in a small private firm for a large pension fund Long estimates the market value of the firm’s equity to be $800 million After careful deliberation, Long determines that an investment representing 5.0% of the firm’s equity is appropriate for the pension fund A minority interest discount and a marketability discount relating to the investment have been estimated to equal 25% and 20% respectively After making the investment, Long met with Bruce Will, the head of the pension fund’s board Will was not completely satisfied with the idea of investing in alternative investments To mitigate his concerns, Long presented him with the information given in Exhibit Exhibit 1: Correlation of Alternative Investments with Traditional Asset Classes Private Stocks NCREIF NAREIT Bonds Equity Stocks 1.0 Private Equity -0.12 1.0 NCREIF -0.09 0.35 1.0 NAREIT 0.45 0.55 0.53 1.0 Bonds 0.23 0.05 0.13 0.19 FinQuiz.com © 2018 - All rights reserved 1.0 CFA Level III Mock Exam – Questions (PM) After studying the figures, Will got convinced about the benefits of investing in more non-traditional asset classes He asked Long to provide him with the details of commodity investments and their risk and return characteristics Since Will showed an interest in commodities, Long attempted to explain to him the return components to a commodity index using the data provided in Exhibits and Exhibit 2: Commodity Futures Futures Contract Maturity Price (May) Futures Price (July) Change in Spot Price Convenience Yield August $150.55 $151.60 $0.60 15% September $147.90 $149.00 $0.60 22% Exhibit 3: Commodity Index Return Components (to a long position) Year Collateral Yield Roll Return Spot Return 1980 7.5% 11.0% 5.5% 2010 8.5% -11.0% 36.0% Will was still confused about the factors contributing to commodity returns While talking to Long about it, he stated the following: “I have heard that physical commodities are exposed to event risk How true is that?” Will’s query made Long ponder over the effect of the unique characteristics of this asset class on the -returns earned in the commodity markets FinQuiz.com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) 55 The value of the equity investment of the pension fund in the private equity firm is closest to: A $22 million B $24 million C $20 million 56 Which of the values given in the correlation matrix seems most inaccurate? The correlation between: A stocks and NAREIT B NCREIF and NAREIT C private equity and stocks 57.Given the data in Exhibit 2, the roll return is most likely: A positive, but is likely to decrease B negative, but is likely to increase C positive, and is likely to increase 58 The most appropriate response to Will’s question is that physical commodities are exposed to: A positive event risk B negative event risk C event risk only with respect to changes in the business cycle 59 For the year 2010, the data in Exhibit least likely implies that the: A market is in contango B market supply is less than the market demand C convenience yield has followed an increasing trend 60 The existence of real options in the commodity market will most likely result in: A a downward-sloping term structure of futures prices B an upward-sloping term structure of futures prices C commodities being an excellent inflation hedge FinQuiz.com © 2018 - All rights reserved ...CFA Level III Mock Exam – Questions (PM) FinQuiz. com – 4th Mock Exam 2018 (PM Session) Questions Topic Minutes 1-6 Ethical and Professional Standards 18 7-12 Ethical and Professional Standards... business relationships FinQuiz. com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) In offering additional services and products to only a few clients, and engaging in tag-along... only if A&J approves of it FinQuiz. com © 2018 - All rights reserved CFA Level III Mock Exam – Questions (PM) Questions through 12 relate to Ethical & Professional Standards DIM Case Scenario