Reading 11 Concentrated Single Asset Positions FinQuiz.com FinQuiz.com CFA Level III Item-set - Solution Study Session June 2018 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 Reading 11 Concentrated Single Asset Positions FinQuiz.com FinQuiz Level III 2018 – Item-set Solution Reading 11: Concentrated Single Asset Positions Question ID: 19275 Correct Answer: B Personal Risk Bucket Home Cash/Treasuries* Total $ Millions 2.00 2.19 4.19 Market Risk Bucket Equity* Commodities* Total* $ Millions 2.19 2.19 4.19 Aspirational Risk Bucket DA shares $ Millions 20.00 Total 20.00 *Martin’s total funds = $20 million/0.7 = $28.5714 million Cumulative allocation to personal and market risk buckets = $28.5714 million × 0.3 = $8.5714 million Allocation to cash/treasuries, equities or commodities = ($8.5714 million – $2 million)/3 = $2.1905 million Allocation to personal risk bucket = Home + Cash/Treasuries = $(2.00 + 2.1905) million = $4.1905 million FinQuiz.com © 2018 - All rights reserved Reading 11 Concentrated Single Asset Positions FinQuiz.com Question ID: 19276 Correct Answer: A Martin most likely suffers from the endowment effect, which is described as the tendency to demand more to sell something than what others are willing to pay to buy it Martin believes the stock is worth more than what it was trading for because of the hard work he has put into growing the company He attaches more value to the stock than its actual worth, especially given the poor performance of the company over the past two years B is incorrect Martin does not suffer from the anchoring and adjustment bias There is no evidence of Martin making a decision based on adjustment from an initial position or anchor C is incorrect Martin does not suffer from the overconfidence and familiarity bias He has not incorporated the firm’s recent poor performance when arriving at the $60/share floor for the stock’s selling price Poor past performance will require Martin to adjust the asking price downward from the current market price He does not demonstrate overconfidence in forecasting ability or superior knowledge in corporate affairs Thus, he does not suffer from this bias Question ID: 19277 Correct Answer: B Strategy B will generate the highest proceeds and will be most suitable for paying off the $25 million loan The proceeds generated by each of the three strategies are outlined below: Strategy A: $26 million × 0.68 = $17.68 million Strategy B: $26 million × 0.75 = $19.50 million* Strategy C: $26 million × 0.70 = $18.20 million *Since Chappell has utilized all capital loss carryforwards, there is none available to offset the capital gains incurred on the sale and leaseback transaction Question ID: 19278 Correct Answer: C The loan suggested by Strategy B is a non-recourse loan meaning that the lender can only look to the property that was mortgaged to the lender in the event of default This means that the investor has economically acquired (purchased) the equivalent of a put option issued (written) by the lender with a strike price equal to the value of the loan, $19.5 million ($26 million × 0.75) Question ID: 19279 Correct Answer: C Strategy Y is most suitable, given Ali’s needs and requirements The investor is protected from a decline in the price up to the strike of the short put $40 Additionally, Ali can participate in any increase in the price of the stock above and beyond the strike of the long put ($43) A is incorrect Strategy W is not an appropriate strategy This strategy synthetically creates a short forward position By purchasing puts and selling calls, the investor will lock in a price of $45 regardless of the direction of the stock price movement If the stock price declines below $45 the FinQuiz.com © 2018 - All rights reserved Reading 11 Concentrated Single Asset Positions FinQuiz.com investor will exercise the puts, deliver her shares and receive $45 from the dealer If the stock price increases above $45 the calls will be exercised; the investor will be responsible for delivering her shares and will receive $45 in return Therefore, this position will remove any upside potential B is incorrect Strategy X is inappropriate This is because the strategy will cap upside potential at $48 and the investor will retain full downside exposure to the shares (to the extent the stock price declines by more than the premium received) Question ID: 19280 Correct Answer: B Contributions to an exchange fund are not considered to be a taxable event Taking this advantage solely into account, exchange funds are an appropriate diversification vehicle for Ali since she wishes to minimize taxes A is incorrect Investors choosing to participate in an exchange fund must remain in the fund for at least seven years Thus exchange funds impose lockup periods and investors must pay a penalty fee for a speedier exit The requirement to keep her funds tied to this vehicle for a minimum of seven years does not make exchange funds an appropriate diversification vehicle since Ali will face a liquidity event (boat purchase) in three months time C is incorrect After seven years fund partners have the option of redeeming their interest in the partnership and receiving a basket of securities at the discretion of the fund manager Thus, Ali will have little discretion with respect to the composition of this basket further making this an inappropriate vehicle Recall that Ali has expressed the desire for discretion FinQuiz.com © 2018 - All rights reserved .. .Reading 11 Concentrated Single Asset Positions FinQuiz. com FinQuiz Level III 20 18 – Item- set Solution Reading 11: Concentrated Single Asset Positions Question ID: 1 927 5 Correct Answer:... – $2 million) /3 = $2. 1905 million Allocation to personal risk bucket = Home + Cash/Treasuries = $ (2. 00 + 2. 1905) million = $4.1905 million FinQuiz. com © 20 18 - All rights reserved Reading 11. .. Millions 2. 00 2. 19 4.19 Market Risk Bucket Equity* Commodities* Total* $ Millions 2. 19 2. 19 4.19 Aspirational Risk Bucket DA shares $ Millions 20 .00 Total 20 .00 *Martin’s total funds = $20 million/0.7