Level III SS & Item Set Quiz (12 questions, 36 minutes) Jane Grant Case Study Jane Grant, CFA is a fund manager at Global Assets LLC and currently manages a fund which focuses on the pharmaceutical industry Outside of work, Jane designs clothes for a few close friends for a nominal fee She does not disclose this outside business activity to her employer or clients The fund managed by Jane invests in small-cap, publicly traded companies and is recommended only for investors who are able to assume a high level of risk Six months ago, Jane invested in MiraclePro, a pharmaceutical company focusing on medicines and treatments for cancer and other terminal illnesses A year ago, MiraclePro’s market capitalization doubled shortly after they announced the launch of a drug that successfully treated Alzheimer’s disease Jane tells her clients that the fund has been able to benefit immensely from the doubling of MircalePro’s market capitalization One of the founders of MiraclePro, James Welsh, is on the board of Global Assets In the last few months, MiraclePro has launched a number of new products and James Welsh’s information about the launches led Jane to purchase additional stock in MiraclePro before the launch became public in the media Global Assets also has a strategic partnership with a life insurance company, OneLife When the sales representatives of Global Assets market the firm’s products (mutual funds, annuities, etc.) to the investing public, they also market life insurance policies of OneLife In return for the marketing of their products, OneLife pays Global Assets a 2% commission This commission arrangement is not disclosed to clients In addition, the Global Assets sales team frequently receives gifts of nominal value from OneLife To motivate the sales representatives to perform better, Global Assets has decided to hold a competition amongst the representatives to choose the Sales Representative of the Year The winner is determined by the amount of new revenue generated for the firm The prize is a cash award of USD 100,000 While announcing details of the competition, the CEO advises the staff to focus their sales efforts on Global Assets’ front-end load funds since they earn the highest fees He also adds that the staff should not disclose this competition to clients In a separate meeting with the board, the CEO announces that the firm would benefit by adoption of the Asset Manager Code of Professional Conduct Not only would it encourage ethical and fair practices in the firm but it would also help them increase business volumes During the meeting, the CEO suggests several recommendations that can be implemented to achieve compliance with the Asset Manager Code of Professional Conduct: Recommendation 1: Global Assets has an investment banking business in addition to its fund management business To avoid any conflicts, we should create a separate wholly owned subsidiary to undertake the investment banking business Recommendation 2: We should utilize only one stockbroker in each market to ensure timely and efficient trades in each of the markets the Fund invests in Copyright © IFT All rights reserved www.ift.world Page Level III SS & Item Set Quiz (12 questions, 36 minutes) Which of the following statements is most likely accurate regarding Jane's actions in relation to her business activity outside of work? Jane is: A Not obligated to disclose these outside business activities because they not present a conflict of interest B In violation of the Code and Standards for not disclosing her outside business activities to her employer C In violation of the Code and Standards by including high risk investments in the fund portfolio assets With regard to the investment in MiraclePro, Global Assets least likely violated which of the following Standards of Professional Conduct? Suitability A Misrepresentation B Material Non-public Information With respect to Global Asset’s relationship with OneLife, which of the following is most likely a violation of the Code and Standards: A Marketing OneLife’s products along with its own B Receiving a commission from OneLife C Not disclosing the commission arrangement to clients and potential clients By participating in Global Asset’s Sales Representative of the Year competition, the sales representatives are least likely to violate the standard with respect to: A Loyalty, prudence and care B Suitability C Additional compensation arrangements Which of the following is most likely correct with respect to Recommendation and the Asset Manager Code? A Recommendation is consistent with the Asset Manager Code B Maintaining the investment banking business, even as a separate subsidiary, is not consistent with the Asset Manager Code C It is acceptable to maintain both the fund management and investment banking businesses as long as any possible conflicts are clearly disclosed If Recommendation were to be implemented, which aspect of the Asset Manager Code would most likely be violated? A Fair dealing B Best execution C Priority of Transactions Copyright © IFT All rights reserved www.ift.world Page Level III SS & Item Set Quiz (12 questions, 36 minutes) Daniel Strife Case Study Daniel Strife has recently joined Dyne Wealth Management Services (Dyne), a local investment bank primarily catering to small scale retail investors as an economic and financial analyst Daniel has completed an MSc in Economics and is currently registered for the Level III exam Daniel will be working as part of the research team headed by Bob Navis, CFA Bob introduces Daniel to the research team and states that he is a valuable addition to the team given his background in both economics and finance Commenting on Daniels qualifications, Bob states that: “You made an excellent choice in pursuing the CFA charter We make it a policy to hire people who are pursuing the CFA program All our analysts are CFA charterholders This helps guarantee good investment performance for our clients Even our statistician, Anton, is a CFA candidate He has passed the Level I exam and is planning on registering for the next stage in June.” Subsequent to introducing Daniel to the firm’s senior management, Bob presents Daniel with the firm’s code of ethics and standards which is a simplified adaption of the CFA Institute Code and Standards Bob walks him through the key points of the standards He states that due to space limitations the firm does not have a rigid firewall between the sell-side research and the investment banking divisions Both divisions share the same office space Bob also states that the firm possesses a restricted list of securities and documented procedures for interdepartmental communications A compliance officer investigates possible violators and takes suitable remedial actions During this discussion Daniel verbally informs Bob that he works as a part time economics and finance lecturer at a local university He conducts classes over the weekend and receives a wage on an hourly basis Bob thanks Daniel for his openness A month later, Bob asks Daniel to prepare a “Pager” on Davidson Dockyard which he has been researching for the past few weeks A “Pager” is a short report prepared by Dyne Wealth Management Services for its retail clients The Pager contains a brief description of the company and key data such as the current price of the stock, price earnings ratio (P/E), price to book ratio (P/BV) ratio and a peer comparison The disclaimer that accompanies the report states that, Dyne Wealth Management Services follows a “top down approach” when analyzing the future prospects of a firm and a recommendation is based on the current relative valuation of the stocks multiples against market averages and sector averages Bob does the necessary top down and relative value analysis and given his understanding of economics, uses an econometric model built by him to supplement his top down approach analysis The econometrics model provides forecasts for world ship building and repair activities as well as forecasts for Davidson Dockyard’s revenue and profits The model estimates are the basis for the forward pricing multiples of the stock which he compares against forward estimates for the market and the shipbuilding sector Bob is impressed by his work and states that due to the lack of space, it is not necessary to present a detailed explanation of the econometric model in the report Bob formats the report and emails a copy to all of Dyne’s clients and select media representatives Subsequently Daniel prepares color printouts of the report and couriers it to the firm’s largest clients who pay a premium for a higher level of service Given his grounding in both economics and equity research, Daniel is frequently called upon by the firm to collaborate with the investment banking division The investment banking division is Copyright © IFT All rights reserved www.ift.world Page Level III SS & Item Set Quiz (12 questions, 36 minutes) currently facilitating the acquisition of a beachfront property with the intention of constructing a high-end boutique hotel in partnership with a foreign investor The foreign investor is scheduled to arrive in the country in two days for a meeting with Dyne to discuss the terms of the arrangement Bob asks Daniel to work with Paul from the investment banking division to put together some material for a presentation on the prospects for the tourism industry in the country Daniel is currently preparing a detailed equity report on Proteus Hotels which has not been released to Dyne’s clients In an email to Paul, Daniel shares the “Industry Analysis” segment of his report which contains some analysis of the tourism sector and is based on research conducted by the Ministry of Tourism which appeared in the Daily Mirror Newspaper He presents the salient points in “bullet-point form” but leaves the original material virtually unchanged Paul cites the source of the analysis as the “Daily Mirror Newspaper” and the presentation carries the names and contact details of the employees of the investment banking division During the meeting with the foreign investor, Daniel makes a presentation on the tourism industry by largely summarizing the extensive research he has conducted and by emphasizing those aspects which are relevant to the prospects for boutique hotels The foreign investor is impressed with Dyne’s professionalism states that he is looking forward to a long term and profitable relationship with Dyne Impressed with Daniel’s presentation skills, Dyne’s CEO would like him to be more involved in road shows conducted periodically for soliciting new clients To facilitate these activities, the management presented Daniel with a tablet PC which contains remote access to the investment banking division’s servers The servers contain equity valuation models, company reports, Dyne’s historical portfolio performance and client lists Bob gives Daniel permission to take the tablet PC home and to access the server’s data for his own reference via the tablet PC as well as to make use of its other functions outside of office hours Daniel is very pleased with this as not only does he make use of it for preparing for upcoming presentations at Dyne but it is also a good teaching aid At one of his lectures at the university, Daniel demonstrates to the students the appropriate way for balancing financial statements by showing them the financial model for Proteus Hotels Daniel had built from scratch At a subsequent lecture, Daniel makes use of the historical performance of a former client’s equity portfolio in order to demonstrate the computations for the “Treynor-Black model.” With respect to Bob’s statement relating to the CFA Program and the team investment performance, has he violated the standards relating to the responsibility of a CFA Institute member or candidate: A No B Yes, by guaranteeing investment performance only C Yes, by guaranteeing investment performance and by incorrectly referencing Anton’s candidacy in the CFA Program During their discussion has either Daniel or Bob violated the Standards? A No B Yes, by failing to obtain written permission from the firm for his lecturing activities C Yes, by not adhering to best practices regarding firewalls For the purpose of business cards and letter heads, Daniel should most likely state his name and qualifications as: A Daniel Strife, MSc Economics Copyright © IFT All rights reserved www.ift.world Page Level III SS & Item Set Quiz (12 questions, 36 minutes) B Daniel Strife, MSC Economics, CFA Level III candidate C Daniel Strife, CFA expected 2013 10 With respect to the publication of the pager report on Davidson’s Dockyards, Bob has most likely: A Not violated the CFA Institute Code and Standards B Violated the CFA Institute Code and Standards by removing his econometric model C Violated the CFA Institute Code and Standards by couriering a hardcopy of his report to the largest clients 11 With respect to the work done with the investment banking division, which of the following most likely represent a failure to adhere to the recommended procedure set out in the CFA Institute Code and Standards: A Paul failing to include Daniels name in the presentation B Paul citing the source of the research as the Daily Mirror Newspaper C Daniel presenting only a summary of his complete research 12 With respect to his lecturing activities, Daniel has least likely violated the standard pertaining to: A Preservation of confidentiality B Record retention C Loyalty to employer Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (6 questions, 18 minutes) Mr and Mrs Gregory Smith are going to retire at the end of this year Mr Smith is 65 years old while Mrs Smith is 60 years old They seek the help of a financial consultant to manage their investment portfolio during their retirement years Tim Burton, CFA agrees to help them out During their first meeting, Tim asks them about their return objectives They tell Tim that they will need USD 80,000 per year to fund their living expenses In addition, the Smiths also donate USD 10,000 every year to their favorite charity, Make a Wish Foundation Mr Smith’s employer is giving him a lump sum payment (gratuity) of USD 600,000 at the end of the year when he retires In addition, the Smiths have ve investments of USD 350,000 in a diversified stock portfolio and cash savings of USD 300,000 They also own their own home, valued at USD 700,000 at the present time Tim confirms that the only source of income after Mr Smith’s retirement will be from ttheir investment fund Inflation is expected to be 6% Mr and Mrs Smith have one daughter, who is married and lives with her family in London They would like to leave her with a USD 1,000,000 gift when they pass away Mr and Mrs Smith would also like their heir home to be given to charity and converted into an orphanage once they pass away Tim then asks them about taxation Mr Smith confirms that they have both a tax deferred account and a taxable account Presently, the Flat and Heavy Tax Regime is in place place in the US Mr Smith asks Tim which assets would be most appropriate in a taxable account in such a regime and Tim responds accordingly Tim then lists the Smith’s joint probabilities of survival over the next years in the table below The nominal risk-free free rate is 9% while inflation has been mentioned earlier and is expected to remain at that level over the next years Year Age 66 67 68 69 70 Mr Smith 0.8155 0.7925 0.7667 0.7278 0.7004 Age 61 62 63 64 65 Mrs Smith 0.9770 0.9512 0.9105 0.8850 0.8367 What is the required nominal return of the Smiths investment portfolio (ignore taxes)? A 7.2% B 10.6% C 13.2% Based on the case study, what is the risk ability of the Smiths? A Below average B Average Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (6 questions, 18 minutes) C Above average Which one of the following most likely is not part of the unique circumstances circumstances section of the IPS of Mr and Mrs Smith? A Donations of USD 10,000 every year to Make a Wish Foundation Foundation B USD 1,000,000 00,000 gift for their daughter daughter C Desire to give their house to charity to be an orphanage o Which of the following assets would be most appropriate in a taxable account in a Flat and Heavy Tax Regime for the Smiths? A Bonds B Actively traded stocks C High dividend paying stocks What is their joint probability of survival in Year 3? A 0.6981 B 0.9791 C 0.6772 What is the capitalized value of the Smith’s core capital spending needs over the next years? A 404,870 B 439,606 C 450,000 Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (6 questions, 18 minutes) Bill Kohl, CFA, is the manager of an endowment for American University The endowment funds are used for awarding scholarships to 5% of the total student population The Dean of the University has recently had a meeting with Bill, in which he told him that he wanted to give more scholarships to deserving students He asked him about the current income earned from the endowment and whether it could be increased in order to award more scholarships Bill replied by saying that the endowment currently has a rolling 3-year average spending rule The following table shows details of the endowment’s market values during the last years: Year 2008 2009 2010 2011 2012 Market value of Endowment USD 1,000,000 USD 1,050,000 USD 1,100,000 USD 1,300,000 USD 1,350,000 The spending rate is 5% while the inflation rate for educational institutions is 6.5% Furthermore, the administration expenses for the endowment amount to 0.5% of the fund’s market value A few months later, Bill Kohl gets an offer from Ace Electronics for becoming the manager for their employee defined-benefit pension fund He decides to accept the offer The last pension fund manager had left the fund in considerable disarray Therefore, Bill’s first task is to get the fund in order and have a meeting with the top management to answer several of their questions The following are some of the questions asked by the CEO during the meeting: Question 1: If the value of plan assets falls short of projected benefit obligation (PBO), then what will happen? Question 2: What will be the effect on the pension liability if any of the following take place? Scenario 1: An increase in the company’s retirees’ savings rate Scenario 2: A decrease in the number of participants in the fund Scenario 3: Medical innovations resulting in changes to the mortality rate Question 3: If the plan has features of early retirement and provision for lump-sum distributions, what happens to the liquidity requirement? At the end of the meeting, the CEO, out of curiosity, asks Bill about the difference between endowments, insurance companies and pension funds Bill says he has limited knowledge about life insurance companies but tells the CEO all the differences he can think of at that moment What is the rolling 3-year average spending rule for the endowment? A USD 58,000 B USD 62,500 C USD 67,500 Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (6 questions, 18 minutes) What is the most likely minimum return requirement for the endowment? A 5.0% B 11.5% C 12.0% Which of the following is most likely to occur if the value of pension assets is less than the projected benefit obligation, as questioned by the CEO? A An underfunded plan that has less ability to take risk and requires contributions B An overfunded plan that has ability to take risk without affecting the plan coverage C A pension surplus may induce the sponsor to increase contributions Which of the scenarios listed by the CEO is least likely to have an impact on the company’s pension liability? A Scenario B Scenario C Scenario Which of the following is the least accurate description of an issue affecting the liquidity requirement of a DB plan? A The greater the number of retired lives, the greater the liquidity requirement B Plan features such as early retirement option and/or lump sum payments increase liquidity needs C A young, growing workforce which generally implies a higher liquidity requirement Which of the following is most likely true regarding endowments and insurance companies? A Endowments are less able to assume risk than non-life insurance companies B Endowments have lower liquidity requirements than non-life insurance companies C Both endowments and insurance companies are subject to similar legal and regulatory requirements Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (6 questions, 18 minutes) Finn Gilroy, CFA, is an analyst at an investment firm in Ireland Ireland is currently experiencing deflation and he is struggling to suggest investments for his clients He decides to research on what investments are profitable during deflationary periods A few months later, Finn notices that Ireland is experiencing rising short-term short term interest rates and flat bond yields He also notes that long-term long interest rates are not rising His supervisor upervisor asks him to write a report on these changing economic factors and conclude what phase of the business cycle Ireland is experiencing based on these economic indicators When Finn distributes the report to his clients, one of them, Anna Gallagher asks him about foreign investments She wants to diversify her investments by investing in either India or China To help her make this decision, Finn gathers some information on economic indicators of both countries The data is presented in the Table below: Economic Indicator % change from FY11 to FY12 (weighted by each economic indicator’s GDP percentage) India China Consumer spending 5.5% 7.0% Business capital investment 3.1% 4.5% Government investment 3.0% 5.5% Miscellaneous GDP factors Sum of weighted % change -2.0% 9.6% -5.0% 5.0% 12.0% Finn then uses the data in the table to analyze which of the two countries is expected to achieve a higher economic growth during the next year if these current trends are sustained Next, he decides to calculate the expected return for India and China’s equity markets For India’s equity market, he collects the following information: - Dividend yield will be 1.45% - Shares outstanding will decline 0.90% - Long term inflation rate will be 2% per year - Expansion rate for P/E multiples will be 0.20% per year - Long term corporate real earnings growth will be 4.0% per year Once Anna has decided which country to invest in, she asks Finn to gather some data about the energy sector of the country Specifically, she wants wants to know about the alternative energy industry (solar energy, wind power, etc.) which does not have a liquid market While collecting data, Finn observes that the data series available are generally quarterly and tend to hide a great deal of the volatility ty that Finn knows to exist because appraised values are used instead of market values When Finn expresses his concerns about the quality of data collected for the energy industry, Anna asks Finn if it would be possible to invest in the agricultural industry industry of the chosen country instead Finn agrees to collect the data A few weeks later, he meets with Anna again and he tells her that while collecting data for the agricultural industry for the last two years, he observed that the country experienced a significant gnificant drought during the last year which had affected crop production There is no reason to believe that such relationships will continue in the future Copyright © IFT All rights reserved www.ift.world Page Level III SS 14 Item Set Quiz (6 questions, 18 minutes) to market every week If the value of the derivative contract is positive for FFM it makes a payment to the counter party Which of the statements pertaining to ERM is most likely correct? A Statement B Statement C Statement Which of the above mentioned risks are most likely a source of non-financial risk? A Model risk and interest rate risk B Model risk and settlement risk C Settlement risk and interest rate risk Based on Guidetti’s estimate of VAR for the commodity investment strategy, which of the following statements is most likely accurate? During a seven-day period, there is a: A 5% probability that the portfolio will lose no more than €14 million B 5% probability the portfolio will lose at least €14 million C 95% probability the portfolio will lose at least €14 million Based on the details given above, which of the following statements is most likely accurate? A The combined daily VAR of both investment strategies is €16 million B The combined daily VAR of both investment strategies is less than €16 million C The combined daily VAR of both investment strategies is more than €16 million Which of the above limitations of VAR analysis pointed out by Guidetti is least likely correct? A Limitation B Limitation C Limitation Guidetti’s comments are least likely correct with respect to: A the use of OTC derivatives to manage credit risk B the use of marking to market to control credit risk C which party makes the payment when the contract value is positive Copyright © IFT All rights reserved www.ift.world Page Level III SS 15 Item Set Quiz (6 Questions, 18 minutes) Jerry Mitchells, CFA, works at Diamond Securities The firm specializes in the use of derivatives to alter and manage exposures of their clients’ portfolios During this week, Jerry meets three of his clients, each of whom has asked his advice on using derivatives for their portfolios Stephanie D’Silva Stephanie is an old client of Jerry’s for whom he manages a portfolio of various equities During the meeting, Stephanie mentions that her investment in Falcon Corporation stock has increased considerably in value and she wants to know how she can protect her gains using derivatives Jerry replies, “You can consider two option strategies: covered calls or protective puts Covered calls involve adding a short call to your long position in the Falcon stock which will provide some protection against a fall in price of the underlying stock position, but it will also limit upside gains A protective put also provides downside protection, but it retains upside potential Unlike covered calls, protective puts require an upfront premium payment.” Stephanie then asks Jerry about some option strategies she had heard about from her colleagues at work namely: butterfly spread strategy, straddle strategy and collar strategy She expects the volatility of the S&P 500 Index to increase She wants to know which strategies to consider assuming the volatility does indeed increase Texas Instruments Next, Jerry meets with Sasha Cohen, manager of the Texas Instruments’ pension fund The fund consists of USD 60 million allocated 50% to stocks and 50% to bonds It has a target allocation of 65% equity and 35% bonds The fund has separate stock and bond portfolios and their details are provided in the table below Equity USD 30 million S&P 500 Index 1.15 - Asset Class Current Market Value Benchmark Current beta Current duration Debt USD 30 million Barclays Capital Aggregate Bond Index 4.50 Sasha believes that equity values will increase next year and wants to use derivatives to temporarily rebalance the portfolio to take advantage of that She wants to maintain the current beta of the stock portfolio In order to rebalance the pension fund to its target allocation, Jerry suggests using S&P 500 Index futures and Barclays Capital Aggregate Bond Index futures contracts Details of these are given in the table below: Derivative Instrument S&P 500 Index Futures Contract price Contract Beta Contract Duration USD 150,000 1.05 - Barclays Capital Aggregate Bond Index Futures USD 450,000 6.50 Cash duration is assumed to be 0.25 Copyright © IFT All rights reserved www.ift.world Page Level III SS 15 Item Set Quiz (6 Questions, 18 minutes) University of Karachi Trust Jerry then meets Iqbal Hasan who manages a fixed income portfolio for the University of Karachi Trust The market value of the portfolio is PKR 500 million and its duration if 5.40 Iqbal believes that interest rates will rise and wants to use a swap to decrease the portfolio’s duration to 4.0 He asks Jerry to explain to him how such a swap will work Jerry suggests a strategy that uses a payfixed position in a 3-year interest rate swap with semi-annual payments For this purpose, assume that the duration of a fixed rate bond is equal to 75% of its maturity Iqbal then asks, if it would be possible to cancel the swap prior to its maturity Jerry responds with the following statements: Statement 1: During the life of the swap, you could enter into a new receive-fixed pay-floating swap with the same terms as the original swap except it would have a maturity equal to the remaining maturity of the original swap Statement 2: You could purchase a payer swaption with the same terms as the original swap Is Jerry’s response to Stephanie regarding reducing exposure to Falcon Corporation stock most likely correct? A Yes B No, he is incorrect about covered calls C No, he is incorrect about protective puts Which one of the following is least likely to be used to take advantage of the expected volatility of the S&P 500 Index, relative to market expectations? A Butterfly Spread Strategy B Straddle Strategy C Collar Strategy The number of Barclays Capital Aggregate Bond Index futures Sasha must sell to rebalance the Texas Instruments pension fund to its target allocation is closest to: A 74 B 13 C 140 The number of S&P 500 Index futures Sasha must buy to rebalance the Texas Instruments pension fund to its target allocation is closest to: A 52 B 66 C 117 Copyright © IFT All rights reserved www.ift.world Page Level III SS 15 Item Set Quiz (6 Questions, 18 minutes) The duration of the swap in Jerry’s proposal to Iqbal is closest to: A –1.75 B –2.00 C –2.75 Is Jerry’s correct with respect to the two statements? A Yes B Statement is correct but Statement is incorrect C Both statements are incorrect Copyright © IFT All rights reserved www.ift.world Page Level III SS 16 Item Set Quiz (6 Questions, 18 minutes) Harriet Miller, CFA, works as a portfolio manager for Devine Asset Management She has several clients and prides herself for choosing the best trading strategies for her customers During the week, Harriet meets with various clients offering them investment advice She first meets with Kate Jordan who married recently, and plans to have children in the near future Her current portfolio is valued at USD 2.5 million and is invested in equities and risk-free securities She wants to have enough savings for her children and asks Harriet to develop a rebalancing strategy that will prevent her portfolio from dropping below USD 1.5 million Harriet states that according to various reports on the economy equity prices will be trending upwards Kate also wants to minimize her allocation to risk-free securities during a time when equity prices are increasing Harriet then tells Kate that her clients use one of the three types of rebalancing strategies: a buy-and-hold strategy, a constant-mix strategy, or a constant-proportion portfolio insurance (CPPI) strategy Harriet then meets Rahil Dewan, CFO of Tech Inc., which owns equity investments in several publicly listed companies as part of its pension fund Tech Inc has equity investments in Habib Mills and would like to sell this stock over the next six months The total number of shares to be sold would exceed 150% of Habib Mills’ average daily volume In addition, Habib Mills has a high level of institutional investor ownership Harriet must determine the best trading strategy to sell the shares of Habib Mills Back at work, Harriet starts working on some potential equity investments She follows one company, D-Link Systems and her independent analysis suggests that D-Link’s common shares are significantly undervalued D-Link Systems is scheduled to hold a press conference the next day to announce several new products Harriet believes that after the press conference, other investors will also realize that the stock is undervalued She also notes that there is a liquid market for D-Link’s shares, sufficient enough to absorb a large order without a significant impact on price Harriet wants to place a large ‘buy’ order and must decide on a trading strategy Later that afternoon, Harriet reads a research report recommending purchase of a small-cap company’s stock and decides to take a position The following sequence of events occurs: - On 1st February, the company stock closes at USD 15.00 The next morning, Harriet places a limit order expiring at the end of the day to purchase 20,000 shares at USD 15.00 Harriet then purchases a total of 6,000 shares at USD 14.95 with commissions of USD 300 On 2nd February, the company stock closes at USD 15.25 and VWAP is USD 15.10 No additional shares were purchased and the remaining order is cancelled Harriet tells her supervisor that her trading was successful because she paid less than the day’s (2nd February) VWAP of USD 15.10 Her supervisor notes that VWAP does not consider the costs of missed trade opportunities A few months later, the board of the firm Harriet works for approves the use of algorithmic trading strategies to lower net trading costs Managers such as Harriet may select either a volume-weighted average price (VWAP) strategy or an implementation shortfall strategy Harriet receives approval from the committee to buy shares in: Copyright © IFT All rights reserved www.ift.world Page Level III SS 16 Item Set Quiz (6 Questions, 18 minutes) - China Harbor Company (CHC) Cyprus Meat Inc (CMI) Africa Diamonds Inc (ADI) Argentina Cloth Mills (ACM) Harriet does some research and realizes it will not be appropriate to use only one algorithmic trading strategy for all four companies She wants to determine if the VWAP or the implementation shortfall strategy is suitable for each company Trading characteristics of the securities are shown in the table below: Table Security Size of order (shares) Average daily volume Price Bid-ask spread % Urgency to complete trade CHC 300,000 6,000,000 $75.00 Low High CMI 50,000 1,500,000 $20.00 Low Low ADI 40,000 50,000 $50.00 High High ACM 40,000 150,000 $12.00 Low Low Intra-day trading volume pattern Even throughout the day Higher at end of the day Higher at end of the day Even throughout the day What is the most appropriate rebalancing strategy for Kate Jordan’s portfolio? A Buy-and-hold B Constant-mix C Constant-proportion portfolio insurance (CPPI) What is the best trading strategy for Harriet to complete the sell order for Habib Mill’s shares? A Limit order B Market order C Crossing networks What is the best trading strategy for Harriet to complete the buy order for D-Link System’s shares? A Limit order B Market order C Crossing networks Copyright © IFT All rights reserved www.ift.world Page Level III SS 16 Item Set Quiz (6 Questions, 18 minutes) What is the missed trade opportunity cost, in basis points, for the small-cap company trade? A 117 B 140 C 25 Which security is best suited to be purchased using a VWAP strategy? A CHC B CMI C ACM Which security is best suited to be purchased using an implementation shortfall strategy? A CHC B CMI C ADI Copyright © IFT All rights reserved www.ift.world Page Level III SS 17 Item Set Quiz (6 Questions, 18 minutes) Jonathan Stiles is a fund manager at Apex Investments He is busy collecting data for his fund performance up till 31st March 2013 for his quarterly performance appraisal He gathers the following data for performance of his fund in sectors The overall benchmark return was 2.50% Sectors Technology Agriculture Pharmaceutical Portfolio Weights (%) 8.50 15.50 18.00 Sector Benchmark Weights (%) 7.50 13.50 21.00 Portfolio Return (%) 3.75 1.50 3.50 Sector Benchmark Return (%) 3.50 1.25 3.25 At the same time, Jonathan also is analyzing his personal savings account to calculate the return he earned during the month of March Using his bank statement, he extracts the following information: Balance at the beginning of the month Cash inflow on Day 11 Value of account on Day 11 Cash inflow on Day 17 Value of account on Day 17 Balance at the end of the month $1,100,000 $50,000 $1,200,000 $20,000 $1,270,000 $1,300,000 During the appraisal time, the Chief Investment Officer suggests that hedge fund performance should be evaluated by comparing the manager’s performance with the median of a universe of hedge funds with similar mandates The managers argue that this is not an appropriate evaluation method and cite reasons for their argument Dalia Juncker an investment manager also at Apex, is analyzing the performance of her account and the benchmark portfolio for the month of March Statistical measures related to the account are given below: Return (%) Beta Std deviation (%) 30-Day T-bill (%) Juncker Account 2.5 0.8 1.2 0.3 Benchmark Portfolio 2.6 0.8 1.4 0.3 Market Index 3.0 1.00 1.5 0.3 The pure sector allocation return for the technology sector is closest to: A 0.035% B 0.01% C 0.0125% Copyright © IFT All rights reserved www.ift.world Page Level III SS 17 Item Set Quiz (6 Questions, 18 minutes) The within-sector selection return for the agriculture sector was closest to: A +0.03375% B +0.03875% C -0.0135% The allocation/selection interaction return for the pharmaceutical sector was closest to: A – 0.030% B – 0.105% C – 0.0075% What is the time-weighted rate of return for Jonathan’s personal savings account for the month of March? A 11.48% B 12.00% C 18.18% Which of the following reasons is least likely true about why a median manager benchmark is inappropriate for judging fund manager performance? A It is not measurable B It cannot be specified in advance C It is not investable Based on the data related to the Juncker account and benchmark portfolio, the Sharpe ratio and Treynor measure for the account and benchmark portfolio most likely indicate that, in comparison to the benchmark portfolio, the Juncker account had: A Inferior risk-adjusted performance B Superior risk-adjusted performance C Risk-adjusted performance that was not clearly inferior or superior Copyright © IFT All rights reserved www.ift.world Page Level III SS 18 Item Set (18 min.) Ariel Investment Management is preparing its measurement and reporting practices in order to comply with the GIPS standards The following paragraphs present a few excerpts from their practices manual: Asset Valuation Ariel values its investments at the lower of cost or book value Trade date accounting is used consistently for all transactions In some cases, transactions may be recorded up to three days after the trade date The country where Ariel is based has laws and regulations related to performance reporting In some cases there are conflicts between local laws and the GIPS standards The Chief Investment Officer wants to know what to in case of such a conflict Trading Expenses Ariel calculates both gross-of-fees and net-of-fees returns after deduction of estimated trading returns incurred during the period Composites Ariel includes all discretionary (fee paying and non-fee paying) as well as nondiscretionary portfolios in at least one composite For the company’s emerging markets portfolio, the clients have placed restrictions on the investment manager, stating that investments in tobacco companies and breweries cannot be made Alcohol and tobacco companies represent less than 1% of the total companies in emerging markets As a result, the company has categorized the emerging markets portfolio as nondiscretionary Returns All returns are reported annually except for returns in the year 2005 This is because the firm was established in the second half of 2005 Hence, it reports annualized composite returns for the six months ended 31st December 2005 as part of its performance presentation Do Ariel’s policies on asset valuation most likely comply with GIPS standards? a Yes b No, because valuations should be based on fair value c No, because settlement date accounting should be used for all transactions What should the Chief Investment Officer in case of the valuation conflict stated above? a Follow local laws and regulations and disclose the conflict b Follow GIPS standards c Follow the stricter regulation of the two Is Ariel’s use of estimated trading expenses most likely compliant with GIPS standards? a Yes b No, estimated trading expenses can only be used when calculating net-of-fees returns c No, estimated trading expenses cannot be used for calculating gross-of-returns or for Copyright © IFT All rights reserved www.ift.world Page Level III SS 18 Item Set (18 min.) calculating net-of-fees returns Is Ariel’s practice regarding creation of a composite correct? a Yes b No, non-fee paying discretionary portfolios should not be included in a firm’s composite c No, nondiscretionary portfolios should not be included in a firm’s composite Is Ariel’s policy relating to the emerging markets portfolios most likely correct? a Yes b No, because a portfolio can only be nondiscretionary when a manager cannot implement the intended investment strategy c No, because a portfolio can only be classified as nondiscretionary when clients place restrictions on sectors, credit ratings and durations Is Ariel’s treatment of returns for the six months ended 31st December 2005 most likely correct? a Yes b No, because only gross-of-fees returns can be annualized c No, returns for less than one year cannot be annualized Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (12 questions, 36 minutes) Katherine Hult Case Study Katherine Hult, CFA, works for Rocky Road Investments in New York She works as a financial consultant and helps individuals manage their investments and savings It is her company’s policy to review the client’s IPS once a year to monitor any change in risk taking ability and willingness, individual’s circumstances and any behavioral biases they may have The following paragraphs detail profiles of three of her clients Client 1: Mrs Wentworth Mrs Wentworth is retired and lives alone in New York She has no children and donates a considerable amount of her retirement earnings to charity During the annual meeting, Katherine tried to convince her to invest in international stocks (given her high risk ability) but Mrs Wentworth refused Mrs Wentworth believes that all international stocks are risky, even though Katherine has shown her several research reports stating otherwise Client 2: Mr Jack Black Mr Jack Black belongs to a rich entrepreneurial family and has a number of investments in startup companies He prides himself on knowing good investments and having a keen sense of the market As a result, he keeps investing in a new startup every month When a startup succeeds he tells all his friends about his superior investment skills but when a startup fails, he blames it on unexpected market conditions Client 3: Mr Henry Tillman Mr Henry Tillman is in his mid-forties and an executive in a pharmaceutical company He started his investment in his early 20s and since then has made little change to his portfolio despite Katherine’s insistence Henry’s portfolio is mainly invested in pharmaceutical and oil company stocks and he doesn’t want to change the portfolio He tells Katherine that his parents left him this portfolio and he won’t sell it off Next month, Katherine prepares a presentation on behavioral biases and investor types for newly hired internees at her firm One of the internees asks a question about mental accounting bias and its consequences, which Katherine then explains Another internee asks about the three methods for decision making that most investors apply Katherine replies by explaining the methods namely decision theory, bounded rationality and prospect theory Katherine then moves on to explaining the different investor types: Passive Preserver, Friendly Follower, Independent Individualist and Active Accumulator She then describes the following investor and asks the internees which investor type she closely resembles ‘Kristie Matthews has moderate risk tolerance and suffers from cognitive biases She likes to invest and has recently bought a large chunk of stock in a cosmetic company that was recommended to her by a few friends who invest actively What kind of investor profile categorizes her best? Which of the following behavioral biases is most likely demonstrated by Mrs Wentworth? A Conservatism bias B Confirmation bias C Availability bias Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (12 questions, 36 minutes) Which of the following is most likely demonstrated by Jack Black? A Illusion of knowledge bias B Self-attribution bias C Hindsight bias Which of the following biases did Henry Tillman NOT demonstrate? A Anchoring and adjustment bias B Status quo bias C Endowment bias Which of the following is not a typical consequence of mental accounting bias? A Allocating funds to different ‘buckets.’ B Neglecting to focus on total return and total risk C A higher risk profile in the portfolio due to pursuit of higher returns An investor chooses an investment option based on available information This is most likely an example of: A Decision theory B Bounded rationality C Prospect theory Which of the following best describes the behavioral investor type for Kristie Matthews? A Friendly follower B Independent individualist C Active accumulator Dave Daisuke Case Study Dave Daisuke, CFA, works as an investment consultant at Thorpe Investments He has been asked by his firm to make a presentation about the commonly recognized behavioral biases and their implications for financial decision making Daisuke decides to use the profiles of his clients to help explain how behavioral biases affect investment policy and asset allocation decisions It is also his intention to draw a parallel between traditional finance and behavioral finance Client 1: Mr Jack Porter Mr Porter is single, 52-year-old, corporate executive of a multinational automobile company He lives in London but has residences in both London and Paris He earns a salary of e 80,000 annually and lives within his annual income net of taxes His current portfolio is e 3,750,000 which is mainly composed of 80 per cent equities with half of it in his employer’s stock and 20 per cent in investment grade bonds Mr Porter feels that his investment acumen is the reason for the appreciation of his portfolio value since he believes he is smarter and more informed than everyone else He wants to retire in ten years time and bequeath his assets remaining at his death to his favourite charities Mr Porter does not want to change his current asset allocations despite Daisuke’s proposed comprehensive financial plan Client 2: Mrs Joan Crawley Mrs Crawley is a 65-year-old, retired school teacher who lives alone She is in good health and Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (12 questions, 36 minutes) devotes her time to the charities involved in eradicating illiteracy She lives entirely from the income of her portfolio valued at $1,550,000 Mrs Crawley has kept investments in certain securities despite experiencing losses and sells of investments that have appreciated in value She has recently come to Daisuke to help her make an investment plan in which she can preserve the purchasing power of her assets She would like to help her granddaughter financially and maintain her current lifestyle Mrs Crawley told Daisuke that she has a limited knowledge of the financial markets and her deceased husband was the “investor” in the family Her portfolio consists of mainly bonds and some cash but she doesn’t want to make investments in equities for fear of loosing portfolio value Client 3: Miss Sylvie Dukakis Miss Dukakis is a 35-year-old technological expert who mainly invests in high growth companies She has recently made investments in the stock of Zenith Pharmaceuticals and believes that the stock would reach a 52-week high of $420 Dukakis before coming to Daisuke has traded more than it was prudent and her portfolio is mainly concentrated in technological and pharmaceutical equities She feels that since she works in the technological sector she has more information about it and can make accurate predictions about the future Miss Dukakis knows how the technological sector has performed in the past and her expectations in the future incorporate that information Daisuke further describes the various behavioral theories developed with respect to decision making One of his colleagues asks him to explain the Prospect theory Daisuke responds that the Prospect theory relaxes the assumptions of expected utility theory and risk aversion He elaborates by saying that Prospect Theory and Bounded Rationality describe how people actually behave and make decisions while Decision Theory is normative and describes how people should behave Which of the following biases is most likely demonstrated by Mr Porter? A Overconfidence bias B Representativeness bias C Confirmation bias Which of the following is least likely demonstrated by Mrs Crawley? A Loss-aversion bias B Regret-aversion bias C Mental-accounting bias Which of the following biases is NOT demonstrated by Miss Dukakis? A Illusion of control bias B Confirmation bias C Hindsight bias Which of the following is a consequence of the representativeness bias? A Adopt a view or forecast based almost solely on new information or a small sample B Placements of investments into discrete buckets C Misidentify risk tolerances because of how questions about risk tolerance were set up Behavior of market participants is not necessarily rational but is rather behavior that is perceived to result in less than optimal rational outcomes Individuals act in their own self interest, make Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (12 questions, 36 minutes) mistakes, and learn The biases identified in behavioral finance are consistent with: A Expected Utility Theory B Efficient Market Hypothesis C Adaptive Market Hypothesis Miss Dukakis exhibits which bias by focusing on the achievement of a 52-week high of $420? A Anchoring and adjustment bias B Framing bias C Availability bias Copyright © IFT All rights reserved www.ift.world Page ... reserved www.ift.world Page Level III SS & Item Set Quiz (12 questions, 36 minutes) B Daniel Strife, MSC Economics, CFA Level III candidate C Daniel Strife, CFA expected 2013 10 With respect to the... 450,000 Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (6 questions, 18 minutes) Bill Kohl, CFA, is the manager of an endowment for American University The endowment... requirements Copyright © IFT All rights reserved www.ift.world Page Level III SS Item Set Quiz (6 questions, 18 minutes) Finn Gilroy, CFA, is an analyst at an investment firm in Ireland Ireland is currently