Free CFA Institute CFA-Level-III Exam Questions

Paul Dennon is senior manager at Apple Markets Associates, an investment advisory firm. Dennon has beenexamining portfolio risk using traditional methods such as the portfolio variance and beta. He has rankedportfolios from least risky to most risky using traditional methods.Recently, Dennon has become more interested in employing value at risk (VAR) to determine the amount ofmoney clients could potentially lose under various scenarios. To examine VAR, Paul selects a fund run solelyfor Apple's largest client, the Jude Fund. The client has $100 million invested in the portfolio. Using thevariance-covariance method, the mean return on the portfolio is expected to be 10% and the standard deviationis expected to be 10%. Over the past 100 days, daily losses to the Jude Fund on its 10 worst days were (inmillions): 20, 18, 16, 15, 12, 11, 10, 9, 6, and 5. Dennon also ran a Monte Carlo simulation (over 10,000scenarios). The following table provides the results of the simulation:Figure 1: Monte Carlo Simulation DataThe top row (Percentile) of the table reports the percentage of simulations that had returns below thosereported in the second row (Return). For example, 95% of the simulations provided a return of 15% or less, and97.5% of the simulations provided a return of 20% or less.Dennon's supervisor, Peggy Lane, has become concerned that Dennon's use of VAR in his portfoliomanagement practice is inappropriate and has called for a meeting with him. Lane begins by asking Dennon tojustify his use of VAR methodology and explain why the estimated VAR varies depending on the method usedto calculate it. Dennon presents Lane with the following table detailing VAR estimates for another Apple client,the York Pension Plan.To round out the analytical process. Lane suggests that Dennon also incorporate a system for evaluatingportfolio performance. Dennon agrees to the suggestion and computes several performance ratios on the YorkPension Plan portfolio to discuss with Lane. The performance figures are included in the following table. Notethat the minimum acceptable return is the risk-free rate.Figure 3: Performance Ratios for the York Pension PlanUsing the historical data over the past 100 days, the 1-day, 5% VAR for the Jude Fund is closest to:

Smiler Industries is a U.S. manufacturer of machine tools and other capital goods. Dat Ng, the CFO of Smiler,feels strongly that Smiler has a competitive advantage in its risk management practices. With this in mind, Nghedges many of the risks associated with Smiler's financial transactions, which include those of a financialsubsidiary. Ng's knowledge of derivatives is extensive, and he often uses them for hedging and in managingSrniler's considerable investment portfolio.Smiler has recently completed a sale to Frexa in Italy, and the receivable is denominated in euros. Thereceivable is €10 million to be received in 90 days. Srniler's bank provides the following information:Smiler borrows short-term funds to meet expenses on a temporary basis and typically makes semiannualinterest payments based on 180-day LIBOR plus a spread of 150 bp. Smiler will need to borrow S25 million in90 days to invest in new equipment. To hedge the interest rate risk on the loan, Ng is considering the purchaseof a call option on 180-day LIBOR with a term to expiration of 90 days, an exercise rate of 4.8%, and a premiumof 0.000943443 of the loan amount. Current 90-day LIBOR is 4.8%.Smiler also has a diversified portfolio of large cap stocks with a current value of $52,750,000, and Ng wants tolower the beta of the portfolio from its current level of 1.25 to 0.9 using S&P 500 futures which have a multiplierof 250. The S&P 500 is currently 1,050, and the futures contract exhibits a beta of 0.98 to the underlying.Because Ng intends to replace the short-term LIBOR-based loan with long-term financing, he wants to hedgethe risk of a 50 bp change in the market rate of the 20-year bond Smiler will issue in 270 days. The currentspread to Treasuries for Smiler's corporate debt is 2.4%. He will use a 270-day, 20-year Treasury bond futurescontract ($100,000 face value) currently priced at 108.5 for the hedge. The CTD bond for the contract has aconversion factor of 1.259 and a dollar duration of $6,932.53. The corporate bond, if issued today, would havean effective duration of 9.94 and has an expected effective duration at issuance of 9.90 based on a constantspread assumption. A regression of the YTM of 20-year corporate bonds with a rating the same as Smiler's onthe YTM of the CTD bond yields a beta of 1.05.If Ng purchases the interest rate call, and 180-day LIBOR at option expiration is 5.73%, the annualized effectiverate for the 180-day loan is closest to:

William Bliss, CFA, runs a hedge fund that uses both managed futures strategies and positions in physicalcommodities. He is reviewing his operations and strategies to increase the return of the fund. Bliss has justhired Joseph Kanter, CFA, to help him manage the fund because he realizes that he needs to increase histrading activity in futures and to engage in futures strategies other than fully hedged, passively managedpositions. Bliss also hired Kanter because of Kantcr's experience with swaps, which Bliss hopes to add to hischoice of investment tools.Bliss explains to Kanter that his clients pay 2% on assets under management and a 20% incentive fee. Theincentive fee is based on profits after having subtracted the risk-free rate, which is the fund's basic hurdle rate,and there is a high water mark provision. Bliss is hoping that Kanter can help his business because his firm didnot earn an incentive fee this past year. This was the case despite the fact that, after two years of losses, thevalue of the fund increased 14% during the previous year. That increase occurred without any new capitalcontributed from clients. Bliss is optimistic about the near future because the term structure of futures prices isparticularly favorable for earning higher returns from long futures positions.Kanter says he has seen research that indicates inflation may increase in the next few years. He states thisshould increase the opportunity to earn a higher return in commodities and suggests taking a large, marginedposition in a broad commodity index. This would offer an enhanced return that would attract investors holdingonly stocks and bonds. Bliss mentions that not all commodity prices are positively correlated with inflation so itmay be better to choose particular types of commodities in which to invest. Furthermore, Bliss adds thatcommodities traditionally have not outperformed stocks and bonds either on a risk-adjusted or absolute basis.Kanter says he will research companies who do business in commodities, because buying the stock of thosecompanies to gain commodity exposure is an efficient and effective method for gaining indirect exposure tocommodities.Bliss agrees that his fund should increase its exposure to commodities and wants Kanter's help in using swapsto gain such exposure. Bliss asks Kanter to enter into a swap with a relatively short horizon to demonstrate howa commodity swap works. Bliss notes that the futures prices of oil for six months, one year, eighteen months,and two years are $55, S54, $52, and $5 1 per barrel, respectively, and the risk-free rate is less than 2%.Bliss asks how a seasonal component could be added to such a swap. Specifically, he asks if either thenotional principal or the swap price can be higher during the reset closest to the winter season and lower for thereset period closest to the summer season. This would allow the swap to more effectively hedge a commoditylike oil, which would have a higher demand in the winter than the summer. Kanter says that a swap can onlyhave seasonal swap prices, and the notional principal must stay constanl. Thus, the solution in such a casewould be to enter into two swaps, one that has an annual reset in the winter and one that has an annual reset inthe summer.Given the information, the most likely reason that Bliss's firm did not earn an incentive fee in the past year wasbecause:

Eugene Price, CFA, a portfolio manager for the American Universal Fund (AUF), has been directed to pursue acontingent immunization strategy for a portfolio with a current market value of $100 million. AUF's trustees arenot willing to accept a rate of return less than 6% over the next five years. The trustees have also stated thatthey believe an immunization rate of 8% is attainable in today's market. Price has decided to implement thisstrategy by initially purchasing $100 million in 10-year bonds with an annual coupon rate of 8.0%, paidsemiannuallyPrice forecasts that the prevailing immunization rate and market rate for the bonds will both rise from 8% to 9%in one year.While Price is conducting his immunization strategy he is approached by April Banks, a newly hired junioranalyst at AUF. Banks is wondering what steps need to be taken to immunize a portfolio with multiple liabilities.Price states that the concept of single liability immunization can fortunately be extended to address the issue ofimmunizing a portfolio with multiple liabilities. He further states that there are two methods for managingmultiple liabilities. The first method is cash flow matching which involves finding a bond with a maturity dateequal to the liability payment date, buying enough in par value of that bond so that the principal and final couponfully fund the last liability, and continuing this process until all liabilities are matched. The second method ishorizon matching which ensures that the assets and liabilities have the same present values and durations.Price warns Banks about the dangers of immunization risk. He states that it is impossible to have a portfoliowith zero immunization risk, because reinvestment risk will always be present. Price tells Banks, "Be cognizantof the dispersion of cash flows when conducting an immunization strategy. When there is a high dispersion ofcash flows about the horizon date, immunization risk is high. It is better to have cash flows concentrated aroundthe investment horizon, since immunization risk is reduced."Regarding Price's statements on the two methods for managing multiple liabilities, determine whether hisdescriptions of cash flow matching and horizon matching are correct.

Mark Rolle, CFA, is the manager of the international bond fund for the Ryder Investment Advisory. He isresponsible for bond selection as well as currency hedging decisions. His assistant is Joanne Chen, acandidate for the Level 1 CFA exam.Rolle is interested in the relationship between interest rates and exchange rates for Canada and Great Britain.He observes that the spot exchange rate between the Canadian dollar (C$) and the British pound is C$1.75/£.Also, the 1-year interest rate in Canada is 4.0% and the 1-year interest rate in Great Britain is 11.0%. Thecurrent 1-year forward rate is C$1.60/£.Rolle is evaluating the bonds from the Knauff company and the Tatehiki company, for which information isprovided in the table below. The Knauff company bond is denominated in euros and the Tatehiki company bondis denominated in yen. The bonds have similar risk and maturities, and Ryder's investors reside in the UnitedStates.Provided this information, Rolle must decide which country's bonds are most attractive if a forward hedge ofcurrency exposure is used. Furthermore, assuming that both country's bonds are bought, Rolle must alsodecide whether or not to hedge the currency exposure.Rolle also has a position in a bond issued in Korea and denominated in Korean won. Unfortunately, he is havingdifficulty obtaining a forward contract for the won on favorable terms. As an alternative hedge, he has entered aforward contract that allows him to sell yen in one year, when he anticipates liquidating his Korean bond. Hisreason for choosing the yen is that it is positively correlated with the won.One of Ryder's services is to provide consulting advice to firms that are interested in interest rate hedgingstrategies. One such firm is Crawfordville Bank. One of the loans Crawfordville has outstanding has an interestrate of LIBOR plus a spread of 1.5%. The chief financial officer at Crawfordville is worried that interest ratesmay increase and would like to hedge this exposure. Rolle is contemplating either an interest rate cap or aninterest rate floor as a hedge.Additionally, Rolle is analyzing the best hedge for Ryder's portfolio of fixed rate coupon bonds. Rolle iscontemplating using either a covered call or a protective put on a T-bond futures contract.The hedge that Rolle uses to hedge the currency exposure of the Korean bond is best referred to as a: