Free CFA Institute CFA-Level-III Exam Questions

Rowan Brothers is a full service investment firm offering portfolio management and investment banking services. For the last ten years, Aaron King, CFA, has managed individual client portfolios for Rowan Brothers, most of which are trust accounts over which King has full discretion. One of King's clients, Shelby Pavlica, is a widow in her late 50s whose husband died and left assets of over $7 million in a trust, for which she is the only beneficiary. Pavlica's three children are appalled at their mother's spending habits and have called a meeting with King to discuss their concerns. They inform King that their mother is living too lavishly to leave much for them or Pavlica's grandchildren upon her death. King acknowledges their concerns and informs them that, on top of her ever-increasing spending, Pavlica has recently been diagnosed with a chronic illness. Since the diagnosis could indicate a considerable increase in medical spending, he will need to increase the risk of the portfolio to generate sufficient return to cover the medical bills and spending and still maintain the principal. King restructures the portfolio accordingly and then meets with Pavlica a week later to discuss how he has altered the investment strategy, which was previously revised only three months earlier in their annual meeting. During the meeting with Pavlica, Kang explains his reasoning tor altering the portfolio allocation but does not mention the meeting with Pavlica's children. Pavlica agrees that it is probably the wisest decision and accepts the new portfolio allocation adding that she will need to tell her children about her illness, so they will understand why her medical spending requirements will increase in the near future. She admits to King that her children have been concerned about her spending. King assures her that the new investments will definitely allow her to maintain her lifestyle and meet her higher medical spending needs. One of the investments selected by King is a small allocation in a private placement offered to him by a brokerage firm that often makes trades for King's portfolios. The private placement is an equity investment in ShaleCo, a small oil exploration company. In order to make the investment, King sold shares of a publicly traded biotech firm, VNC Technologies. King also held shares of VNC, a fact that he has always disclosed to clients before purchasing VNC for their accounts. An hour before submitting the sell order for the VNC shares in Pavlica's trust account. King placed an order to sell a portion of his position in VNC stock. By the time Pavlica's order was sent to the trading floor, the price of VNC had risen, allowing Pavlica to sell her shares at a better price than received by King. Although King elected not to take any shares in the private placement, he purchased positions for several of his clients, for whom the investment was deemed appropriate in terms of the clients* objectives and constraints as well as the existing composition of the portfolios. In response to the investment support, ShaleCo appointed King to their board of directors. Seeing an opportunity to advance his career while also protecting the value of his clients' investments in the company, King gladly accepted the offer. King decided that since serving on the board of ShaleCo is in his clients' best interest, it is not necessary to disclose the directorship to his clients or his employer. For his portfolio management services, King charges a fixed percentage fee based on the value of assets under management. All fees charged and other terms of service are disclosed to clients as well as prospects. In the past month, however. Rowan Brothers has instituted an incentive program for its portfolio managers. Under the program, the firm will award an all-expense-paid vacation to the Cayman islands for any portfolio manager who generates two consecutive quarterly returns for his clients in excess of 10%. King updates his marketing literature to ensure that his prospective clients are fully aware of his compensation arrangements, but he does not contact current clients to make them aware of the newly created performance incentive. According to the CFA Institute Standards of Professional Conduct, which of the following statements is correct concerning King's directorship with ShaleCo?

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:

Geneva Management (GenM) selects long-only and long-short portfolio managers to develop asset allocationrecommendations for their institutional clients.GenM Advisor Marcus Reinhart recently examined the holdings of one of GenM's long-only portfolios activelymanaged by Jamison Kiley. Reinhart compiled the holdings for two consecutive non-overlapping five yearperiods. The Morningstar Style Boxes for the two periods for Kiley's portfolio are provided in Exhibits 1 and 2.Exhibit 1: Morningstar Style Box: Long-Only Manager for Five-Year Period 1Exhibit 2: Morningstar Style Box: Long-Only Manager for Five-Year Period 2Reinhart contends that the holdings-based analysis might be flawed because Kiley's portfolio holdings areknown only at the end of each quarter. Portfolio holdings at the end of the reporting period might misrepresentthe portfolio's average composition. To compliment his holdings-based analysis, Reinhart also conducts areturns-based style analysis on Kiley's portfolio. Reinhart selects four benchmarks:1. SCV: a small-cap value index.2. SCG: a small-cap growth index.3. LCV: a large-cap value index.4. LCG: a large-cap growth index.Using the benchmarks, Reinhart obtains the following regression results:Period 1: Rp = 0.02 + H0.01(SCV) + 0.02(SCG) + 0.36(LCV) + 0.61(LCG)Period 2: Rp = 0.02 + 0.01(SCV) + 0.02(SCG) + 0.60(LCV) + 0.38(LCG)Kiley's long-only portfolio is benchmarked against the S&P 500 Index. The Index's current sector allocations areshown in Exhibit 3.Exhibit 3: S&P 500 Index Sector AllocationsGenM strives to select managers whose correlation between forecast alphas and realized alphas has beenfairly high, and to allocate funds across managers in order to achieve alpha and beta separation. GenM givesReinhart a mandate to pursue a core-satellite strategy with a small number of satellites each focusing on arelatively few number of securities.In response to the core-satellite mandate, Reinhart explains that a Completeness Fund approach offers twoadvantages:Advantage 1: The Completeness Fund approach is designed to capture the stock selecting ability of the activemanager, while matching the overall portfolio's risk to its benchmark.Advantage 2: The Completeness Fund approach allows the Fund to fully capture the value added from activemanagers by eliminating misfit risk.Which one of the following statements about Kiley's long-only portfolio is most correct1? Kiley's portfolio:

John Green, CFA, is a sell-side technology analyst at Federal Securities, a large global investment banking andadvisory firm. In many of his recent conversations with executives at the firms he researches, Green has hearddisturbing news. Most of these firms are lowering sales estimates for the coming year. However, the stockprices have been stable despite management's widely disseminated sales warnings. Green is preparing hisquarterly industry analysis and decides to seek further input. He calls Alan Volk, CFA, a close friend who runsthe Initial Public Offering section of the investment banking department of Federal Securities.Volk tells Green he has seen no slowing of demand for technology IPOs. "We've got three new issues due outnext week, and two of them are well oversubscribed." Green knows that Volk's department handled over 200IPOs last year, so he is confident that Volk's opinion is reliable. Green prepares his industry report, which isfavorable. Among other conclusions, the report states that "the future is still bright, based on the fact that 67%of technology IPOs are oversubscribed." Privately, Green recommends to Federal portfolio managers that theybegin selling all existing technology issues, which have "stagnated," and buy the IPOs in their place.After carefully evaluating Federal's largest institutional client's portfolio, Green contacts the client andrecommends selling all of his existing technology stocks and buying two of the upcoming IPOs, similar to therecommendation given to Federal's portfolio managers. Green's research has allowed him to conclude that onlythese two IPOs would be appropriate for this particular client's portfolio. Investing in these IPOs and selling thecurrent technology holdings would, according to Green, "double the returns that your portfolio experienced lastyear."Federal Securities has recently hired Dirks Bentley, a CFA candidate who has passed Level 2 and is currentlypreparing to take the Level 3 CFA® exam, to reorganize Federal's compliance department. Bentley tells Greenthat he may be subject to CFA Institute sanctions due to inappropriate contact between analysts andinvestment bankers within Federal Securities. Bentley has recommended that Green implement a firewall torectify the situation and has outlined the key characteristics for such a system. Bentley's suggestions are asfollows:1. Any communication between the departments of Federal Securities must be channeled through thecompliance department for review and eventual delivery. The firm must create and maintain watch, restricted,and rumor lists to be used in the review of employee trading.2. All beneficial ownership, whether direct or indirect, of recommended securities must be disclosed in writing.3. The firm must increase the level of review or restriction of proprietary trading activities during periods inwhich the firm has knowledge of information that is both material and nonpublic.Bentley has identified two of Green's analysts, neither of whom have non-compete contracts, who are preparingto leave Federal Securities and go into competition. The first employee, James Ybarra, CFA, has agreed totake a position with one of Federal's direct competitors. Ybarra has contacted existing Federal clients using aclient list he created with public records. None of the contacted clients have agreed to move their accounts asYbarra has requested. The second employee, Martha Cliff, CFA, has registered the name Cliff InvestmentConsulting (CIC), which she plans to use for her independent consulting business. For the new businessventure, Cliff has developed and professionally printed marketing literature that compares the new firm'sservices to that of Federal Securities and highlights the significant cost savings that will be realized by switchingto CIC. After she leaves Federal, Cliff plans to target many of the same prospects that Federal Securities istargeting, using an address list she purchased from a third-party vendor. Bentley decides to call a meeting withGreen to discuss his findings.After discussing the departing analysts. Green asks Bentley how to best handle the disclosure of the followingitems: (1) although not currently a board member. Green has served in the past on the board of directors of acompany he researches and expects that he will do so again in the near future; and (2) Green recently inheritedput options on a company for which he has an outstanding buy recommendation. Bentley is contemplating hisresponse to Green.According to Standard 11(A) Material Nonpublic Information, when Green contacted Volk, he:

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%, paidsemiannually.Price 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."Assuming an immediate (today) increase in the immunized rate to 11%, the portfolio required return that wouldmost likely make Price turn to an immunization strategy is closest to: