Free CFA Institute CFA-Level-III Exam Questions

Jack Mercer and June Seagram are investment advisors for Northern Advisors. Mercer graduated from aprestigious university in London eight years ago, whereas Seagram is newly graduated from a mid-westernuniversity in the United States. Northern provides investment advice for pension funds, foundations,endowments, and trusts. As part of their services, they evaluate the performance of outside portfolio managers.They are currently scrutinizing the performance of several portfolio managers who work for the ThompsonUniversity endowment.Over the most recent month, the record of the largest manager. Bison Management, is as follows. On March 1,the endowment account with Bison stood at $ 11,200,000. On March 16, the university contributed $4,000,000that they received from a wealthy alumnus. After receiving that contribution, the account was valued at $17,800,000. On March 31, the account was valued at $16,100,000. Using this information, Mercer andSeagram calculated the time-weighted and money-weighted returns for Bison during March. Mercer states thatthe advantage of the time-weighted return is that it is easy to calculate and administer. Seagram states that themoney-weighted return is, however, a better measure of the manager's performance.Mercer and Seagram are also evaluating the performance of Lunar Management. Risk and return data for themost recent fiscal year are shown below for both Bison and Lunar. The minimum acceptable return (MAR) forThompson is the 4.5% spending rate on the endowment, which the endowment has determined using ageometric spending rule. The T-bill return over the same fiscal year was 3.5%. The return on the MSCI WorldIndex was used as the market index. The World index had a return of 9% in dollar terms with a standarddeviation of 23% and a beta of 1.0.The next day at lunch, Mercer and Seagram discuss alternatives for benchmarks in assessing the performanceof managers. The alternatives discussed that day are manager universes, broad market indices, style indices,factor models, and custom benchmarks. Mercer states that manager universes have the advantage of beingmeasurable but they are subject to survivor bias. Seagram states that manager universes possess only onequality of a valid benchmark.Mercer and Seagram also provide investment advice for a hedge fund, Jaguar Investors. Jaguar specializes inexploiting mispricing in equities and over-the-counter derivatives in emerging markets. They periodically engagein providing foreign currency hedges to small firms in emerging markets when deemed profitable. This mostcommonly occurs when no other provider of these contracts is available to these firms. Jaguar is selling a largeposition in Mexican pesos in the spot market. Furthermore, they have just provided a forward contract to a firmin Russia that allows that firm to sell Swiss francs for Russian rubles in 90 days. Jaguar has also entered into acurrency swap that allows a firm to receive Japanese yen in exchange for paying the Russian ruble.Regarding their statements about manager universes, determine whether Mercer and Seagram are correct orincorrect.

Andre Hickock, CFA, is a newly hired fixed income portfolio manager for Deadwood Investments, LLC. Hickockis reviewing the portfolios of several pension clients that have been assigned to him to manage. The firstportfolio, Montana Hardware, Inc., has the characteristics shown in Figure 1.Hickock is attempting to assess the risk of the Montana Hardware portfolio. The benchmark bond index thatDeadwood uses for pension accounts similar to Montana Hardware has an effective duration of 5.25. Hissupervisor, Carla Mity, has discussed bond risk measurement with Hickock. Mity is most familiar with equity riskmeasures, and is not convinced of the validity of duration as a portfolio risk measure. Mity told Hickock, "I havealways believed that standard deviation is the best measure of bond portfolio risk. You want to know thevolatility, and standard deviation is the most direct measure of volatility."Hickock is also reviewing the bond portfolio of Buffalo Sports, Inc., which is comprised of the following assetsshown in Figure 2.The trustees of the Buffalo Sports pension plan have requested that Deadwood explore alternatives to reducethe risk of the MBS sector of their bond portfolio. Hickock responded to their request as follows:"I believe that the current option-adjusted spread (OAS) on the MBS sector is quite high. In order to reduce yourrisk, I would suggest that we hedge the interest rate risk using a combination of 2-year and 10-year Treasurysecurity futures. I would further suggest that we do not take any steps to hedge spread risk at this time."In assessing the risk of a portfolio containing both bullet maturity corporate bonds and MBS, Hickock shouldalways consider that:

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:

Matrix Corporation is a multidivisional company with operations in energy, telecommunications, and shipping.Matrix sponsors a traditional defined benefit pension plan. Plan assets are valued at $5.5 billion, while recentdeclines in interest rates have caused plan liabilities to balloon to $8.3 billion. Average employee age at Matrixis 57.5, which is considerably higher than the industry average, and the ratio of active to retired lives is 1.1. JoeElliot, Matrix's CFO, has made the following statement about the current state of the pension plan."Recent declines in interest rates have caused our pension liabilities to grow faster than ever experienced in ourlong history, but I am sure these low rates are temporary. I have looked at the charts and estimated theprobability of higher interest rates at more than 90%. Given the expected improvement in interest rate levels,plan liabilities will again come back into line with our historical position. Our investment policy will therefore beto invest plan assets in aggressive equity securities. This investment exposure will bring our plan to an overfunded status, which will allow us to use pension income to bolster our profitability."