Free CFA Institute CFA-Level-III Exam Questions

Albert Wulf, CFA, is a portfolio manager with Upsala Asset Management, a regional financial services firm thathandles investments for small businesses in Northern Germany. For the most part, Wulf has been handlinglocally concentrated investments in European securities. Due to a lack of expertise in currency management heworks closely with James Bauer, a foreign exchange expert who manages international exposure in some ofUpsala's portfolios. Both individuals are committed to managing portfolio assets within the guidelines of clientinvestment policy statements.To achieve global diversification, Wulf's portfolio invests in securities from developed nations including theUnited States, Japan, and Great Britain. Due to recent currency market turmoil, translation risk has become ahuge concern for Upsala's managers. The U.S. dollar has recently plummeted relative to the euro, while theJapanese yen and British pound have appreciated slightly relative to the euro. Wulf and Bauer meet to discusshedging strategies that will hopefully mitigate some of the concerns regarding future currency fluctuations.Wulf currently has a $1,000,000 investment in a U.S. oil and gas corporation. This position was taken with theexpectation that demand for oil in the U.S. would increase sharply over the short-run. Wulf plans to exit thisposition 125 days from today. In order to hedge the currency exposure to the U.S. dollar, Bauer enters into a90-day U.S. dollar futures contract, expiring in September. Bauer comments to Wulf that this futures contractguarantees that the portfolio will not take any unjustified risk in the volatile dollar.Wulf recently started investing in securities from Japan. He has been particularly interested in the growth oftechnology firms in that country. Wulf decides to make an investment of ¥25,000,000 in a small technologyenterprise that is in need of start-up capital. The spot exchange rate for the Japanese yen at the time of theinvestment is ¥135/€. The expected spot rate in 90 days is ¥132/€. Given the expected appreciation of the yen,Bauer purchases put options that provide insurance against any deprecation of the euro. While delta-hedgingthis position, Bauer discovers that current at-the-money yen put options sell for €1 with a delta of -0.85. Hementions to Wulf that, in general, put options will provide a cheaper alternative to hedging than with futuressince put options are only exercised if the local currency depreciates.The exposure of Wulf’s portfolio to the British pound results from a 180-day pound-denominated investment of£5,000,000. The spot exchange rate for the British pound is £0.78/€. The value of the investment is expected toincrease to £5,100,000 at the end of the 180 day period. Bauer informs Wulf that due to the minimal expectedexchange rate movement, it would be in the best interest of their clients, from a cost-benefit standpoint, tohedge only the principal of this investment.Before entering into currency futures and options contracts, Wulf and Bauer discuss the possibility of alsohedging market risk due to changes in the value of the assets. Bauer suggests that in order to hedge against apossible loss in the value of an asset Wulf should short a given foreign market index. Wulf is interested inexecuting index hedging strategies that are perfectly correlated with foreign investments. Bauer, however,cautions Wulf regarding the increase in trading costs that would result from these additional hedging activities.Regarding the Japanese investment in the technology company, determine the appropriate transaction in putoptions to adjust the current delta hedge, given that the delta changes to -0.92. Assume that each yen putallows the right to self ¥1,000,000.

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."

Theresa Bair, CFA, a portfolio manager for Brinton Investment Company (BIC), has recently been promoted to lead portfolio manager for her firm's new small capitalization closed-end equity fund, the Quaker Fund. BIC is an asset management firm headquartered in Holland with regional offices in several other European countries. After accepting the position, Bair received a letter from the three principals of BIC. The letter congratulated Bair on her accomplishment and new position with the firm and also provided some guidance as to her new role and the firm's expectations. Among other things, the letter stated the following: "Because our firm is based in Holland and you will have clients located in many European countries, it is essential that you determine what laws and regulations are applicable to the management of this new fund. It is your responsibility to obtain this knowledge and comply with appropriate regulations. This is the first time we have offered a fund devoted solely to small capitalization securities, so we will observe your progress carefully. You will likely need to arrange for our sister companies to quietly buy and sell Quaker Fund shares over the first month of operations. This will provide sufficient price support to allow the fund to trade closer to its net asset value than other small-cap closed-end funds. Because these funds generally trade at a discount to net asset value, if our fund trades close to its net asset value, the market may perceive it as more desirable than similar funds managed by our competitors." Bair heeded the advice from her firm's principals and collected information on the laws and regulations of three countries: Norway, Sweden, and Denmark. So far, all of the investors expressing interest in the Quaker Fund are from these areas. Based on her research, Bair decides the following policies are appropriate for the fund: Note: Laws mentioned below are assumed for illustrative purposes. • For clients located in Norway the fund will institute transaction crossing, since, unlike in Holland, the practice is not prohibited by securities laws or regulations. The process will involve internally matching buy and sell orders from Norwegian clients whenever possible. This will reduce brokerage fees and improve the fund's overall performance. • For clients located in Denmark, account statements that include the value of the clients' holdings, number of trades, and average daily trading volume will be generated on a monthly basis as required by Denmark's securities regulators, even though the laws in Holland only require such reports to be generated on a quarterly basis. • For clients located in Sweden, the fund will not disclose differing levels of service that are available for investors based upon the size of their investment. This policy is consistent with the laws and regulations in Holland. Sweden's securities regulations do not cover this type of situation.Three months after the inception of the fund, its market value has grown from $200 million to $300 million and Bair's performance has earned her a quarter-end bonus. Since it is now the end of the quarter, Bair is participating in conference calls with companies in her fund. Bair calls into the conference number for Swift Petroleum. The meeting doesn't start for another five minutes, however, and as Bair waits, she hears the CEO and CFO of Swift discussing the huge earnings restatement that will be necessary for the financial statement from the previous quarter. The restatement will not be announced until the year's end, six months from now. Bair does not remind the officers that she can hear their conversation. Once the call has ended, Bair rushes to BIC's compliance officer to inform him of what she has learned during the conference call. Bair ignores the fact that two members of the firm's investment banking division are in the office while she is telling the compliance officer what happened on the conference call. The investment bankers then proceed to sell their personal holdings of Swift Petroleum stock. After her meeting, Bair sells the Quaker Fund's holdings of Swift Petroleum stock. By selling the Quaker Fund's shares of Swift Petroleum, did Bair violate any CFA Institute Standards of Professional Conduct?

Dakota Watson and Anthony Smith are bond portfolio managers for Northern Capital Investment Advisors,which is based in the U.S. Northern Capital has $2,000 million under management, with S950 million of that inthe bond market. Northern Capital's clients are primarily institutional investors such as insurance companies,foundations, and endowments. Because most clients insist on a margin over the relevant bond benchmark,Watson and Smith actively manage their bond portfolios, while at the same time trying to minimize trackingerror.One of the funds that Northern Capital offers invests in emerging market bonds. An excerpt from its prospectusreveals the following fund objectives and strategies:“The fund generates a return by constructing a portfolio using all major fixed-income sectors within the Asianregion (except Japan) with a bias towards non-government bonds. The fund makes opportunistic investmentsin both investment grade and high yield bonds. Northern Capital analysts seek those bond issues that areexpected to outperform U.S. bonds with similar credit risk, interest rate risk, and liquidity risk-Value is added byfinding those bonds that have been overlooked by other developed world bond funds. The fund favors nondollar, local currency denominated securities to avoid the default risk associated with a lack of hard currency onthe part of issuer."Although Northern Capital does examine the availability of excess returns in foreign markets by investingoutside the index in these markets, most of its strategies focus on U.S. bonds and spread analysis of them.Discussing the analysis of spreads in the U.S. bond market, Watson comments on the usefulness of the optionadjusted spread and the swap spread and makes the following statements:Statement 1: Due to changes in the structure of the primary bond market in the U.S., the option adjustedspread is increasingly valuable for analyzing the attractiveness of bond investments.Statement 2: The advantage of the swap spread framework is that investors can compare the relativeattractiveness of fixed-rate and floating-rate bond markets.Watson's view of the U.S. economy is decidedly bearish. She is concerned that the recent withdrawal of liquidityfrom the U.S. financial system will result in a U.S. recession, possibly even a depression. She forecasts thatinterest rates in the U.S. will continue to fall as the demand for loanable funds declines with the lack of businessinvestment. Meanwhile, she believes that the Federal Reserve will continue to keep short-term rates low inorder to stimulate the economy. Although she sees the level of yields declining, she believes that the spread onrisky securities will increase due to the decline in business prospects. She therefore has reallocated her bondportfolio away from high-yield bonds and towards investment grade bonds.Smith is less decided about the economy. However, his trading strategy has been quite successful in the past.As an example of his strategy, he recently sold a 20-year AA-rated $50,000 Mahan Corporation bond with a7.75% coupon that he had purchased at par. With the proceeds, he then bought a newly issued A-rated QuincyCorporation bond that offered an 8.25% coupon. By swapping the first bond for the second bond, he enhancedhis annual income, which he considers quite favorable given the declining yields in the market.Watson has become quite interested in the mortgage market. With the anticipated decline in interest rates, sheexpects that the yields on mortgages will decline. As a result, she has reallocated the portion of NorthernCapital's bond portfolio dedicated to mortgages. She has shifted the holdings from 8.50% coupon mortgages to7.75% coupon mortgages, reasoning that if interest rates do drop, the lower coupon mortgages will rise in pricemore than the higher coupon mortgages. She identifies this trade as a structure trade.Smith is examining the liquidity of three bonds. Their characteristics are listed in the table below:Which of the following best describes the relative value analysis used in the Northern Capita! Emerging marketbond fund? It is a:

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: