Free CFA Institute CFA-Level-III Exam Questions

Pace Insurance is a large, multi-line insurance company that also owns several proprietary mutual funds. Thefunds are managed individually, but Pace has an investment committee that oversees all of the funds. Thiscommittee is responsible for evaluating the performance of the funds relative to appropriate benchmarks andrelative to the stated investment objectives of each individual fund. During a recent investment committeemeeting, the poor performance of Pace's equity mutual funds was discussed. In particular, the inability of theportfolio managers to outperform their benchmarks was highlighted. The net conclusion of the committee wasto review the performance of the manager responsible for each fund and dismiss those managers whoseperformance had lagged substantially behind the appropriate benchmark.The fund with the worst relative performance is the Pace Mid-Cap Fund, which invests in stocks with acapitalization between S40 billion and $80 billion. A review of the operations of the fund found the following:• The turnover of the fund was almost double that of other similar style mutual funds.• The fund's portfolio manager solicited input from her entire staff prior to making any decision to sell an existingholding.• The beta of the Pace Mid-Cap Fund's portfolio was 60% higher than the beta of other similar style mutualfunds.• No stock is considered for purchase in the Mid-Cap Fund unless the portfolio manager has 15 years offinancial information on that company, plus independent research reports from at least three different analysts.• The portfolio manager refuses to increase her technology sector weighting because of past losses the fundincurred in the sector.• The portfolio manager sold all the fund's energy stocks as the price per barrel of oil rose above $80. Sheexpects oil prices to fall back to the $40 to S50 per barrel range.A committee member made the following two comments:Comment 1: "One reason for the poor recent performance of the Mid-Cap Mutual Fund is that the portfoliolacks recognizable companies. I believe that good companies make good investments."Comment 2: "The portfolio manager of the Mid-Cap Mutual Fund refuses to acknowledge her mistakes. Sheseems to sell stocks that appreciate, but hold stocks that have declined in value."The supervisor of the Mid-Cap Mutual Fund portfolio manager made the following statements:Statement 1: "The portfolio manager of the Mid-Cap Mutual Fund has engaged in quarter-end window dressingto make her portfolio look better to investors. The portfolio manager's action is a behavioral trait known as overreaction."Statement 2: "Each time the portfolio manager of the Mid-Cap Mutual fund trades a stock, she executes thetrade by buying or selling one-third of the position at a time, with the trades spread over three months. Theportfolio manager's action is a behavioral trait known as anchoring."Indicate whether Statement 1 and Statement 2 made by the supervisor are correct.

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?

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:

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:

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.