Free CFA Institute CFA-Level-III Exam Questions

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?

Robert Keith, CFA, has begun a new job at CMT Investments as Head of Compliance. Keith has just completed a review of all of CMT's operations, and has interviewed all the firm's portfolio managers. Many are CFA charterholders, but some are not. Keith intends to use the CFA Institute Code and Standards, as well as the Asset Manager Code of Professional Conduct, as ethical guidelines for CMT to follow. In the course of Keith's review of the firm's overall practices, he has noted a few situations which potentially need to be addressed. Situation 1: CMT Investments' policy regarding acceptance of gifts and entertainment is not entirely clear. There is general confusion within the firm regarding what is and is not acceptable practice regarding gifts, entertainment and additional compensation. Situation 2: Keith sees inconsistency regarding fee disclosures to clients. In some cases, information related to fees paid to investment managers for investment services provided are properly disclosed. However, a few of the periodic costs, which will affect investment return, are not disclosed to the clients. Most managers are providing clients with investment returns net of fees, but a few are just providing the gross returns. One of the managers stated "providing gross returns is acceptable, as long as I show the fees such that the client can make their own simple calculation of the returns net of fees." Situation 3: Keith has noticed a few gaps in CMT's procedure regarding use of soft dollars. There have been cases where "directed brokerage" has resulted in less than prompt execution of trades. He also found a few cases where a manager paid a higher commission than normal, in order to obtain goods or services. Keith is considering adding two statements to CMT's policy and procedures manual specifically addressing the primary issues he noted. Statement 1: "Commissions paid, and any corresponding benefits received, are the property of the client. The benefit(s) must directly benefit the client. If a manager's client directs the manager to purchase goods or services that do not provide research services that benefit the client, this violates the duty of loyalty to the client.” Statement 2: "In cases of "directed brokerage," if there is concern that the client is not receiving the best execution, it is acceptable to utilize a less than ideal broker, but it must be disclosed to the client that they may not be obtaining the best execution." Situation 4: Keith is still evaluating his data, but it appears that there may be situations where proxies were not voted. After completing his analysis of proxy voting procedures at CMT, Keith wants to insert the proper language into the procedures manual to address proxy voting. Situation 5: Keith is putting into place a "disaster recovery- plan," in order to ensure business continuity in the event of a localized disaster, and also to protect against any type of disruption in the financial markets. This plan includes the following provisions: • Procedures for communicating with clients, especially in the event of extended disruption of services provided. • Alternate arrangement for monitoring and analyzing investments in the event that primary systems become unavailable. • Plans for internal communication and coverage of crucial business functions in the event of disruption at the primary place of business, or a communications breakdown. Keith is considering adding the following provisions to the disaster recovery plan in order to properly comply with the CFA Institute Asset Manager Code of Professional Conduct: Provision 1: "A provision needs to be added incorporating off-site backup for all pertinent account information." Provision 2: "A provision mandating testing of the plan on a company-wide basis, at periodical intervals, should be added." Situation 6: Keith is spending an incredible amount of time on detailed procedures and company policies that are in compliance with the CFA Institute Code and Standards, and also in compliance with the CFA Institute Asset Manager Code of Professional Conduct. As part of this process, he has had several meetings with CMT senior management, and is second-guessing the process. One of the senior managers is indicating that it might be abetter idea to just formally adopt both the Code and Standards and the Asset Manager Code of Conduct, which would make a detailed policy and procedure manual redundant. Keith wants to assure CMT's compliance with the requirements of the CFA Institute Code and Standards of Professional Conduct. Which of the following statements most accurately describes CMT's responsibilities in order to assure compliance?

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.

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:

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: