2009 l3 sample exam v3 qa

Question 1 When disclosing the Martin Industries deal to Rowan, did Carney violate any CFA Institute Standards of Professional Conduct?. 67-71 Study Session 1-2-a Demonstrate a thorough

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NEW-Level III Version 3 2009 Sample Exam

1

Don Rowan Case Scenario

Don Rowan, CFA, works for an investment bank that is advising a client about a potential acquisition of Martin Industries Although Rowan is not working on the Martin deal, Julia Carney, CFA, a colleague in the same department who is directly involved with the acquisition, telephones Rowan at home to ask for his advice about the acquisition

Rowan’s wife, Joanne West, a nurse, overhears the telephone conversation between Carney and Rowan When West questions Rowan about why Carney called him at home, Rowan explains, “She is a colleague in

my department who is working on an important deal with Martin and was simply seeking my advice.” That evening, West tells her friend Ruth Boyle about the conversation between Rowan and Carney

Two weeks later, Boyle, a research assistant at an asset management firm, reads an article about Martin Industries in the financial press After further reading and investigation, Boyle, who is a CFA candidate, hypothesizes that the firm may be a prime takeover target She informs her supervisor of her hypothesis Her supervisor, a CFA charterholder and portfolio manager who emphasizes diligent research, tells Boyle to do more research and then write a report

Boyle collects the data needed for her report and gathers previously published research reports from

reputable firms to assist in her analysis She conducts primary research and scrutinizes the reports including the assumptions, the timeliness, and the rigor of analysis During lunch, she observes that Martin’s common stock price is starting to increase She completes her report and places a call to her father, a member of CFA Institute who is an advisor at the firm where she holds her children’s education fund Boyle tells him, “I think Martin stock may be a good buy Buy 300 shares for the children’s education fund.” Her father immediately purchases the shares according to his daughter’s instructions He then places an order to purchase a block of 5,000 shares of Martin stock, which he allocates among his client and personal accounts

Late the next day, Boyle gives her completed report to her supervisor She takes care to disclose in the report that “the author is a beneficial owner of Martin Industries common stock.” The report, which references

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previously published reports as Boyle’s main sources, recommends purchase of Martin stock for investors with above-average risk tolerance The supervisor reads the report immediately and is impressed with

Boyle’s work He questions Boyle about her research, her sources, and her recommendation Satisfied with Boyle’s responses, he places an order to purchase a block of 25,000 shares to be allocated among his clients

Question 1

When disclosing the Martin Industries deal to Rowan, did Carney violate any CFA Institute Standards of

Professional Conduct?

A No.

B Yes, relating only to client confidentiality.

C Yes, relating to both client confidentiality and fiduciary duty to employer.

Correct Answer = A

"Guidance" for Standards I — VII, CFA Institute

2009 Modular Level III, Vol 1, pp 67-71

Study Session 1-2-a

Demonstrate a thorough knowledge of the Code of Ethics and Standards of Professional Conduct by interpreting the Code and Standards in various situations involving issues of professional integrity

According to Standard III (E), Duties to Clients: Preservation of Confidentiality, members may disclose information received from clients to fellow employees in an effort to improve client service The Standard relating to Duties to Employers does not include a fiduciary duty

2 When disclosing Carney's involvement in the Martin Industries deal to West, did Rowan violate any CFA Institute Standards?

A No.

B Yes, only the Standard relating to client confidentiality.

C Yes, the Standards relating to client confidentiality and to fiduciary duty to employer.

Correct Answer = B

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Study Session 1-2-a

Standard III (E) Duties to Clients: Preservation of Confidentiality, requires that members preserve the confidentiality

of information communicated to them by their clients The Standard relating to Duties to Employers does not include a fiduciary duty

3 When buying Martin Industries stock for her children's education fund, did Boyle violate any CFA Institute

Standards?

A No.

B Yes, relating to priority of transactions.

C Yes, relating to material nonpublic information.

Study Session 1-2-a

According to Standard VI (B), Conflicts of Interest: Priority of Transactions, members may undertake transactions

in accounts for which they are a beneficial owner only after their clients and employers have had adequate

opportunity to act

4 With respect to the block trade in Martin Industries stock, did Boyle's father violate any CFA Institute Standards?

A No.

B Yes, relating only to reasonable basis.

C Yes, relating to both reasonable basis and material nonpublic information.

"Pearl Investment Management (A), (B), and (C)," Glen Holdern, Jr., CFA

2009 Modular Level III, Vol 1, p 197

Study Sessions 1-2-a, 2-5-a

Demonstrate a thorough knowledge of the Code of Ethics and Standards of Professional Conduct by interpreting the

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Code and Standards in various situations involving issues of professional integrity.

Evaluate professional conduct and formulate an appropriate response to actions that violate the CFA Institute Code

of Ethics and Standards of Professional Conduct

According to Standard V (A), Investment Analysis, Recommendations, and Action: Diligence and Reasonable Basis, members must exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions They must have a reasonable and adequate basis, supported by appropriate research and investigation for any investment action Boyle did not have a reasonable and adequate basis, supported by appropriate research and investigation for his block purchase

5 When completing and submitting her report on Martin Industries, did Boyle violate any CFA Institute Standards?

A No.

B Yes, because she did not disclose the amount of her beneficial ownership.

C Yes, because she did not attempt to disseminate the material nonpublic information.

2009 Modular Level III, Vol 1, pp 24-25, 38-39, 80-81, 89-91

Evaluate professional conduct and formulate an appropriate response to actions that violate the CFA Institute Code

of Ethics and Standards of Professional Conduct

Boyle did not commit a violation By disclosing that she was beneficial owner of Martin stock, she alerted readers that her recommendation may be biased Including other people's work is not a violation if it is referenced, as it was

by Boyle Boyle's report was based on the Mosaic Theory and she was free to act on the collection of material

6 When trading in Martin Industries stock, did Boyle's supervisor violate any CFA Institute Standards?

A No.

B Yes, because he was trading on material nonpublic information.

C Yes, because he purchased a single block rather than purchasing shares for individual client

accounts

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2009 Modular Level III, Vol 1, pp 38-39, 53, 80-81

Evaluate professional conduct and formulate an appropriate response to actions that violate the CFA Institute Code of Ethics and Standards of Professional Conduct

Boyle's supervisor did not commit a violation The new research report provided a reasonable basis for his investment decision He did not possess material nonpublic information Fair dealing allows a single block purchase to be allocated among individual accounts

7

Bobby Sarkar Case Scenario

Bobby Sarkar, Chief Investment Officer for the Daniels Corporation pension plan, is meeting with the Investment Policy Committee to evaluate portfolio managers for the pension fund

To help with the evaluation Sarkar has collected information on

three active portfolio managers This information is presented

below in Exhibit 1 and Exhibit 2.

Exhibit 1 Investment Manager Data December 31, 2007

ManagerA

ManagerB

ManagerC

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Exhibit 2 Returns-Based Style Analysis December 31, 2007

ManagerA

ManagerB

ManagerC

The Russell 1000 indexes consist of large capitalization stocks, while the Russell 2000 indexes consist

of small capitalization stocks

Reena Hashmi, one of the members of the investment policy committee, makes the following

statement, "I think it would be cheaper to use a passive investment strategy instead of using active portfolio managers."

Question

Based on the information presented in Exhibits 1 and 2, manager A is most likely following a:

A value investment strategy.

B growth investment strategy.

C semi-active investment strategy.

"Equity Portfolio Management," Gary L Gastineau, Andrew R Olma, and Robert G Zielinski

2009 Modular Level III, Vol 4, pp 179-181, 206-215

Study Session 11-33-b, i

Discuss the rationales for passive, active, and semi-active (enhanced index) equity investment approaches anddistinguish among those approaches with respect to expected active return and tracking risk

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Compare and contrast techniques for identifying investment styles and characterize the style of an investor when given a description of the investor's security selection method, details on the investor's security

holdings, or the results of a returns-based style analysis

Manager A has a low P/E, high dividend yield and a style fit of 87%, which suggests that he is following an active value strategy Furthermore, Exhibit 2 shows that he is following a value strategy, 58% weight on the Russell 1000 value index, and 35% weight on the Russell 2000 value index The weights on the other two growth indexes are minimal

8 Based on the information presented in Exhibits 1 and 2, manager B is most likely following a:

Correct Answer = C

The data in Exhibits 1 and 2 indicate that manager B has no clear value or growth bias However, manager B has thelowest overall tracking risk, which is a feature of semi-active managers Also note that the style fit is 95% compared

to 87% for manager A and 85% for manager B, both of whom are active managers

9 Based on the information presented in Exhibits 1 and 2, manager C is most likely following a:

Feedback: You have answered incorrectly.

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Manager C has a high P/E, low dividend yield, high EPS growth and a style fit of 85%, which suggests that he is following an active growth strategy Furthermore, Exhibit 2 shows that he is following a growth strategy, 28% weight on the Russell 1000 growth index, and 65% weight on the Russell 2000 growth index The weights on the other two growth indexes are minimal

10 A contrarian investing substyle would most likely be used by:

A manager A.

B manager B.

C manager C.

on the Russell 2000 value index The weights on the other two growth indexes are minimal

11 Which of the following managers most likely follows a market oriented style with a small capitalization bias?

A Manager A.

B Manager B.

C Manager C.

Study Session 11-33-g, h, i

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Explain and justify the use of equity investment style classifications and discuss the difficulties in applying style definitions consistently.

Explain the rationales and primary concerns of value investors and growth investors and discuss the key risks of each investment style

Compare and contrast techniques for identifying investment styles and characterize the style of an investor when given a description of the investor's security selection method, details on the investor's security holdings, or the results of a returns-based style analysis

Manager B follows a market oriented style with a small cap bias The data in Exhibits 1 and 2 indicate that manager

B has no clear value or growth bias However, Exhibit 2 shows weights of 50% each on the Russell 2000 growth and Russell 2000 value indexes Both of these indexes are small cap indexes

12 The investment strategy suggested by Hashmi can be implemented by:

A equitizing a market neutral portfolio.

B following a long-short investment strategy.

C taking a long position in cash and index futures contracts.

Correct Answer = C

Study Session 11-33-e

Compare and contrast alternative methods for establishing passive exposure to an equity market, including indexed separate or pooled accounts, index mutual funds, exchange-traded funds, equity index futures, and equity total return swaps

One way to implement a passive investment strategy is to take a long position in cash and to take a long position in index futures contracts

13

Nabil Shariff Case Scenario

Nabil Shariff is the senior manager for MIR Capital's U.S.-based Global Bond Portfolio Shariff is meeting with a junior portfolio manager,

Jennifer Eastwood, to discuss strategies to improve performance and manage the risk exposure of the portfolio Summary data for the

portfolio is presented in Exhibit 1.

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Exhibit 1 Summary Information for MIR Capital's Global Bond Portfolio

Country Risk-Free US$ / Currency Bond Country Weight Duration Beta Return Spot Forecast Yield

Statement 1: "This will also result in a widening of credit spreads as U.S companies issue more investment

grade bonds."

Statement 2: "Given the yield curve outlook, callable bonds will outperform bullet maturities and bullets

will outperform putable bonds."

Shariff concludes the discussion on the U.S component of the global bond portfolio by asking Eastwood to report back with a recommendation for an appropriate strategy to moderate portfolio credit risk

The discussion then turns to the international component of the Global Bond Portfolio Eastwood asks

Shariff:

"Given the data in Exhibit 1, should we hedge our currency risk in the pound or euro?"

At this point Shariff must leave to attend a meeting with MIR Capital's partners, but he indicates that he will respond to Eastwood after the meeting

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"Relative-Value Methodologies for Global Credit Bond Portfolio Management," Jack Malvey

Study Session 9-30-b

Evaluate the portfolio implications of cyclical changes in the primary corporate bond market (such as an increase or decrease in new issue supply) and secular changes (such as a shift in dominant product structures)

Contrary to the normal supply-price relation where rising supply causes prices to fall and spreads to widen,

increased supply in the investment grade credit market causes spreads to narrow as new issue valuations validate and enhance secondary market valuations

14 In Statement 2, is Eastwood most likely correct with regard to the performance of callable bonds and putable bonds,

respectively, compared to bullets?

A Yes.

B No, because callable and putable bonds both outperform bullets.

C No, because callable bonds underperform bullets while putable bonds outperform bullets Correct Answer = B

"Relative-Value Methodologies for Global Credit Bond Portfolio Management," Jack Malvey

2009 Modular Level III, Vol 4, pp 68, 71, 77-80

Study Session 9-30-d, e

Discuss the primary reasons for secondary market trading, including yield/spread pickup trades, credit-upside trades, credit-defense trades, new issue swaps, sector-rotation trades, yield curve-adjustment trades, structure trades,and cash flow reinvestment

Discuss and evaluate corporate bond portfolio strategies that are based on relative value, including total return analysis, primary market analysis, liquidity and trading analysis, secondary trading rationales and trading

constraints, spread analysis, structure analysis, credit curve analysis, credit analysis, and asset allocation/sector

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