2010 l3 sample exam v2 qa

Kapoor is considering adding leverage to the portfolio by borrowing £55 million in a two-month repo agreement involving physical delivery of the portfolio's holdings of AAA-rated British

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NEW-Level 3 Version 2 2010 Sample

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Daksa Kapoor Case Scenario

Daksa Kapoor, CFA, lives in London, where she works as the fixed-income portfolio manager of the Cray Investments pension fund The portfolio that Kapoor manages currently holds £60 million in British sovereign bonds, £110 in British corporate bonds, and £85 million in British mortgage-backed securities The duration of this £255 millionportfolio is 6.25 years

The board of directors has also established a policy prohibiting investment in any security rated below A by any of the major ratings agencies Recently, a bond held in the portfolio was downgraded to A3 by Moody's, that agency's lowest A rating Kapoor

is worried about the possibility of another downgrade (to Baa1), which would require

an immediate sale with significant transactions costs due to poor liquidity

Kapoor is considering adding leverage to the portfolio by borrowing £55 million in a two-month repo agreement involving physical delivery of the portfolio's holdings of AAA-rated British sovereign bonds The duration of this liability is 0.17 years The proceeds of the repo agreement would be invested in additional British corporate bondsand the resulting £310 million portfolio would have a duration of 5.82 years

If the repo agreement is not entered into, Kapoor intends to reduce the portfolio's duration to 4.00 years She is considering using an interest rate futures contract The futures contract is priced at £97,800 and the duration of the cheapest-to-deliver bond

is 8.35 years The conversion factor for the futures contract is 1.15

The fixed-income portfolio is benchmarked against the British total bond market index Kapoor has proposed adding non-British bonds to the portfolio In a presentation to theboard of directors, she explains her two-part approach to seeking excess returns from international bonds Specifically, she states that she will seek bond markets:

 that have the lowest correlations with British bonds; and

 whose currencies are expected to appreciate relative to the British pound

Kapoor is evaluating a £25 million block of German, euro-denominated bonds for possible inclusion in the portfolio The duration of these bonds is 14.7 years She has estimated the return correlation between German and British bonds as 0.66 and the German country beta as 0.44

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If Kapoor enters into the repo and invests the proceeds as indicated, the duration of

the portfolio's equity position will be closest to:

A

5.65 years

B

5.99 years

C

7.04 years

Correct answer: C

"Fixed Income Portfolio Management – Part II," H Gifford Fong and Larry D Guin

2010 Modular Level III, Vol 4, pp 106-109

Study Session 10-30-a

Evaluate the effect of leverage on portfolio returns and duration

C is correct because the duration of the equity position in a leveraged portfolio is

where A is the value of assets, L is the value of liabilities (debt), and E

= A – L In this case, the duration of the portfolio's equity would become

where 0.17 = 2 / 12 = the duration of the repo agreement

Instructions: Click the Continue button when finished reviewing your results for this question and ready to move on to the next question

B A

binary credit option

C A

credit

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spread option

Correct answer: B

Study Session 10-30-g

Compare and contrast default risk, credit spread risk, and downgrade risk and demonstrate the use of credit derivative instruments to address each risk in the context of a fixed-incomeportfolio

B is correct because Kapoor is concerned about losses associated with a particular credit event, in this case a downgrade "Binary credit options provide payoffs contingent on the occurrence of a specified negative credit event."

3.Question

Which of the characteristics of the repurchase agreement considered by

Kapoor would most likely increase the repo rate?

Correct answer: A

4.Question

If the interest rate futures contract is used to reduce the interest rate

exposure in Kapoor's portfolio, the number of futures contracts that should

be sold is closest to:

A 611.

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B 703.

C 808.

Correct answer: C

Study Session 10-30-e

Construct and evaluate an immunization strategy based on interest rate futures

C is correct because the approximate number of futures contracts needed to change aportfolio's duration from its initial level (DI) to a target level (DT) is

where PI is the initial market value of the portfolio and CTD refers to the cheapest-to-deliver bond (p 117) In this

contracts

5.Question

Which of these statements is most accurate regarding Kapoor's two-part

approach to achieving excess returns from non-British bonds?

A Both parts are

appropriate

B Part I is appropriate,

but Part II is inappropriate

Study Session 10-30-h

Explain the sources of excess return for an international bond portfolio

C is correct because low correlations will reduce the overall risk of the portfolio but not produce higher expected returns Currency selection can add value Currency

appreciation relative to the British pound, if achieved, will produce excess returns Instructions: Click the Continue button when finished reviewing your results for this question and ready to move on to the next question

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If British interest rates increase by 50 bps, the percentage change in the value

of the German bonds that Kapoor is evaluating will be closest to:

Study Session 10-30-i

Evaluate (1) the change in value for a foreign bond with domestic interest rates change and (2) the bond's contribution to duration in a domestic portfolio given the duration of the foreign bond and the country beta

A is correct because the percentage change in value for a 100 bps change in British interest rates is the duration of the bonds multiplied by the country beta, so the change for a 50 bps change will be half that or 0.50 × 0.44 × 14.7 = 3.23

Goldsboro Partners Case Scenario

Goldsboro Partners, an investment management firm, intends to offer more products related to the equities traded on the Singapore Exchange (SGX).

Goldsboro is developing a proprietary index of Singapore equities, the Goldsboro Singapore Index (GSI), which is composed of the five stocks traded on the SGX that have the largest market capitalizations Goldsboro must decide how to structure the GSI Information about the prices and market caps of these firms

is found in Exhibit 1.

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Goldsboro has four large, institutional clients who have indicated that they might invest a total of US$240 million in a fund that is indexed to the GSI These clients are very cost-sensitive.

Goldsboro already offers two mutual funds that consist of stocks that are part of the Straits Times Index (STI), a value-weighted index of the 30 largest firms traded on the SGX Exhibit 2 provides information about these two funds (GB1 and GB2), the STI index, and all stocks traded on the SGX.

Goldsboro also offers three independently managed funds, GB-STI-1, GB-STI-2, and GB-STI-3 The three funds are benchmarked against the STI index For the year 2009, Jason Briggs, a client whose Singapore benchmark is the MSCI Singapore Free Index, pursued a core-satellite approach by investing in these three funds, earning a return of 12.4% Information about these three funds, their returns, and Briggs' investments is found in Exhibit 3.

Exhibit 1 Five Largest Singapore Firms: Selected Information in US$

Firm 1/1/2009 Price @ 1/1/2010 Price @ Change in Price

Market Cap

@ 1/1/2009 (billions)

Market Cap

@ 1/1/2010 (billions)

Change in Market Cap

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Select exactly 1 answer(s) from the following:

A A price-weighted index

B A value-weighted index

C An equal-weighted index

Instructions: Number of answers: 1 You must select the specified number of answers to complete this question

"Equity Portfolio Management," Gary L Gastineau, Andrew R Olma, CFA, and

Robert G Zielinski, CFA

Study Session 11-32-d

Distinguish among the predominant weighting schemes used in the construction

of major equity share indices and evaluate the biases of each

B is correct because this weighting methodology produced the largest return of

13.5% for the GSI The return on a value-weighted index is the percentage

change in the total market capitalization of the firms in the index or

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

Study Session 11-32-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

B is correct because the clients are identified as being cost-sensitive and, of the three choices offered, pooled accounts generally have the lowest fees

9.Question

According to the information provided in Exhibit 2, Fund GB1 is best

characterized as having what equity style?

Select exactly 1 answer(s) from the following:

2010 Modular Level III, Vol 4, pp 222-227, 235-237

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

C is correct because a market-oriented equity style is one that is neither value nor

growth Fund GB1 has characteristics that are almost identical to the broader STI

index While two (dividend yield and P/E) of the four reported characteristics lean

slightly toward a growth style, the other two (P/B, projected EPS growth) lean

slightly toward a value style

10.Question

Goldsboro's Fund GB2 would appeal to an investor who is most closely focused on:

A price.

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A is correct because Fund GB2 follows a value style (higher dividend yield, lower P/E, P/B, and earnings growth) Value investors are focused on price

11.Question

The characterization of Briggs' investment as following a core-satellite approach is most

likely:

A correct.

B incorrect, because too little of the portfolio was passively invested.

C incorrect, because the funds invested in are benchmarked against

the wrong index

12.Question

During 2009, the "misfit" active return earned by Briggs' investments was closest to:

A 0.3%.

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Sylvie Verbeeten Case Scenario

Sylvie Verbeeten is the Chief Investment Officer at one of Europe's largest defined benefit pension plans On an annual basis, her investment team creates an economic forecast and draws implications for investment returns over a mid-term horizon This year, the economic forecast implied low equity and bond returns over the next few years Low returns will make

it challenging for the pension plan's assets to generate returns sufficient to meet its pension liabilities.

Verbeeten and her investment team, led by Jean Bertram, are looking for opportunities to increase the return of the pension plan's asset portfolio They are performing due diligence

on a number of these opportunities that may add long-term return enhancements to the portfolio.

Bertram has compiled the analysis and is meeting with Verbeeten to make an investment recommendation He has narrowed down the potential opportunities to alternative

investments During the meeting, he describes his rationale for choosing alternative

investments, stating that the asset class "provides good diversification benefits relative to stocks and bonds and have returns that are similar to those assets classes, although

performance appraisal is more difficult."

One category of alternative investments is private equity Bertram notes that there are two types of private equity funds: venture capital funds and buyout funds There are a number of differences between the two, including:

Bertram also notes that there are various types of venture capital investments The type depends on what stage the privately held business is in For example, a young company that has proven that an idea has a reasonable chance of commercial success may require

financing to bring the idea to market.

Bertram understands that private equity funds are typically structured as limited

partnerships He explains to Verbeeten that in such a structure, the general partner makes all investment decisions and is compensated in two ways: a fixed percentage of the capital committed by the limited partners, called the management fee, and a fixed percentage of the fund's cash inflows, called the carried interest.

Bertram creates a list of issues that Verbeeten and the investment team will need to address

if and when a strategy for private equity investing is formulated The list includes these

Difference 1: Venture capital funds are usually more highly leveraged

Difference 2: Cash flows to venture capital investors usually come earlier

Difference 3: Returns to venture capital funds are subject to greater error in measurement.

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Question

Bertram's rationale for choosing alternative investments is most likely:

A correct.

B incorrect, because of his beliefs about returns.

C incorrect, because of his beliefs about performance appraisal.

"Alternative Investments Portfolio Management," Jot K Yau, Thomas Schneeweis, Thomas

R Robinson, and Lisa R Weiss

Study Session 13-36-a

Characterize the common features of alternative investments and their markets and discuss how they may be grouped by the role they typically play in a portfolio

B is correct because alternative investments' "relative illiquidity tends to be associated with

a return premium as compensation."

14.Question

Of the many due diligence checkpoints involved in selecting active managers of alternative

investments, Verbeeten's investment team is least likely to need the ability to analyze:

A decision risk.

B market opportunity.

Issue 1: The absence of a secondary market to sell private equity commitments

Issue 2: The requirement to make provisions for capital commitment over a period of time

Issue 3: The scale of investment needed to achieve sufficient diversification within the

allocation to private equity

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Which of the differences between venture capital funds and buyout funds

described by Bertram is most likely correct?

2010 Modular Level III, Vol 5, p 41

Compare and contrast venture capital funds with buyout funds

C is correct because the interim return calculations of private equity funds depend on cash flow transactions and on the valuation of the portfolio of companies These

valuations are subject to more uncertainty for venture capital funds than for buyout firms that invest in established companies

16.Question

Bertram provided an example of a type of company that may seek outside

venture capital financing What stage of financing is this company in?

A Seed

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