2013 level III sample exam version 1

Miriam Bukenya, CFA, is the head of compliance at Jacaranda Asset Management, a manager of both retail and institutional portfolios.. The firm recently adopted the CFA Institute Code of

2013 Level III Sample Exam Version 1

Jacaranda Asset Management Case Scenario

Most financial services regulatory bodies in East Africa are moving toward risk-based supervision models Miriam Bukenya, CFA, is the head of compliance at Jacaranda Asset Management, a manager of both retail and institutional portfolios She is currently revising the company's compliance policies to address risk in all areas of the business and is checking different aspects of the firm to ensure that it will be able to meet new risk-based supervision regulations when they become effective in six months' time The firm recently adopted the CFA Institute Code of Ethics and Standards of Professional Conduct as its own Code and Standards

While reviewing Jacaranda's compliance manual, Bukenya realizes it needs a few changes to comply with the new risk-based regulations To ensure she uses best practice, she consults with Luc Remmy, CFA, the head of compliance at her former employer, Mercury Advisory Services Remmy, who now runs an independent consulting firm, e-mails Bukenya the compliance manual he uses for his own firm While reviewing the compliance manual, Bukenya notices that many sections look familiar She finds a statement in the document indicating that it is for the "sole use of Mercury Advisory Services." When questioned, Remmy states that he used only the table of contents of Mercury's document and none of the other content in the document to develop his compliance manual

Bukenya looks at the marketing materials Jacaranda uses to communicate to existing and prospective clients to ensure that everything mentioned in the material is factual and complies with the CFA Standards of Professional Conduct The following statements are examined:

Statement 1: Jacaranda looks for investments offering intrinsic value through a

top-down approach including a review of forecasts of economic and

industry performance We evaluate historical and projected company

financials, perform extensive financial ratio analysis, conduct management interviews, and determine target prices using a variety of valuation models

Statement 2: Jacaranda may, at times, hire outside advisers to manage real estate

holdings on behalf of clients These advisers have the necessary

expertise to manage property assets.

Statement 3: Jacaranda has four CFA charterholders among its senior management

Their participation in the CFA examination program has enhanced their investment management skills All of these managers passed the three exams in the shortest time possible

The new risk-based regulations also require accurate and complete performance presentations, with all discretionary accounts included in at least one composite Bukenya believes Jacaranda's performance presentation policy meets these new requirements as well as the CFA Institute Code of Ethics and Standards of Professional Conduct since Jacaranda's single composite includes all current and terminated client accounts and presentations include this statement: "Detailed information regarding the performance presentation is available upon request." While Jacaranda does not currently comply with GIPS Standards, she encourages the firm to

do so within the next few years

Bukenya then reviews Jacaranda's record-keeping policy Currently, the policy requires retention of hard copies of all supporting documentation for investment recommendations and decisions made during the last five years This policy meets the new risk-based regulations Client meeting minutes and communication logs are kept electronically and backed up on a remote server Fund managers and research analysts are responsible for maintaining their own personal notes and research models This policy also applies to Jacaranda's independent research contractor, Mathew Ochieng, who (for security reasons) does not have access to the company's server Ochieng, who undertakes research only for Jacaranda, sends his research reports to the Head of Research, who then archives the electronic copies

While reviewing Jacaranda's counterparty risk policy, Bukenya discovers that trader Jackson Gatera recently convinced the back office to override controls designed to prevent overexposure to specific stockbrokers This was in violation of company rules The rules state that if the trading allocation to a specific broker is breached, trading through that broker must be suspended until the exposure drops to within the exposure limits The Counterparty Risk Committee predetermines these limits

The new risk-based regulations also require companies to gather client information as part of "Know Your Client" and anti-money-laundering processes Bukenya creates a confidentiality policy restricting access to existing and prospective client information

The information is available only to personnel who are authorized by the existing or prospective client The one exception is if the client or prospective client is thought to

be conducting illegal activities In this circumstance, the information can be released without authorization if the information is demanded through a court order or other legal requirement

1 Which of the following CFA Institute Standards of Professional Conduct did

Remmy least likely violate?

A Loyalty

B Misrepresentation

C Responsibilities of Supervisors

2 Which marketing statement should Bukenya most likely revise to conform to

the CFA Institute Code of Ethics and Standards of Professional Conduct?

A Statement 1

B Statement 2

C Statement 3

3 Does Jacaranda's performance presentation policy most likely meet

recommended procedures for complying with CFA Institute Code of Ethics and Standards of Professional Conduct?

A Yes

B No, because of the structure of the composite

C No, because it is not in compliance with GIPS standards

4 Jacaranda's record-keeping policy is most likely in violation of CFA Institute

Standard V (C) Record Retention regarding the:

A retention time frame

B keeping of hard and electronic copies

C retention of personal notes and research models

5 In response to Gatera's actions, Bukenya should least likely recommend

which of the following actions to prevent violations of the CFA Institute Code of Ethics and Standards of Professional Conduct?

A Investigate further

B Increase supervision of Gatera

C Report Gatera to CFA Institute

6 Does Bukenya's confidentiality policy most likely violate CFA Institute

Standard III (E) Preservation of Confidentiality?

A No

B Yes, regarding client status

C Yes, regarding type of information

Ptolemy Foundation Case Scenario

The Ptolemy Foundation was established to provide financial assistance for research and education in the field of astronomy Tom Fiske, the foundation's chief investment officer, and his staff of three analysts employ a top-down process that begins with an economic forecast, assignment of asset class weights, and select ion of appropriate index funds The team meets once a week to discuss a variety of topics ranging from economic modeling to economic outlook, portfolio performance, and investment opportunities, including those in emerging markets

At the start of the meeting, Fiske ash the analyst s, Len Tuoc, Kim Spenser, and Pier Poulsen, to describe and justify their different approaches to economic forecasting They reply:

Tuoc: "I prefer econometric modeling Robust models built with detailed

regression analysis can help predict recessions well because the established relationships among the variables seldom change."

Spenser: "I like the economic indicators approach For example, the composite of

leading economic indicators is based upon an analysis of its forecasting usefulness in past cycles They are intuitive, simple to construct, require only a limited number of variables, and third-party versions are also available."

Poulsen: "The checklist approach is my choice This straightforward approach

considers the widest range of data Using simple statistical methods like time-series analysis, an analyst can quickly assess which measures are extreme This approach relies less on subjectivity and is less time-consuming."

The team then discusses what the long-term growth path for U.S GDP should be in the aftermath of exogenous shocks due to the financial crises that began in 2008 They examine several reports from outside sources and develop a consensus view of 10-year annual growth expectations for the items in Exhibit 1

After a review of the portfolio and his discussion with the investment team, Fiske determines a need to increase U.S large-cap equities He prefers to forecast the average annual return for U.S large-cap equities over the next 10 years using the Grinold-Kroner model and the data in Exhibit 2

The analysts think that adding to U.S Treasuries would fit portfolio objectives but they are concerned that the Federal Reserve is likely to raise the feel funds rate soon They assemble the data in Exhibit 3 in order to use the Taylor rule to help predict the Fed's next move with respect to interest rates

To assess the attractiveness of emerging market equities, Fiske suggests that they use the data in Exhibit 4 and determine the expected return of small-cap emerging market equities using the Singer-Terhaar approach

Finally, upon examining the data pertaining to the European equity markets, the investment team believes there are attractive investment opportunities in selected countries Specifically, they compare the recent economic data with long-term average trends in three different countries (Exhibit 5)

7 Regarding the approaches to economic forecasting, the statement by which

analyst is most accurate?

A Tuoc

B Spenser

C Poulsen

8 Using the data in Exhibit 1 and the simplest approach to analyze aggregate

trend growth for U.S GDP, the most likely estimate for the 10-year annual

GDP growth (in %) is:

A 3.0

B 3.5

C 3.6

9 Using the data in Exhibit 2 and Fiske's preferred approach, the estimated expected annual return (in %) for U.S large-cap equities over the next 10

years is closest to:

A 5.6

B 7.6

C 8.4

10 Using the data in Exhibit 3 and the investment team's approach to predict the

Fed's next move, the new fed funds rate (in %) will most likely be:

A 2.1

B 2.6

C 2.9

11 Using the data in Exhibit 4 and Fiske's suggested approach, the forecast of

the expected return (in %) for small-cap emerging market equities is closest

to:

A 8.94

B 9.54

C 9.85

12 Among the three countries examined by the investment team, which is in the

most attractive phase of the business cycle for equity returns?

A Spain

B Ireland

C Hungary

Sophia Doulton Case Scenario

Sophia Doulton, CFA, owns Doulton Investments, LLC, an asset management firm She is preparing for a meeting with Jorge Thompson, a new client At an earlier meeting, Thompson provided information about his current portfolio holdings and the investment policy statement (IPS) created for him by his previous investment adviser Thompson has stated that he is generally happy with the IPS but left the previous adviser because of high fees and poor investment returns He asked Doulton to review the JPS and let him know if changes are warranted

Thompson's current IPS includes the strategic asset allocation shown in Exhibit 1 Doulton's long-term and short-term return expectations for each asset class are included

The IPS allows for asset allocations that diverge from its strategic allocations based

on the following rules and reasoning:

Rule 1: The portfolio should always overweight emerging market equities because

most long-term forecasts show high expected returns for this asset class relative to the others

Rule 2: The asset manager may make tactical allocations to asset classes not

included in the strategic asset allocation because the portfolio manager has discretion to pursue excess returns wherever they are available

Rule 3: The total allocation to bonds (U.S and non-U.S.) should never be less

than 35% because Thompson views the bond allocation as being his retirement portfolio and does not want too much risk taken with that money

Doulton is considering two additional asset classes that could be added to Thompson's

strategic asset allocation Information about the current portfolio and these two asset classes is found in Exhibit 2

Thompson's previous investment adviser used a single-period mean-variance approach to determine his optimal strategic asset allocation Doulton is concerned about this because most of the portfolio's returns are taxable and are subject to a variety of marginal rates, depending on the type and length of the investment Furthermore, Thompson's income over the next 10 years will likely result in substantial additional contributions to the portfolio Doulton plans to recommend a different approach to optimization for Thompson

Thompson does not currently hedge any of the currency risk in his strategic portfolio, which contains a 40% foreign asset exposure He asks Doulton to estimate the impact

of currency risk on that part of his portfolio Doulton estimates the standard deviation

of Thompson's foreign assets in local currency terms to be 22%, the standard deviation of the exchange rate is 12%, and the correlation between foreign asset returns in local currency and exchange rate movements is 0.4

13 Based on Doulton's return expectations provided in Exhibit 1, she would

most likely implement which of these tactical asset allocation adjustments

relative to the strategic asset allocations?

14 Which of the asset allocation rules in Thompson's IPS is least appropriate?

A Rule 1

B Rule 2

C Rule 3

15 The tactical asset allocation rules in Thompson's IPS suggest which of these behavioral influences?

A Fear of regret

B Los aversion

C Mental accounting

16 Using the information provided in Exhibits 1 and 2, Doulton should most likely recommend adding which new asset class(es) to Thompson's strategic

asset allocation?

A New asset class #1

B New asset class #2

C Both new asset classes

17 Which approach to optimization would be most appropriate for Doulton to

recommend to Thompson?

A Black-Litterman

B Monte Carlo simulation

C Resampled efficient frontier

18 The contribution of currency risk to the risk of Thompson's foreign assets is

closest to:

A 1.44%

B 3.06%

C 6.97%