2013 l3 sample exam v2 ans

4, Reading 25, Section 5.2.1 Study Session 10-25-a Evaluate the effect of leverage on portfolio duration and investment returns... Question Based on Exhibit 1, the number of futures cont

Trang 1

Level III Version 2_v11 2013 Sample Exam

Click here to go to MyCFA.

1

Laredo Case Scenario

Tyler Austin is a fixed-income portfolio manager at Laredo Advisors He manages a USD($)1 billion

fund that opportunistically seeks the best ideas across fixed-income markets He meets daily with Odessa Houston, the fund’s senior analyst, to discuss trade ideas that might be implemented that day Austin has identified six ideas that he would like Houston to evaluate in more detail for potential inclusion in the fund Austin notes that the current low level of interest rates is limiting the potential absolute return the fund generates He asks Houston to evaluate the use of leverage to enhance returns He can borrow 25% of the fund’s value at an annual interest rate of 1.50% and earn a rate of return of 5% per year on the invested funds

Austin tells Houston that he is concerned about the potential for rates to rise and wants to explore how the fund’s duration can be changed using the futures market The fund currently has duration of 5, and he would like to eliminate all interest rate risk Houston uses the data in Exhibit 1 for her analysis

Exhibit 1 Futures Market Data

Duration of Cheapest-to-Deliver Bond 4.9Market Price of Cheapest-to-Deliver Bond USD($)96,500Austin is intrigued by the incremental yield he could earn by buying an Italian sovereign bond A dealer provides a quote at a spread of 350 basis points over U.S Treasuries for a 5% coupon, 10-year maturity Italian Buoni Del Tesoro Poliennali (BTP) bond with duration of 6.75 He asks Houston to assess how much this bond spread could widen over the six-month period he intends to hold the bond before the yield

advantage relative to Treasuries would be eliminated

Austin asks Houston whether the euro-denominated bonds they buy should be hedged back to the U.S dollar, the fund’s domestic currency Houston responds that they should hedge back to the U.S dollar

because short-term interest rates are 2.50% in the eurozone and 0.25% in the U.S and her forecast shows that she expects the euro to depreciate by 1.75% relative to the U.S dollar

There are U.S.-denominated and euro-denominated bonds in the fund; therefore, Austin wonders whether the fund’s duration is still simply an average of the durations of each bond Houston comments, “International interest rates are not perfectly correlated Currently, the fund has 80% of the portfolio in U.S issuers with average duration of 5.5 and the remainder in German issuers with average duration of 3.5 Historically, the country beta of Germany—i.e., for German rates relative to U.S rates—is estimated to be 0.62.”

Trang 2

Laredo Case Scenario (continued)

Finally, Austin tells Houston that his models are showing mortgage securities as having the most attractive spread relative to other fixed-income sectors He believes there are certain risks associated with mortgages and would like to hedge them He asks Houston to identify the risks and possible ways to hedge them Houston replies with the following statements:

Statement 1: Option-adjusted spread (OAS) is the risk premium for holding mortgage securities;

therefore, you don’t want to hedge this spread risk If you do hedge against the spread widening, you’ll also give up the benefit from the spread narrowing If you believe yield spreads are wide, try to capture the OAS over time by increasing the allocation to mortgage securities

Statement 2: The durations of mortgage securities change in an undesirable way when interest rates

change You can effectively manage this negative convexity by buying options or by hedging dynamically Hedging dynamically with futures requires lengthening duration after rates have declined and shortening it after rates have risen The cost associated with dynamically managing negative convexity is forgoing part of the spread over Treasuries.Statement 3: You can manage volatility risk by buying options or by hedging dynamically When the

volatility implied in option prices is higher than you believe future realized volatility will

be, you should hedge by purchasing options When you believe future volatility will be higher than implied volatility, you should hedge dynamically

Question

If Austin utilizes leverage as he proposes, the rate of return on the portfolio’s equity funds will be closest to:

Feedback

“Fixed-Income Portfolio Management – Part II,” H Gifford Fong and Larry D Guin, CFA

2013 Modular Level III, Vol 4, Reading 25, Section 5.2.1

Study Session 10-25-a

Evaluate the effect of leverage on portfolio duration and investment returns

B is correct The profit on the borrowed funds accrues to the equity; therefore, the rate of return increases from 5% in the all-equity case to 5.88% when leverage is used:

50,000,000 + 12,500,000 – 3,750,000 = 5.875%

1,000,000,000The table below provides the calculations:

Borrowed Funds Equity funds

Trang 3

Question

Based on Exhibit 1, the number of futures contracts Austin needs to sell in order to eliminate all interest rate

risk in the portfolio is closest to:

Feedback

Study Session 10-25-d

Demonstrate the advantages of using futures instead of cash market instruments to alter portfolio risk

C is correct To hedge against rising rates and eliminate all interest rate risk, the fund Austen manages needs

to target duration of 0 by selling the following number of Treasury futures contracts:

3

Question

Given Austin’s time horizon, the amount by which spreads for BTPs could widen before their yield

advantage relative to Treasuries would be eliminated is closest to:

Feedback

2013 Modular Level III, Vol 4, Reading 25, Section 6.4

Study Session 10-25-k

Describe how breakeven spread analysis can be used to evaluate the risk in seeking yield advantages across international bond markets

A is correct because the yield advantage is 350 basis points annually, or 175 bps over Austin’s six-month

horizon The BTP has a duration of 6.75; therefore, 1.75% = 6.75 × W This can be reduced to 175 / 6.75 =

26 W = 26 bps.

Trang 4

Question

Based on Houston’s forecast for the EUR relative to the USD and assuming interest rate parity holds, should

Austin most likely hedge the portfolio’s EUR exposure using forward contracts?

Feedback

Study Session 10-25-j

Recommend and justify whether to hedge or not hedge currency risk in an international bond investment

B is correct because using interest rate parity, the euro is expected to depreciate by 0.25% –2.50% = –2.25% Houston believes that the euro will depreciate by only 1.75% Based on expected returns alone, Austin should not hedge the currency risk using a forward contract because he would lock in a 2.25% loss in the euro

5

Question

Based on Houston’s comment regarding international interest rates, the contribution to the portfolio’s overall

duration from German bonds is closest to:

Feedback

Study Session 10-25-i

Evaluate: (1) the change in value for a foreign bond when 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 duration of the German bonds is 3.5 and the country beta is estimated to be 0.62 relative to the U.S The duration contribution to a U.S domestic portfolio is 3.50 × 0.62 = 2.17 Because a portfolio’s duration is a weighted average of the duration of the bonds in the portfolio, the contribution to the portfolio’s duration is equal to the adjusted German bond duration of 2.17 multiplied by its weight in the portfolio; 2.17 × 0.20= 0.43

purchasing options

Trang 5

McMorris Asset Management Case Scenario

McMorris Asset Management (MCAM) is an investment adviser based in Atlanta, Georgia Tom Morris manages the active equity portfolios Dan McKeen manages the semiactive equity portfolios and the

semiactive derivatives portfolios They are preparing to meet with Maggie Smith, the chief investment officer of Philaburgh Capital, who is considering hiring MCAM to replace one of its current managers

At the meeting, Morris and McKeen discuss with Smith MCAM’s investment approaches and present her with the risk and return characteristics detailed in Exhibit 1

Exhibit 1 Summary Information for MCAM’s Investment Strategies

Approaches Active

Equity Semiactive Equity Derivatives Semiactive

market-Reason 1: Enhance portfolio performance by increasing the beta

Reason 2: Generate alpha by identifying undervalued or overvalued securities

Reason 3: Benefit from events that give rise to price changes, which are more prevalent on the short

side than the long side

Smith considers each approach listed in Exhibit 1 but is uncertain as to an optimal investment strategy She makes the following comments about market efficiency:

Comment 1: A firm’s stock price does not reflect all publically available company information, and

good research can uncover sound investment opportunities

Comment 2: Our mandate is for managers to limit volatility around the benchmark return while

providing incremental returns which exceed management costs

Smith states, “In order to ensure investment discipline, Philaburgh uses two methods to evaluate an

investment manager’s style.” She then reviews the current characteristics of MCAM’s active equity approach

as presented in Exhibit 2

Trang 6

McMorris Asset Management Case Scenario (continued)

Exhibit 2 Method 1 Based on Current-Period Data:

Equity Active MCAM for Characteristics

Active Equity Benchmark

Weighted Average Market

and Approach MCAM?s between Correlations

Value Blend Growth

Coefficient of Determination 0.39 0.45 0.65Smith indicates that Philaburgh’s performance measurement is compliant with the Global Investment

Performance Standards In considering investment performance, Morris identifies three risks that may prevent MCAM’s active equity approach from generating incremental returns:

Risk 1: Misjudging that a stock’s earnings multiple will not contract

Risk 2: Incorrectly estimating a stock’s earnings per share growth vs consensus expectation

Risk 3: Misjudging whether a stock’s undervaluation will correct within the investor’s investment

horizon

Smith concludes by telling Morris that she is impressed by MCAM’s track record in adding alpha in the U.S stock market However, she believes that the European equity markets are likely to outperform the U.S equity markets over the next five years She asks whether MCAM can structure a portfolio to capture both opportunities Morris offers to combine his long-short active equity strategy with a Euro Stoxx 50 index strategy

Trang 7

Question

Based on Exhibit 1, the approach that is least likely efficient with respect to delivering active returns for a

given level of tracking risk is:

Feedback

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

2013 Modular Level III, Vol 4, Reading 27, Section 3

Study Session 11-27-c

Recommend an equity investment approach when given an investor’s investment policy statement and beliefs concerning market efficiency

C is correct because Comment 1 describes the characteristics of an active approach while Comment 2

describes the characteristics of a semiactive approach

Trang 8

Question

Based on Exhibits 2 and 3, what can Smith most likely determine about MCAM’s investment style over

time? MCAM’s style has:

Feedback

Study Session 11-27-i

Compare 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

B is correct The active equity strategy was not value-oriented because the returns-based style analysis indicates a growth orientation given a 0.65 coefficient of determination with respect to growth returns The current holdings, however, depict a value orientation when compared with the manager’s normal benchmark given the differences in dividend yield and P/E MCAM’s style has drifted over time from growth to value

2013 Modular Level III, Vol 4, Reading 27, Sections 5.1.1, 5.1.2

The type of portfolio that Morris recommends to Smith to take advantage of both U.S and European equity

market opportunities is most likely:

Feedback

Trang 9

Mary Bing Case Scenario

Mary Bing is a senior portfolio manager at NMS Advisors (NMSA), an investment and wealth management firm with offices in Boston and Chicago NMSA provides investment advisory and asset allocation services

to private and institutional clients Bing is an expert in the use of derivatives to manage portfolios Bing

is assisted by two analysts, Rakesh Sharma and Hernando Torres Bing is performing a review of client portfolios She has collected the stock and bond index futures information that is presented in Exhibit 1 Futures prices are shown after accounting for the multiplier Bing also notes that risk-free bonds with one year to maturity yield 1.5%

Exhibit 1 Selected Information on Futures Contracts

Barclays US Aggregate Bond Index $165,260 N/A 4.89

Bing manages a portfolio invested in U.S small-cap stocks for the Wellington Academy Endowment The portfolio has a current market value of $321 million Bing and her team believe that small-cap stocks will perform well over the next three months After consulting with the trustees of the endowment, Bing decides

to raise the beta of the portfolio from 0.8 to 1.2 for the next three months Bing has also been informed that the endowment has received a $15 million cash donation that is to be invested in small caps Bing and her team decide to use futures to equitize the new cash inflow for a period of three months

Another one of Bing’s clients is KP McLane Incorporated (KPM Inc.), a U.S.-based manufacturer of men’s apparel The current market value of KPM Inc.’s pension portfolio is $950 million with a 65% allocation

to U.S midcap stocks and a 35% allocation to U.S bonds The stock allocation has a beta of 1.45, and the bond allocation has a modified duration of 5.3 Bing’s research indicates that midcap stocks are likely to underperform over the near term Accordingly, she decides to reduce the allocation to midcap stocks to 60% and increase the bond allocation to 40%

KPM Inc exports a significant portion of its products to eurozone countries KPM Inc expects the dollar

to rise against the euro and is concerned that this could lead to a decline in sales in the eurozone KPM Inc asks Bing for advice on how to manage this risk exposure

TCMS is a medical college that is a client of NMSA TCMS currently has a two-year loan outstanding with

a 5.5% fixed annual interest rate Bing expects a decline in interest rates and advises TCMS to enter into a two-year interest rate swap where TCMS would pay LIBOR + 0.5% and receive a 5.5% fixed rate From TCMS’s perspective, the duration of a two-year fixed rate loan is –1.5 years and the duration of a floating rate loan is –0.125 Bing asks Torres, “Can you comment on the overall impact of the interest rate swap on TCMS?”

Torres responds, “The net effect of entering the swap is to reduce the interest rate sensitivity of the overall loan plus swap position relative to the loan by itself; however, if the swap is added, it will be harder for TCMS to predict cash flows, and from this perspective, the swap does not serve as a good hedge.”

Bing asks Sharma, “We adjusted the asset allocation of the KPM Inc pension fund using futures Could we have used swaps to carry out the change?”

Sharma responds, “Yes, we could have used a combination of a fixed-income swap on the Barclays US Aggregate Bond Index and an equity swap on the S&P 400 MidCap Index, where the notional value is $47.5 million.”

Trang 10

Question

In order to adjust the beta of the $321 million Wellington Academy Endowment portfolio, the number of

small-cap futures contracts Bing would need to buy is closest to:

Feedback

“Risk Management Applications of Forward and Futures Strategies,” Don M Chance

Study Session 15-36-a

Demonstrate the use of equity futures contracts to achieve a target beta for a stock portfolio and calculate and interpret the number of futures contracts required

B is correct The number of futures, N f, is calculated as follows:

That is, buy 467 S&P Small Cap 600 futures contracts

Trang 11

“Risk Management Applications of Forward and Futures Strategies,” Don M Chance

Study Session 15-36-b

Construct a synthetic stock index fund using cash and stock index futures (equitizing cash)

B is correct In order to create a synthetic equity position (equitize cash) using the $15 million cash inflow, Bing should purchase futures and invest in risk-free bonds The number of contracts is:

Nf = V(1 + r) qf T

67.42 = 15,000,000(1 + 0.015)0.25

223,300That is, 67 contracts long

The amount to be invested in risk-free bonds is:

14,905,516 = 67(223,300)

(1 + 0.015)0.25

Định dạng
Số trang	22
Dung lượng	306,41 KB