L3 mock sample exam CFA level III guideline answers 2004

LOS: The candidate should be able to “The Portfolio Management Process and the Investment Policy Statement” Study Session 9 m discuss the determination of the risk objective; s explain

Trang 1

LEVEL III, QUESTION 1

Topic: Portfolio Management − Individual

Minutes: 9

Reading References:

1 The Psychology of Investing, John R Nofsinger (Prentice Hall, 2002)

A “Psychology and Finance,” Ch 1

B “Overconfidence,” Ch 2

C “Fear of Regret and Seeking Pride,” Ch 3

D “Considering the Past,” Ch 4

E “Mental Accounting,” Ch 5

F “Representativeness and Familiarity,” Ch 7

2 Irrational Exuberance, Robert J Shiller (Broadway Books, 2000)

D “Psychological Anchors for the Market,” Ch 7

Purpose:

To test the candidate’s ability to identify and apply major tenets of behavioral finance in the context of observed investor behavior

LOS: The candidate should be able to

“Overconfidence” (Study Session 9)

a) discuss the effect of overconfidence on investors’ trading;

b) describe how overconfidence may affect risk-taking behavior

“Fear of Regret and Seeking Pride” (Study Session 9)

a) explain how the fear of regret and seeking of pride affects investors’ holding periods of winning and losing investments;

b) describe how the concept of “reference point” may affect an investor’s trading behavior

“Considering the Past” (Study Session 9)

a) compare and contrast the “house money,” “snake bite,” “trying to break even,” and

“endowment” effects on investor decision-making behaviors;

b) explain how various events in the past may affect an investor’s future risk taking

“Representativeness and Familiarity” (Study Session 9)

b) infer the characteristics of a portfolio constructed by an investor affected by the concept of familiarity;

c) discuss the investment decision problems of investors affected by the concept of familiarity

“Psychological Anchors for the Market” (Study Session 4)

d) explain how overconfidence may influence investors’ judgment about future stock price movements

Trang 2

2004 Level III Guideline Answers Morning Session - Page 2

Guideline Answer:

Maclin’s three

statements

Identify the behavioral

finance concept most

directly exhibited in

each of Maclin’s three

statements

Explain how each behavioral finance

concept is affecting Maclin’s investment

decision-making

“I have used the Internet

extensively to research the

outlook for the housing

market over the next five

years, and I believe now is

the best time to buy a

Overconfidence causes us to misinterpret the accuracy of our information and our skill in analyzing it Maclin has assumed that the information he collected on the internet is accurate without attempting to verify it or consult other sources He also assumes he has skill in evaluating and analyzing the real estate-related information he has collected, although there is no information in the question that suggests he posses such an ability

“I do not want to sell any

bond in my portfolio for a

lower price than I paid for

Trang 3

“I will not sell any of my

company stock because I

know my company and I

believe it has excellent

prospects for the future.”

Familiarity

Representativeness

Maclin is evaluating his holding of company stock based on his familiarity with the company rather than on sound investment and portfolio principles

Company employees, because of this familiarity, may have a distorted perception of their own company, assuming a “good company” will also be a good investment Irrational investors believe an investment in a company with which they are familiar will produce higher returns and have less risk than non-familiar

investments

Maclin is confusing his company (which may well be a good company) with the company’s stock (which may or may not

be an appropriate holding for his portfolio and/or a good investment) and its future performance This can result in employees overweighting their company stock

resulting in an under-diversified portfolio

Trang 4

Minutes: 20

1 Managing Investment Portfolios: A Dynamic Process, 3rd edition (AIMR, forthcoming)

A “The Portfolio Management Process and the Investment Policy Statement,” John L Maginn, Donald L Tuttle, Dennis W McLeavey, and Jerald E Pinto

B “Managing Individual Investor Portfolios,” James W Bronson, Matthew H Scanlan, and Jan R Squires

2 Questions 7, 8, and 9, including Guideline Answers, 2001 CFA Level III Examination,

reprinted in Exams and Guideline Answers, 2001, 2002, and 2003 (AIMR, 2003)

3 “Structuring the Global Investment Process,” Ch 13, International Investments, 5th edition, Bruno Solnik and Dennis McLeavey (Addison Wesley, 2003)

Purpose:

To test the candidate’s ability to formulate an investment policy statement that appropriately reflects the circumstances of an individual investor

“The Portfolio Management Process and the Investment Policy Statement” (Study Session 9) m) discuss the determination of the risk objective;

s) explain how unique circumstances can be considered a constraint

“Managing Individual Investor Portfolios” (Study Session 9)

i) discuss each of the major objectives that are part of an individual investor’s investment policy statement;

l) prepare an investment policy statement for an individual investor

Questions 7, 8, and 9, including Guideline Answers (Study Session 9)

a) formulate and justify an investment policy statement for an individual investor

“Structuring the Global Investment Process” (Study Session 18)

d) discuss the components of a formal investment policy statement;

f) evaluate the appropriateness of an investment policy statement for a global investor

Trang 5

Overall:

The Maclins’ overall risk tolerance is below average, as their below-average willingness

to take risk dominates their average ability to take risk in determining their overall risk

tolerance

ii The Maclins’ return objective is to grow the portfolio to meet their educational and retirement needs as well as to provide for ongoing net expenses The Maclins will require annual after-tax cash flows of £26,000 (calculated below) to cover ongoing net expenses and will need £2 million in 18 years to fund their children’s education and their

retirement To meet this objective, the Maclins’ pretax required return is 7.38 percent which is determined below

The after-tax return required to accumulate £2 million in 18 years beginning with an investable base of £1,235,000 (calculated below) and with annual outflows of £26,000 is 4.427 percent, which when adjusted for the 40 percent tax rate, results in a 7.38 percent pretax return (4.427%/(1 − 0.04) = 7.38%)

Annual Cash Flow = –£26,000

Trang 6

Asset Base = £1,235,000

Less One-time Needs:

The Maclins have a two-stage time horizon, because of their changing cash flow and

resource needs The first stage is the next 18 years The second stage begins with their

retirement and the university education years for their children

ii Liquidity requirements

The Maclins have one-time immediate expenses (£50,000) that include the deposit on the house they are purchasing and the charitable donation in honor of Louise’s father

iii Tax concerns

The U.K has a 40 percent marginal tax rate on both ordinary income and capital gains

Therefore there is no preference for investment returns from taxable dividends or interest over capital gains Taxes will be a drag on investment performance because all

expenditures will be after tax

iv Unique circumstances

The large holding of the Barnett Co common stock (representing 18 percent of the

Maclins’ total portfolio) and the resulting lack of diversification is a key factor to be

included in evaluating the risk of the Maclins’ portfolio and in the future management of the Maclins’ assets

The Maclins’ desire not to invest in alcohol and tobacco stocks is another constraining

factor, especially in the selection of any future investment style or manager

Trang 7

Minutes: 18

B “Managing Individual Investor Portfolios,” James W Bronson, Matthew H Scanlan, and Jan R Squires

2 Questions 7, 8 and 9, including Guideline Answers, 2001 CFA Level III Examination,

reprinted in Exams and Guideline Answers, 2001, 2002, 2003 (AIMR, 2003)

3 “Structuring the Global Investment Process,” Ch 13, International Investments, 5th edition, Bruno Solnik and Dennis McLeavey (Addison Wesley, 2003)

Purpose:

To test the candidate’s ability to critique an existing asset allocation for an individual investor and develop an appropriate asset allocation based on an investment policy statement

“Managing Individual Investor Portfolios” (Study Session 9)

j) distinguish between an individual investor’s ability to take risk and willingness to take risk Questions 7, 8, and 9, including Guideline Answers (Study Session 9)

b) recommend and justify changes in asset allocation based on stated objectives and expected returns, expected volatility, and expected correlations of returns;

c) recommend and justify changes in asset allocations incorporating all aspects of the

investment policy statement

“Structuring the Global Investment Process” (Study Session 18)

m) determine an appropriate strategic asset allocation for a global investor;

Trang 8

A

Identify two aspects of the

recommended asset allocation in

Exhibit 3-1 that are inconsistent with

the Maclins’ investment objectives

and constraints

Support each of your responses with one reason

1 The cash reserve is too high 1 The 15 percent or £185,250 cash allocation is not

consistent with the liquidity constraint

2 The large allocation to a low-return asset contributes

to a shortfall in return relative to required return

2 The 15 percent allocation to Barnett

Co common stock is too high

1 The risk of holding a 15 percent position in Barnett stock, with a standard deviation of 48, is not

appropriate for the Maclins’ below-average risk tolerance and –12 percent shortfall risk limitation

2 The large holding in Barnett stock is inconsistent with adequate portfolio diversification

3 Shortfall risk exceeds the limitation

of –12 percent return in any one year

The Maclins have stated that their shortfall risk limitation is –12 percent return in any one year

Subtracting 2 times the standard deviation from the portfolio’s expected return (6.70 percent – (2 × 12.40 percent)) gives a result (–18.10 percent) that is below their shortfall risk limitation

4 The expected return is too low (the

allocation between stocks and bonds is

not consistent with return objective)

The portfolio’s expected return of 6.70 percent is less than the return objective of 7.38 percent

Trang 9

B Note: The Maclins have purchased their home and made their charitable contribution

Asset Class

Recommend the most

appropriate allocation range for

each of the asset

classes in Exhibit 3-2

(circle one for each

asset class)

Justify each appropriate allocation range with one

reason based on the Maclins’ investment objectives

The following sample allocations are provided to illustrate that selected ranges meet the

return objective

Trang 10

Sample allocation 1:

(%)

Return (%)

Weighted Return (%)

U.K Small-capitalization Equities 10 11.0 1.10 U.K Large-capitalization Equities 10 9.0 0.90

Sample allocation 2:

(%)

Return (%)

Weighted Return (%)

U.K Small-capitalization Equities 10 11.0 1.10 U.K Large-capitalization Equities 10 9.0 0.90

Trang 11

Topic: Portfolio Management − Individual

Minutes: 7

“The Implications of Rebalancing the Investment Portfolio for the Taxable Investor,” pages

49-51, Jeffrey E Horvitz, Journal of Wealth Management (Institutional Investor, Fall 2002)

Purpose:

To test the candidate’s understanding of the implications of different rebalancing methods

“The Implications of Rebalancing the Investment Portfolio for the Taxable Investor” (Study Session 11)

a) evaluate the significance of costs associated with rebalancing;

b) judge the success of rebalancing for asset classes with various correlations and in different market environments;

c) justify the use of standard deviations as opposed to fixed percentage bands or proportions in determining rebalancing triggers

A i With such a small allocation to an emerging market equities fund (<5 percent of the

portfolio), even a large return on this fund will not significantly change the risk profile of the total portfolio Therefore, reallocating when a fixed percentage band around the 5 percent allocation is exceeded would incur unnecessary transaction and administration costs

ii Given the persistently low correlation with other assets in the portfolio, the hedge fund will exhibit systematically different performance than the rest of the portfolio Therefore, fixed percentage bands would produce substantial rebalancing (with associated costs) to maintain target allocations

B A rebalancing methodology based on standard deviations is likely to be more appropriate

than a methodology based on fixed percentage bands If each asset class is rebalanced when

it exceeds the number of standard deviations set for all asset classes, the more volatile asset classes will be rebalanced only after larger percentage price changes The result should be

less turnover (i.e., lower level of realized capital gains) and lower transactions costs

Trang 12

Level III, QUESTION 5

Topic: Portfolio Management − Economics

Minutes: 18

1 Stocks for the Long Run, 3rd edition, Jeremy J Siegel (McGraw-Hill, 2002)

A “Sources and Measures of Stock Market Values,” Ch 6

2 Irrational Exuberance, Robert J Shiller (Broadway Books, 2000)

A “The Stock Market Level in Historical Perspective,” Ch 1

Purpose:

To test the candidate’s knowledge of and ability to apply various long-term valuation models that emphasize macroeconomic influences

“Sources and Measures of Stock Market Values” (Study Session 4)

e) explain the use of yardsticks for aggregate stock valuation (e.g., price to earnings (P-E) ratio, Tobin’s Q, and ratio of market value to GDP);

g) describe the Fed model of market valuation and discuss the asset-allocation implications of the model;

h) analyze the implications that decreases in the inflation rate may have for using the Fed model

to project future stock performance;

i) summarize and interpret judgments about possible future U.S stock performance that can be derived from extrapolations of historical patterns in market valuation measures

“The Stock Market Level in Historical Perspective” (Study Session 4)

b) characterize the historical relationship between the market’s price-earnings ratio and the market’s subsequent real return

Trang 13

A i Tobin’s Q addresses market value to book value distortions by adjusting the book value

for inflation and computing the “replacement cost” of assets and liabilities on the balance sheet The theory indicates that the “equilibrium” or “correct” market price of a firm or market should equal its assets minus its liabilities, both adjusted for inflation, with the ratio being at unity if the firm or market is valued properly

ii Tobin’s Q is less effective when applied to technology or services companies Although the market values may reflect the “perceived” value of intellectual capital, an inability to analytically value intellectual capital prevents accurate reflection in “replacement cost” estimates

B i The usefulness of the ratio is likely to be reduced Deleveraging (debt reduction)

increases the value of equity and decreases the value of debt, but leaves the total value of firms unchanged This results in an increasing market value of equity to GDP ratio, even though the total intrinsic value to GDP has not changed, making the ratio a less reliable predictor of equity values

ii The usefulness of the ratio is likely to be reduced As an increasing number of firms become public, the aggregate market value of stocks increases, while the total intrinsic value of firms remains unchanged This results in an increasing market value of equity to GDP ratio, even though underlying market fundamentals have not changed, making the ratio a less reliable predictor of equity values

C i The Fed model identifies overvalued equity markets by comparing interest yields on

long-term bonds with earnings yields on stocks When the interest yield rises above the earnings yield, the equity market is overvalued relative to the bond market

ii The Fed model is not likely to be effective in the economic scenario that Webb expects The Fed model breaks down when inflation is very low or when consumer prices are stagnant and deflation threatens In such a scenario, the relation between stock market valuation and bond yields become ambiguous

• Profit margins suffer because pricing power declines (it is harder for firms to raise output prices to cover costs)

• Profit margins also suffer because real wage costs increase (it is hard for firms to negotiate nominal wage cuts)

• Stock valuations are dominated by pricing power and earnings potential, while bond values are dominated by their ability to hedge deflationary risk

Trang 14

Topic: Portfolio Management − Institutional

Minutes: 22

A “The Portfolio Management Process and the Investment Policy Statement,” John L Maginn, Donald L Tuttle, Dennis W McLeavey, and Jerald E Pinto

2 “Managing Institutional Investor Portfolios,” Charles R Tschampion, Laurence B Siegel,

Dean J Takahashi, and John L Maginn, Managing Investment Portfolios: A Dynamic

Process, 3rd edition (AIMR, forthcoming)

Purpose:

To test the candidate’s ability to formulate an investment policy statement that appropriately reflects the circumstances of a foundation

“The Portfolio Management Process and the Investment Policy Statement” (Study Session 9) b) define investment objectives and explain the types of investment objectives;

c) define investment constraints and distinguish among the types of investment constraints; m) discuss the determination of the risk objective;

n) discuss the determination of the return objective;

o) discuss the liquidity requirement and explain how a liquidity requirement can be considered a constraint;

p) discuss the types of time horizons and explain how time horizon can be considered a

constraint;

q) explain how tax concerns can be considered a constraint;

r) explain how legal and regulatory factors can be considered a constraint;

s) explain how unique circumstances can be considered a constraint

“Managing Institutional Investor Portfolios” (Study Session 10)

g) discuss investment objectives and constraints for foundations, endowments, and insurance companies;

h) create a formal investment policy statement for a foundation, an endowment, and an

insurance company;

i) appraise and contrast the factors that affect the investment policies of defined benefit plans, foundations, endowments, and life and nonlife insurance companies;

j) differentiate among the return objectives, risk tolerances, liquidity requirements, time

horizons, tax considerations, regulatory environment, and unique circumstances of defined benefit plans, foundations, endowments, and life and nonlife insurance companies;

l) formulate the overall portfolio management process leading to an investment policy

statement and an asset allocation decision for an institutional investor, including developing objectives and constraints and analyzing capital market expectations

Trang 15

A i Hale’s overall risk objective must consider both willingness and ability to take risk

Willingness:

Hale has above-average willingness to take risk

The Board desires to grow Hale’s corpus at a rate above the rate of healthcare inflation, and Hale has a long-term time horizon The Board is open to taking appropriate risk, and has agreed that a shortfall risk of –14 percent in any given year is acceptable

Ability:

Hale has average ability to take risk

Hale’s long-term time horizon would appear to give it above-average ability to take risk However, Nord’s $2 million annual contribution will cease Thereafter, all growth must

be derived from investments and Hale’s sole mission is to fund the Clinic Hale has historically provided 75-80 percent of the Clinic’s operating budget Because Hale is the primary source of funding for the Clinic, a stable, reliable flow of funds is important to meet the spending rate of 5.10 percent (see succeeding section ii) This need for

continuing, dependable support for the Clinic limits Hale’s ability to take risk Finally, Hale’s $4 million outlay within six months to fund the new facility will reduce the portfolio by 2 percent

Taken together, these factors strongly suggest that Hale has only average ability to take risk

Overall:

Considering both the ability and the willingness of Hale to take risk, the foundation has

an average risk tolerance

ii Hale’s return objective is to provide long-term funding for the Clinic’s operating budget while maintaining the inflation-adjusted value of the portfolio, and taking into

consideration management expenses and the additional healthcare inflation premium Hale’s return requirement is 8.00 percent, calculated as follows:

Trang 16

Return requirement calculation

5.10% Spending rate = ($10 million/$196 million)

Spending = $10 million = $11 million contribution to Clinic reduced by after-tax contribution from computer business of $1 million ($1.25 million pre-tax income – $0.25 million tax = $1 million)

Corpus = $196 million = $200 million reduced by $4 million for new facility contribution

+1.50% Annual inflation rate

+1.00% Health care excess inflation

+0.40% Management expenses on the portfolio

8.00% Return requirement

B i Time horizon

Hale has a single long-term time horizon, determined by its ongoing, long-term

operations with annual spending requirements

ii Liquidity requirements

The Board historically sets aside a cash cushion of 15 percent of the annual spending budget, or $1.65 million This cash reserve of slightly less than 1 percent of the portfolio helps to enable Hale to meet its exact spending requirements at the end of the year In the current year, Hale requires additional liquidity to cover the $4 million outlay for the facility in six months, or 2 percent of the portfolio

iii Tax concerns

Hale is exempt from U.S taxes under Internal Revenue Service rules as long as the annual minimum 5 percent payout requirement is met The computer consulting business

is not related to Hale’s primary business and Hale must pay tax on its income at the full corporate rate Hale should be aware that all income unrelated to its non-profit activities

is taxable

iv Legal and regulatory factors

The Internal Revenue Code mandates conditions for Hale to maintain its tax-exempt status Hale may also be governed by state laws such as Uniform Management of

Institutional Funds (UMIFA) legislation and Prudent Investor standards

Trang 17

Topic: Portfolio Management − Institutional

Minutes: 7

“Managing Institutional Investor Portfolios,” Charles R Tschampion, Laurence B Siegel, Dean

J Takahashi, and John L Maginn, Managing Investment Portfolios: A Dynamic Process, 3rdedition (AIMR, forthcoming)

Purpose:

To test the candidate’s ability to recommend and justify an appropriate asset allocation for a foundation

“Managing Institutional Investor Portfolios” (Study Session 10)

l) formulate the overall portfolio management process leading to an investment policy

statement and an asset allocation decision for an institutional investor, including developing objectives and constraints and analyzing capital market expectations;

n) recommend and justify a general asset allocation that would be appropriate for a defined benefit plan, a foundation, an endowment, or a life insurance company

Định dạng
Số trang	34
Dung lượng	215,62 KB