CFA level 3 mock exam 6 level 3 mock 2017

QUESTION 1 HAS FIVE PARTS A, B, C, D, E FOR A TOTAL OF 31 MINUTES Cynthia McCollum, CFA, is a portfolio manager at Western Brookes, an asset advisory firm.. I would request refraining fr

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FinQuiz.com

CFA Level III Mock Exam 6

June, 2017 Revision 1

or redistribution of this material is strictly prohibited info@finquiz.com.

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FinQuiz.com – 6th Mock Exam 2017 (AM Session)

The morning session of the 2017 Level III CFA Examination has 11 questions For

grading purposes, the maximum point value for each question is equal to the number of minutes allocated to that question

11 Portfolio Management – Monitoring and Rebalancing 12

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QUESTION 1 HAS FIVE PARTS (A, B, C, D, E) FOR A TOTAL OF 31 MINUTES

Cynthia McCollum, CFA, is a portfolio manager at Western Brookes, an asset advisory firm Hart has been asked to construct an investment portfolio for Mona Hart, a senior manager at a manufacturing enterprise McCollum collects the following information on Hart:

• Hart is 52 years old and is the divorced mother of two sons, aged 8 and 12

respectively

• Her living expenses are protected against inflation and amount to $350,000 per annum

• Her annual salary offsets her living expenses on an inflation-adjusted basis

without leaving any funds for saving purposes Her salary is expected to grow at the annual inflation rate of 4% The inflation rate is expected to remain the same for the indefinite future

• She expects her living expenses to reduce by 20% upon her retirement, which is ten years from today

• She is taxed at a rate of 35% on all income, dividends and capital gains

• She has recently received $3 million from her deceased father’s estate which she wishes to employ for investment purposes

During McCollum’s meeting with Hart, the client makes two statements which the

manager feels are essential to incorporate in the decision making process

Statement 1: “My past experience with a venture capital fund investment was unpleasant

Long lock-up periods and high losses meant that my funds were tied up in a poorly performing asset class for quite some time I would request

refraining from all types of alternative asset classes.”

Statement 2: “I would not like my investment portfolio to decline by more than 15% in

nominal terms in any given year and will be satisfied with an annual tax real return of 2.5%.”

pre-A Formulate the return objective of an investment policy statement for Hart

Calculate the after-tax nominal return requirement to achieve this objective

assuming that the inheritance is invested in accordance with the stated before-tax

real rate of return Show your calculations

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B Formulate the risk objective for Hart’s investment portfolio

(5 minutes)

C Construct the constraints section of the investment policy statement Your

answer should address:

of behavioral finance Justify your response

(3 minutes)

ii Considering both her statements, determine three consequences of Hart’s

personality type

(3 minutes)

McCollum proposes four alternative strategic allocations for Hart’s investment portfolio

in the exhibit on next page:

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B (%)

C (%)

D (%)

Expected nominal after-tax return (%) 7.4 11.5 8.4 10.9

E Determine which allocation is most suitable for satisfying Hart’s investment

objectives Justify your response with four reasons

(8 minutes)

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QUESTION 2 HAS THREE PARTS (A, B, C) FOR A TOTAL OF 12 MINUTES

The Trust Department of Granton Advisory oversees the portfolios of high net-worth private clients Sean McEwen is the department’s senior trust officer who is responsible for overseeing the accounts of five clients

In the current year McEwen will be changing his investment approach and base his investment decisions on the psychographic characteristics of investors He will be

applying the following models to make classify investors:

i Barnewall Two-Way Model

ii Bailard, Biehl, and Kaiser (BB&K) Five-Way Model

A Discuss one use and one limitation of classifying investors into personality types

(2 minutes)

Model ‘i’ will be used to classify Sigmund Castro, one of McEwen’s clients Castro is a chief executive officer of a steel manufacturing concern owning a minority stake in the firm Castro has been responsible for the company’s stock price doubling in just less than five years His experimentation with corporate strategy has been the sole reason for the company’s success and growth in his financial wealth

B Applying Model ‘I’ to classify Castro, determine:

i the appropriate classification category and

ii his risk tolerance relative to need for security

Stephen Dale: “I have spent many years building a solid asset base Having started with

almost nothing, I cannot bear losing it to irrational decision-making.”

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Arnold Peterson: “I have to admit that there is a certain thrill to taking on risks especially

when the outcome is uncertain.”

Kevin Singh: “I am the most enthusiastic amongst my fellow colleagues when it comes to

making investment decisions While I do like to form opinions, I prefer screening my ideas by asking for assistance from an experienced individual and opting for those which are most suitable from a risk and return

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Template for Question 2-C

Excerpt

Classify Each

of the Four Clients According to Model ‘ii’

Justify Your Classification

Marc: “The reason for

becoming a stock broker is

Dale: “I have spent many

years building a solid asset

base Having started with

almost nothing, I cannot bear

losing it to irrational

decision-making.”

Peterson: “I have to admit that

there is a certain thrill to

taking on risks especially

when the outcome is

uncertain.”

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Singh: “I am the most

enthusiastic amongst my

fellow colleagues when it

comes to making investment

decisions While I do like to

form opinions, I prefer

screening my ideas by asking

for assistance from an

experienced individual and

opting for those which are

most suitable from a risk and

return perspective.”

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QUESTION 3 HAS TWO PARTS (A, B) FOR A TOTAL OF 18 MINUTES

The Walkers reside in Gratina, a country with an emerging market and currency pegged

to the US dollar The couple is seeking a professional to advise them on how to transfer their $50 million investment portfolio to their daughter, Cynthia, in a tax-efficient

manner They have come to Abdul Rasool, CFA, who is a tax advisor, for a solution

After analyzing the couple’s portfolio, Rasool determines that stocks and bonds

comprising the portfolio earn a pre-tax return of 8% and 6% respectively The asset classes are held in the proportion 80 stocks/20 bonds He also determines that the couple has an expected life expectancy of 20 years

Rasool devises two alternative wealth transfer strategies both of which account for the fact that bequests are taxed at a rate of 50% Cynthia pays a marginal tax rate of 30% Current tax laws permit tax-free transfer of up to $25 million

The first strategy will involve gifting the portfolio to Cynthia

A Determine the after-tax value of the portfolio if the first strategy is executed

Your answer should discuss whether this strategy should be recommended based

on the change in the value of the investment over the investment horizon Show your calculations

He now sets out to determine the adjustments will be required to the investment accounts

to ensure the post-tax weights are kept constant

B Determine the magnitude of adjustments which Rasool will need to make to the

investment accounts to ensure that the original allocation is maintained Show

your calculations

(12 minutes)

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QUESTION 4 HAS ONE PART FOR A TOTAL OF 9 MINUTES

Benjamin Streak recently retired from Cable Inc concluding his thirty year tenure as chief financial officer Over the course of Streak’s employment, he accumulated 200,000 shares of company stock as bonus for his exemplary performance The shares are

currently trading at a price of $30 per share

Streak’s investment portfolio is being managed by Natasha Craig, his asset advisor Craig determines that diversification of the large stock position is crucial to avoid concentration risk She discusses the matter with Streak and jots down the following points regarding her client’s requirements:

• The chosen diversification strategy should be optimal from a tax perspective

• Streak would like to retain voting rights and any dividend income

• He would like to minimize any transaction costs

• He would like to avoid the use of financial leverage

• He would like to retain upside potential

Determine whether each of the following strategies is appropriate or inappropriate to

diversify Streak’s concentrated stock position:

i Outright sale

ii Equity monetization

iii Hedging

Justify each answer by providing two reasons

Answer Question 4 in the template provided on page 12

(9 minutes)

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Template for Question 4

Strategy

Determine Whether Each Strategy is Appropriate or Inappropriate (Circle the Correct Answer)

Justify Each Answer by Providing Two Reasons

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QUESTION 5 HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 22 MINUTES

The Carter Foundation has endowed The Music Fund (MF), a recently established

organization with provide funding to aspiring musicians seeking formal education The fund receives grants from donors located across the globe and is headquartered in Sri Lanka MF has received $30 million in grants to date MF’s policy portfolio is being managed by Wes Moore, an asset manager

The foundation’s chief investment officer (CIO) has mandated that the fund set aside 20% of its annual grant-making and spending budget in a reserve MF’s CIO has

estimated this amount at an average of $10 million per annum for decision making

purposes MF’s management is not permitted to spend this amount until the 12-month average asset value is known with certainty

The CIO makes note that the foundation has overspent its budget in the current year In response to the overspending situation, the CIO states, “We are fortunate to be allowed to carry-back and carry-forward our annual spending Therefore, overspending in excess of the 5% annual spending rule should be beneficial to MF in the long-run.”

In the current year, MF receives a $5 million grant from Michael Thomas, the CEO of a music records company The grant has been awarded in the form of ownership rights to the record company’s stock The CEO has expressly instructed the CIO to avoid

diversifying the fund as it will reduce exposure to the stock

The CIO estimates that annual portfolio management expenses will amount to 1.2% Annual inflation is at 3% and is expected to remain at this rate for the indefinite future

A Formulate the return and risk objectives of MF’s IPS Show your calculations

where necessary

(6 minutes)

B Formulate the constraints section of MF’s IPS Your answer should address the

following and assume the CIO’s estimate with respect to annual grant-making and spending is accurate:

i time horizon

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Answer Question 5-B in the template provided on page 15

(6 minutes)

C Evaluate the impact of a cash reserve fund on grants paid out by MF in a

particular ‘up’ year

(2 minutes)

Moore proposes four alternative asset allocations for the MF policy portfolio Data concerning expected risk, return and asset class weights has been summarized in the exhibit below

Exhibit:

Proposed Asset Allocations for the MF Policy Portfolio

Allocations

A (%)

B (%)

C (%)

D (%)

D Select the asset allocation most appropriate for MF’s portfolio Support your

answer by providing four reasons Assume that the CIO’s estimate with respect to annual grant-making and spending budget is accurate

(8 minutes)

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Template for Question 5-B

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Hanna Abdul, CFA, is an independent economic analyst For her recent study, Abdul will

be comparing the values of the Canadian dollar (CAD) relative to the U.S dollar (USD) observed over the years 2012 to 2014 Upon concluding the assignment, she intends to value a developed market equity index based on economic fundamentals

During 2012 and 2013, the CAD appreciated strongly against the USD with its value rising from $0.75 in 2014 to $0.90 in 2013 However, beginning 2014, the USD rose in value and began to accelerate resulting in the CAD falling to $0.55 Based on purchasing power parity, the long-run value of the CAD is expected to fall in the range of $0.50 to

$0.85

Based on her finding Abdul attempts to explore the reasons underlying the swings in the value of the CAD She employs the relative economic strength, capital flows, and savings investment imbalances approach deriving the following conclusions:

Conclusion 1: “According to the relative economic strength approach, the rise in the

value of the CAD can be attributed to positive domestic economic growth resulting from falling unemployment levels and increased business activity Despite the decline in the value of the CAD in 2014, economic growth was still found to be higher relative to that observed in the US “

Conclusion 2: “According to the capital flows approach, the U.S observed a capital

account surplus in 2012 and 2013.”

Conclusion 3: “According to the savings-investment imbalances, the Canadian economy

was under pressure to increase investment and reduce domestic savings opening up the current account deficit in 2012 and 2013 In 2014, companies were required to cut back on borrowing and spending The CAD fell back in value as companies were required to balance the current account.”

A Determine whether each conclusion is correct or incorrect Justify your response Answer Question 6-A in the Template provided on page 18

(12 minutes)

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Abdul is cognizant of the fact that the government is limited in its ability to control exchange rates with market intervention She aims to discuss this matter in a report summarizing her observations of the USD/CAD exchange rate

B Identify three factors which limit the ability of governments to control exchange

rates with market intervention

(3 minutes)

Next, Abdul analyzes a developed market equity index comprising 5,000 stocks The issuers are large and mature companies operating in a mature economy The value of the index on the date of analysis, January 20, 2014, was $35,000 The forecasted 12-month dividends per share of the index constituents are $150 Due to the mature nature of index constituents, Abdul projects that inflation-adjusted earnings and dividends will equal to that of GDP The relevant economic data to value the index has been summarized in the exhibit below

Exhibit:

Economic Data Relevant to Valuing the Index

Long-term inflation-adjusted growth in capital stock 4.1%

C Estimate the inflation-adjusted discount rate to perpetuity using the

Cobb-Douglas production function and Gordon growth model Show your calculations

(4 minutes)

As of the end of 2014, Abdul discovers that the index is trading 25% below the level observed twelve months earlier He notes that stock issuers have coincidently maintained

a constant dividend yield in the current and previous two years

D Determine which of the following factors – actual dividends paid, required return

on equity, or long-term, real dividend growth – contributes to the price decline Justify your response

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Template for Question 6-A

Determine whether each conclusion is correct or incorrect

(Circle the Correct Choice)

Justify Your Response

Conclusion 1: “According to the

relative economic strength approach,

the rise in the value of the CAD can

be attributed to positive domestic

economic growth resulting from

falling unemployment levels and

increased business activity Despite

the decline in the value of the CAD

in 2014, economic growth was still

found to be higher relative to that

observed in the US.”

Correct

Incorrect

capital flows approach, the U.S

observed a capital account surplus in

2012 and 2013.”

Correct

Incorrect

savings-investment imbalances, the

Canadian economy was under

pressure to increase investment and

reduce domestic savings opening up

the current account deficit in 2012

and 2013 In 2014, companies were

required to cut back on borrowing

and spending The CAD fell back in

value as companies were required to

balance the current account.”

Correct

Incorrect

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Template for Question 6-D

Determine which of the

following factors supports a

price decline

Long-term, real dividend

growth

Required return on equity

Dividends paid

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Hailey Bronso is surgeon running his own medical practice He is seeking to hire an equity manager for his $1 million portfolio He prepares an equity manager questionnaire and sends it out to various investment management firms Based on the results collected, Bronso attempts to narrow his selection to firms employing the top-down forecasting approach, with a historical record of achieving excess returns relative to their

benchmarks, and delegating responsibility within the organization for asset allocation and research in an appropriate manner

A Identify the sections of the equity management questionnaire Bronso should pay

After considerable research, Bronso engages North Advisory Bronso’s investment will

be made in a fund with a quoted base fee rate of 0.50% of beginning AUM plus 30% of performance in excess of the Russell 3000 index

B Discuss two relative strengths and two relative weaknesses of adopting a

performance-fee based structure

Answer Question 7-B in the template provided on page 22

(4 minutes)

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While Bronso enjoys a certain level of risk taking, he has expressed his desire of placing

a limit on the investment manager’s ability to take risk

C Identify a feature which can alleviate Bronso’s concern with respect to

risk-taking

(1 minute)

Four years later, Bronso evaluates the performance of North Advisory’s equity fund relative to the benchmark index, Russell 3,000 equity index The fund is subject to a high water mark

Ending Net Asset Value*

(in Millions)

Russell 3,000 Index Value (in Millions)

*Gross of investment management fees

D-i Determine the value of the high water-mark, gross of investment management

fees, at the end of the third year

D-ii Determine the amount of fees which will be received by North Advisory in the

fourth year, Show your calculations

(4 minutes)

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Discuss two relative strengths and two relative weaknesses of adopting a

performance-fee based structure

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AR Manufacturing offers a defined benefit pension plan The average age of participants covered by the plan is 35 years To finance the fund’s liabilities, the chief investment officer (CIO) has constructed a portfolio of three bond issues The duration of the

portfolio has been set such that it matches that of the average liability structure

Exhibit 1 presents the initial duration of the bond portfolio from the time it was first constructed

One year after constructing the portfolio, the yield curve shifts upwards thereby

decreasing the market prices of the bonds Exhibit 2 presents the new prices of the three issues The CIO is seeking to rebalance the portfolio such that the original dollar duration

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A Determine the cash required to rebalance the portfolio

(2 minutes)

Rather than investing in each of the three bond issues, the CIO devises an alternative strategy for rebalancing the portfolio, which involves selling the Lakehouse Corp issue and investing the proceeds equally in the remaining issues The par value of the

Lakehouse Corp bond is $7.56 million

B Determine the total par value required to maintain the hedge Show your

calculations

(8 minutes)

The CIO recommends constructing a multiple asset portfolio to immunize the pension plan’s liability stream He attempts to determine the conditions which will be required to assure this immunization strategy (presented below):

1 The duration of the portfolio should equal to the average age of the participants,

C Determine which of the stated conditions is correct Justify your response

Answer Question 8-C in the template provided on page 25

(6 minutes)

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Justify Your Response

The duration of the portfolio

should equal to the average

age of the participants, 35

Correct

Incorrect

The portfolio should contain

an asset with a duration

equal to or less than the

duration of the shortest

parallel and non-parallel

yield curve shifts

Correct

Incorrect

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Twain Advisory (TA) is a U.S based firm providing brokerage and investment banking services TA manages two funds, a global equity fund and a fixed income fund The equity fund comprises highly volatile emerging market equities of two countries, Yip and Wilter, and is currently valued at $25 million The expected returns, standard deviation, correlations and weights assigned to the two stocks in the fund are summarized in the exhibit below Bolton Drew, TA’s senior most risk manager, is evaluating the loss

potential of the fund in a given week He will be using a 5% probability level for the analysis

A Calculate the weekly value added risk (VAR) using the analytical method and

interpret your results Show your calculations Assume there are 52 weeks in a typical trading year

(4 minutes)

B Determine whether the analytical method is appropriate for measuring the global

equity fund’s minimum potential loss Justify your answer Your answer should focus on the characteristics of the fund

Answer Question 9-B in the Template provided on page 28

(4 minutes)

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TA’s fixed income fund includes a $10 million allocation to callable bonds Drew will again be using VAR for measuring the risk exposure associated with this allocation He is attempting to determine the probability level which should be used for estimating daily VAR His choices include a probability level of 1%, 5% or 10%

C Determine which probability level is most appropriate for the allocation Justify

to $1.5 million Based on his analysis of the fund’s risk exposures, Drew concludes,

‘Since the plan sponsor is required to fund liabilities, whose value is exposed to interest rate risk and other risks, any calculated VAR measure will be interpreted as the

probability of the policy portfolio’s value falling by a minimum amount of $1.5 million.’

D Evaluate the accuracy of Drew’s conclusion Explain your answer

(3 minutes)

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Determine whether the

analytical method is

appropriate for measuring

the global equity fund’s

minimum potential loss

Appropriate

Inappropriate

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Determine which probability level is most

appropriate for the allocation

1%

5%

10%

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Meredith Stone is a fixed-income analyst at Rust Inc The firm issued $50 million face value worth of callable bonds ten years ago which pay an annual fixed rate of 9.2% The bond issue has a remaining maturity of six years Stone does not anticipate any further decline in interest rates for at least two years and decides to eliminate the call feature, which is not exercisable for another two years, by using a European payer swaption Rust Inc is paying a credit spread of 300 basis points over the LIBOR rate on the bond issue The relevant floating rate is LIBOR

A Determine the transaction which Stone will undertake to synthetically remove the

call feature

(2 minutes)

Two years later, the swaption expires and the relevant market swap fixed rate is 5.0% Stone decides to terminate the swap by entering into a swap at the prevailing market rate and with a maturity equal to that remaining on the original swap The floating rate is equal to LIBOR

B Calculate the Rust Inc.’s annual effective payment/receipt on the transaction

Your answer should include a discussion on the payoffs on the original and new

swap as well as payments to bondholders Show your calculations

(7 minutes)

Rust Inc has puttable bonds in its fixed-income portfolio In response to the

unanticipated decline in market swap rates, the firm would like to remove the embedded put features

C Determine how Rust Inc can synthetically remove the embedded put features

(1 minute)

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QUESTION 11 HAS ONE PART FOR A TOTAL OF 12 MINUTES

Irwin Smith is an asset advisor serving ACE Advisors, a portfolio management firm operating in Kenya Smith is reviewing the asset allocation of one of his client’s

investment portfolios (Exhibit) in an attempt to determine whether any modifications are necessary in light of three projections made by the firm’s economic analyst:

The projections made by ACE’s economic analyst are as follows:

Projection 1: “In response to a rapidly expanding economy, the central bank is expected

to tighten the monetary policy to bring inflation under control.”

Projection 2: “Given the central bank’s reputation to respond slowly to changes in

economic conditions, a rapidly expanding economy can be the sole cause of an

unanticipated surge in inflation.”

Projection 3: “A recession is the only consequence if the economy is not taken care of.”

Exhibit: Asset Allocation of Smith’s Investment Portfolio

For each projection, determine whether allocation to the mentioned asset classes should

be increased, reduced or held constant Explain your answer considering each projection

in isolation

Answer Question 11 in the template provided on page 32

(12 minutes)

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Template for Question 11

For Each Asset Class, Determine Whether the Allocation Should Be Increased, Reduced or Held Constant

Explain Your Answer

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“A recession is the

only consequence if

the economy is not

taken care of.”

Option 1:

Short-term bonds

Option 2:

Long-term Bonds

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FinQuiz.com

CFA Level III Mock Exam 6

June, 2017 Revision 1

or redistribution of this material is strictly prohibited info@finquiz.com.

Trang 35

FinQuiz.com – 6th Mock Exam 2017 (AM Session)

The morning session of the 2017 Level III CFA Examination has 11 questions For

grading purposes, the maximum point value for each question is equal to the number of minutes allocated to that question

11 Portfolio Management – Monitoring and Rebalancing 12

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