Volume II behavioral finance, individual investors, and institutional InvestorsCFA level 3finquiz item set questions, study session 1, reading 2

Holler and Brookes Associates have recently hired a compliance officer to aid the firm with complying with the CFA Institute Standards of Professional Conduct and Code of Ethics.. Peltie

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FinQuiz.com

CFA Level III Item-set - Question

Study Session 1 June 2018

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FinQuiz Item-set ID: 10528

Questions 1(10529) through 6(10535) relate to Reading 2

Mark Webber Case Scenario

Mark Webber, CFA is a research analyst serving Holler and Brookes Associates, a

brokerage/dealer firm situated in the U.S The firm conducts its brokerage business on a national level The firm specializes in the trading of debt and equities of distressed firms However, in addition to distressed securities, the firm executes trade orders for conventional domestic and international securities (i.e equity and fixed income securities)

Webber is currently conducting research on Y.T Automobiles, a small automobiles

manufacturer, which is rumored to be the target of a takeover by a larger automobiles

manufacturer Webber is invited to Y.T Automobiles’ production site where he engages in discussions with company management and factory employees His visit to the productions site leads him to conclude:

Y.T Automobiles’ production activities have been halted due to an insufficient number of orders It is uncertain when production activities will resume

The manufacturer’s production technology is considerably outdated in contrast to the

technology used by competing manufacturers

Factory worker’s salaries are low in contrast to those paid by competitors, which have been one of the sources contributing to employee resignations

Following his visit, Webber decides to acquire further information on automobile industry

practices with respect to salaries paid; production levels, technologies used, and industry

participants’ financial health After discussion with a number of industry experts as well as representatives from different manufacturers, Webber arrives at the following conclusion:

“The automobile industry has in general suffered from the slowdown in demand for automobiles

across the country However based on comparisons between individual industry participants and Y.T Automobiles and between the industry and Y.T Automobiles, the latter manufacturer is either at risk of being acquired in a takeover or could potentially file for bankruptcy Thus the manufacturer is in dire need of external support which may steer the firm onto recovery.”

Holler and Brookes Associates maintains an inventory of distressed company stocks which it terms the ‘distressed fund’ Corporations included in the distressed fund are mainly those

requiring potential investors to take active equity positions and contribute to firm recovery The liquidity of the constituent stocks is low In order to improve the liquidity and enhance the

depressed value of the fund’s stocks portfolio manager, Guy Bridges, transfers a percentage of the stocks to the ‘developed equity fund’, a fund comprising of securities from developed

countries, to subsequently repurchase the stocks following a six-month period As a component

of the latter fund, Bridges believes the demand for the stocks will rise, leading to an increase in stock values

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To encourage investment in the distressed fund, Bridges recommends 30% of his existing clients invest in the fund (the circumstances of the clients highlighted below)

Exhibit Breakdown of Bridges’ clients

Client

Category Circumstances

Percentage of Bridges’ Clients

Recommendation Issued?

A

• Short-term time horizon

• Significant liquidity requirements

• Below average risk tolerance

5% Yes

B

• Intermediate term time horizon

• Significant liquidity requirements

• Average risk tolerance

15% Yes

C

• Long time horizon

• Moderate liquidity requirements

• Above average risk tolerance

30% No

D

• Long time horizon

• Low liquidity requirements

• Above average risk tolerance

40% No

E

• Intermediate term time horizon

• Low liquidity requirements

• Below average risk tolerance

10% Yes

Samuel Emerson is a Level III candidate who has recently transferred from Denver Associates, a brokerage firm Emerson will be managing client portfolios under the supervision of Webber

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identifies Emerson’s achievements at Denver Associates as being achieved at Holler and Brookes Associates

identifies Emerson as being ‘a CFA Program Level III candidate who will attain a

completion status following the upcoming June examinations.’

FinQuiz Question ID: 10529

1 In context of Webber’s research activities conducted and his subsequent conclusion, he has

most likely:

A complied with the CFA Institute Codes and Standards of Professional Conduct

B violated the standards, II (A) Material Nonpublic Information and V (A) Diligence and Reasonable Basis

C violated the standard, II (A) Material Nonpublic Information

2 With respect to the transfer of stocks from the ‘distressed fund’ to the ‘developed equity

fund’, Bridges has most likely:

A complied with the CFA Institute Codes and Standards of Professional Conduct

B violated the standards, II (B) Market Manipulation and III (C) Suitability

C violated the standard, II (B) Market Manipulation

3 By recommending the distressed fund’s stocks to 30% of his clients, Bridges has most likely

violated standard(s):

A III (B) Fair Dealing and III (C) Suitability

B III (B) Suitability only

C III (B) Fair Dealing only

4 In context of the breakdown of Bridges’ clients, which of the following clients should not

have received a recommendation?

A A and E

B A and B

C All three clients

5 The advertisement circulated by Holler and Brookes Associates has least likely violated:

A III (D) Performance Presentation

B V (C) Record Retention

C VII (B) Reference to CFA Institute, the CFA Designation, and the CFA Program

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6 Holler and Brookes Associates have recently hired a compliance officer to aid the firm with complying with the CFA Institute Standards of Professional Conduct and Code of Ethics

Which of the following ethical codes will the officer least likely recommend?

A Investment professionals must act in an ethical manner in their relationships with clients, prospective clients, employers, and global market participants

B Investment professionals must exercise diligence, independence, thoroughness and

independence when analyzing investments, making recommendations or taking

investment actions

C Investment professionals must use reasonable care and exercise independent professional judgment when engaging in professional activities

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Memchuk Investment Associates (MIA) Case Scenario

Memchuk Investment Associates (MIA) is a small asset management firm located in Eringdale, a developing country The firm is host to wide array of local clients including individuals and institutions Its institutional clients base primarily include three major clients: The pension plan

of Grace Incorporated, a surgical equipment manufacturer; The Hortwitz Trust, a foundation whose main purpose is to provide education to unprivileged children in the country’s rural areas; The Senior Citizen Endowment, a non-governmental organization providing housing and

medical care facilities to the country’s senior citizens

Yuri Peltier, CFA is one of the portfolio managers serving MIA He is responsible for managing the investment portfolio of Grace Incorporated’s pension plan The plan’s portfolio is indexed to

a large-cap international index invested in the securities of stable companies The pension plan’s investment policy stresses industry diversification, stability, and avoidance of growth stocks as critical Peltier is exploring three large-cap stocks as potential investments for inclusion in the plan’s investment account

Exhibit Potential Stocks

Stock A Stock B Stock C P/E ratio 11.2 4.5 3.8

Automobile Manufacturing

Based on the data gathered, Peltier allocates stocks B and C to the pension plan’s investment account

Cassandra Lawson is another portfolio manager serving the firm She is responsible for

managing the portfolios of individual clients The development of Eringdale’s economy and the provision of grants to help local companies compete on international levels, by the government, have been two factors which have contributed towards the increasing trend of local companies seeking public listing Trent Engineering Corporation is the latest corporation to seek a public listing of its shares The high level of demand and limited supply for its shares has forced

Lawson to allocate 80% of the purchased shares to suitable client accounts She decides to hold back 20% of the purchased shares and deposit them in her personal account The shares will be held in her account for an eight-month time period after which they will be allocated to the

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accounts of those clients who have exhibited an interest in the shares at the time of the 80% allocation During the eight-month period, she expects these stocks to appreciate in value

The recent investment craze for IPO-listed firms amongst the local market investors has

significantly increased the values of stocks such as that of Trent Engineering Corporation

Tyrone Schmidt, Lawson’s biggest client, has requested that Lawson allocate 40% of the 20% shares, held in her personal account, to his investment account If Lawson agrees to do so,

Schmidt has promised her a round trip cruise to the Bahamas Lawson is unsure of whether to accept or decline the offer but she has informed MIA inwritten of the offer

Francisco Brewer is a Level III candidate and a junior portfolio manager serving the firm

Outside office hours, Brewer has arranged to meet his long time friend at a local restaurant While waiting for his friend, Brewer overhears the conversation of two individuals He gathers that the two individuals are retired and prior to their retirement were working at a software development corporation The two retirees discuss a software development problem present in the corporation’s largest products prior to their retirement They move on to discuss that a flaw

in the source code of the corporation’s largest software product line may lead to a drop in the product line’s forecasted revenues Brewer shares this piece of information with his friend, upon his arrival, and decides to inform a fellow portfolio manager who manages the software

development corporation’s stocks for his clients’ accounts

As MIA’s junior portfolio manager, Brewer has been tasked with managing the investment account of The Senior Citizen’s Endowment under the supervision of Peltier The endowment is relatively new and has a small asset base The endowment’s investment policy exclusively

mandates the inclusion of socially responsible companies in its investment account Apart from this requirement, the investment policy provides no further guidance The endowment’s chief investment officer has complained to Brewer of a recent allocation of emerging market socially responsible companies introducing significant risk to the endowment’s portfolio

7 By allocating stocks B and C to Grace Incorporated pension plan’s investment account, has Peltier violated the CFA Institute Standards of Professional Conduct?

A No

B Yes with respect to stock B

C Yes with respect to stock C

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8 By allocating 80% of Trent Bridge Corporation’s stocks to his clients and retaining 20% of the stocks for his personal account, respectively, has Lawson violated any standard(s)?

Allocating 80% of the stocks to his

B III (C) Suitability III (B) Fair Dealing

C III (A) Loyalty Prudence and Care

and III (B) Fair Dealing

No standards have been violated

9 If Lawson allocates 40% of the 20% Trent Bridge Corporation’s stock, held in her personal account, to Schmidt’s investment account and accepts the round trip cruise offer she will

most likely be violating all of the following standards except for:

A I (B) Independence and Objectivity

B III (B) Fair Dealing

C IV (B) Additional Compensation Arrangements

10.Brewer has most likely violated the standard, II (A) Material Nonpublic Information, by

sharing information on the software development corporation with:

A neither of the two

B his friend and the fellow portfolio manager

C the fellow portfolio manager only

11.By recommending emerging market socially responsible companies for the investment

account of The Senior Citizen’s Endowment, has Brewer violated any Standards of

Professional Conduct?

A Yes, Brewer has violated III (C) Suitability

B Yes, Brewer has violated III (B) Fair Dealing

C No

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12.As Brewer’s supervisor, has Peltier violated any standards?

A Yes, he has violated IV (C) Responsibility of Supervisors

B Yes, he has violated III (C) Suitability and IV (C) Responsibility of Supervisors

C No

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Rice & Helmore Associates Case Scenario

Rice & Helmore Associates is a regional firm which provides investment banking and

investment counseling/management services to individual clients The firm generates a

significant proportion of its annual revenues from its investment counseling department CEO and senior compliance officer, Radolph Herrera, ensures the two divisions are segregated and interact as little as possible Herrera is working on developing additional procedures to ensure greater compliance with the CFA Institute Standards of Professional Conduct

G&J is a medium-sized local food wholesaler The wholesaler is an important client of the firm’s investment banking division and is the firm’s most prized client In order to expand its consumer base, the wholesaler is planning to launch its own clothing line However in order to implement this plan it will need to hire designers and arrange for the necessary financing Feral Sutton, an investment banking employee in charge of the wholesaler, recommends it arranges 40% of its financing by issuing equity and 60% of its financing by issuing 10-Year Corporate BBB-rated bonds

Brent Mullins is an investment analyst serving Rice & Helmore Associates Mullins and Sutton studied together and now work at the same firm They are close friends and frequently spend time with each other during lunch hours Mullins is closely following the food wholesale

industry, including G&J To avoid the appearance of any conflicts, Mullins avoids discussing any information acquired during his research activities Sutton, who is unaware that Mullins is covering the wholesale industry, discusses with Mullins G&J’s expansion plans

Following the discussion with Sutton, Mullins returns to his department and informs Herrera of this valuable piece of information Herrera, aware of the wholesaler’s plans, tells Mullins to ensure he concludes his report with a buy recommendation Contrary to Herrera’s instructions, Mullins analysis of G&J indicates that the company’s plan may not prove to be successful due to the clothing line being too expensive for its consumers Mullins is yet to arrive at a conclusion Mighty-You Inc is a sports equipment manufacturer and retailer which is locally based and operates on a global scale The manufacturer/retailer targets a small market segment by

producing fitness equipment for an older age bracket, 55-85 years Mighty-You Inc solely uses the firm’s investment counseling services Salvatore Delgado, CFA is the investment counselor managing the manufacturer’s investment portfolio Mighty-You Inc has requested Delgado to locate a new broker for directing its trades since it is unsatisfied with the current’s performance Delgado conducts a broker search for his client using factors such as fees charged, execution speed and price, access to global research, and broker skills amongst others to screen the

potential broker-candidates His screening process leaves him with two potential brokers: Mace Brokerage and Harold & Haroon Associates Mace Brokerage is situated in a different country, charges a fee which is substantially higher than the existing broker, provides a relatively higher

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execution speed, and access to research conducted by local and global firms Harold & Haroon Associates is a local broker charging fees lower than the existing broker, offering access to research conducted by local firms, but executing transactions at a poor execution speed

The country’s national market has exhibited considerable volatility over the previous six months

As a result, investment counselors of the firm forecast the risk of their clients’ securities may increase substantially In order to offset these risks, a senior investment counselor serving at the firm recommends the use of derivatives for a six-month period Due to the firm’s inexperience with the asset class, it implements the derivative strategy for a portion of its clients’ portfolios The derivative strategy will be subject to a trial period of one month during which it will be evaluated If the strategy proves to be successful, the firm will implement the strategy for the rest

of the client portfolios and issue a formal written notification to all existing and potential clients

In order to comply with the CFA Institute Standards of Professional Conduct CEO and

compliance officer, Herrera, has decided to implement a number of policies which will enhance its outlook in the investment industry He has drafted three of these policies

Policy 1: The firm should ensure that its investment banking division and investment

research division are separated by an invisible firewall structure and any unsupervised communications between the two departments is allowed once the investment research department has issued the research report

Policy 2: Any proxy votes must be cast in line with the management’s votes and subject to

a cost-benefit analysis In the event proxy voting is costly relative to the firm’s and client’s benefits the voting process should not be conducted, irrespective of the importance of the processes’ benefits to beneficiaries The benefits of clients must always be kept in mind

Policy 3: In conjunction with local regulations, any materials used to conduct research must

be appropriately stored in an electronic form for a period of four years after which they may be discarded

The high volatility present in the national markets has increased the volatility of several

securities traded the national stock market This has resulted in considerable security selection problems for Malcolm Strickland, a portfolio manager serving the firm who manages the

portfolios of risk-averse clients investing in these securities To make these securities suitable for his clients’ portfolios, Strickland purchases the securities for their portfolios and justifies his purchase by issuing the following statement, “Although the purchased securities are presently highly risky, the volatility is projected to fall after a six month period once the market volatility returns to normal levels I advise you all to be patient.”

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13.In context of the discussions between Sutton and Mullins, which of the following CFA

Institute Standards of Professional conducts been least likely violated?

A Standard III (E) Preservation of Confidentiality

B Standard IV (C) Responsibility of Supervisors

C Standard II (A) Material Nonpublic Information

14.In order to avoid violating the CFA Institute Standards of Professional Conduct, Mullins should:

A conclude his report with an investment recommendation based on his independent

analysis of G&J

B follow Herrera’s instructions and conclude his report with a buy recommendation

C decline continuing with the assignment and ask for another assignment

15.Which of the following potential brokers, if appointed, will most likely lead to Delgado

violating Standard III (A) Loyalty, Prudence and Care?

A Mace Brokerage only

B Harold & Haroon Associates

C Either of the two potential brokers

16.By implementing the derivative strategy for a portion of the client portfolios (to offset

national market risks) which of the following standards will least likely be violated?

A Standard III (C) Suitability

B Standard V (A) Diligence and Reasonable Basis

C Standard V (B) Communication with Client and Prospective Clients

17.Which of the following drafted policies are least consistent with the provisions laid out by

the CFA Institute Standards of Professional Conduct?

A 1 and 2

B 2 and 3

C 1 only

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18.By allocating the highly volatile securities to his client portfolios and justifying his

allocation, Strickland has violated:

A Standards III (C) Suitability and V (A) Diligence and Reasonable Basis

B Standards I (D) Misconduct, III (C) Suitability, and III (D) Performance Presentation

C Standards I (C) Misrepresentation and III (A) Loyalty, Prudence and Care

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