CFA CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA volume 2 finquiz item set questions, study session 6, reading 13

that offers portfolio management services to institutional investors including large multinational banks, insurance companies, endowments and pension funds.. David Romano is a portfolio

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FinQuiz.com

CFA Level III Item-set - Question

Study Session 6 June 2018

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FinQuiz Item-set ID: 12424

Questions 1(12514) through 6(12519) relate to Reading 13

Institutional Funds Management (IFM) Case Scenario

Institutional Funds Management (IFM) is an investment firm in the U.S that offers portfolio management services to institutional investors including large multinational banks, insurance companies, endowments and pension funds David Romano is a portfolio manager at the firm with more than eight years of experience with the management of institutional funds and the analysis of financial markets Pinnacle Pharmaceuticals (PP) recently hired Romano for the management of their pension fund PP is a small company with a number of outlet stores in Chicago In addition to selling drugs and medical equipment, the firm also provides its customers with health advisory services The company has been operating for several years now, and about 60% of its employees are retired The average age of an employee at PP is 47 years The firm has

$250 million in pension assets to fund pension liabilities worth $263 million Exhibit 1 displays the firm’s fundamentals for the past year

Exhibit 1 Debt/Total Assets

Net profit Margin

Gross Profit Margin Pinnacle

Romano carried out his own research on the future prospects of Pinnacle Pharmaceuticals After interviewing the firm’s CEO, Kris Cole, and the firm’s suppliers, competitors and customers, Romano discovered that the firm will be receiving a patent for five years for a new drug it plans

to offer The drug is expected to generate significant demand and is expected to increase the firm’s profitability PP is also planning to hire personnel who would manage the marketing and distribution of this product This hiring will increase the active to retired lives ratio to 1.2 When Romano met with Cole to discuss the pension fund’s objectives, Cole made the following

comment:

“Our firm is currently using a discount rate of 6.89% for determining the present value of the pension liabilities However, we plan to increase this rate to 7.5% by next year Our total return objective last year was 10.57% We will decrease our last year’s surplus return objective by 50%

to determine the total return needed for next year.”

Romano is also managing an institutional fund worth $35 million for a foundation called The Premier Literacy Foundation (PLF) PLF has an objective of spending 4.75% of its total assets for the expansion of educational facilities in the country The foundation spends around 0.67% of assets towards the management of its investments In addition, 0.3% is spent annually in

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overheads associated with grant making, including the salaries of program officers and other executives The inflation rate is expected to be 2.5% over the next year The foundation follows a smoothing rule to determine its spending rate While talking to the foundation’s board, Romano made the following comments:

Statement 1: “If carry-backs and carry-forwards are allowed, the smoothing rule would be

much easier to implement.”

PLF also generates income from a small grocery store and real estate PLF has invested 40% of the value of the real estate and has borrowed the rest from a bank The foundation’s board is not sure how income from the grocery store and the real estate will be interpreted by taxing

authorities Romano made the following comment:

Statement 2: “Although foundations bear a very minimal tax burden (1-2%), the total income

from the grocery store and the real estate will be taxed at the regular corporate tax rate.”

The Conventional Bank (TCB) is a large bank with a number of branches in the U.S The bank’s CFO, Brian Day, has hired Romano as a consultant to provide advice on the management of the bank’s securities portfolio Day expects an unexpected increase in interest rates in the future and wants to immunize the bank’s balance sheet against this positive interest rate shock Exhibit 2 displays some information about the bank

Exhibit 2

Market value of liabilities $243,999,452 Market value of assets $368,460,157 Duration of liabilities 3.5 Duration of assets 7.8

The bank has mostly extended credit to large, reputable technology firms, well-established manufacturing enterprises, and wealthy individuals with a sound credit history

FinQuiz Question ID: 12425

1 Based on the information provided, Pinnacle Pharmaceuticals most likely has:

A an above average risk tolerance

B an average risk tolerance

C a below average risk tolerance

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2 The return objective for Pinnacle Pharmaceuticals for next year is closest to:

A 11.18%

B 9.34%

C 8.73%

3 Given the information about PLF, the return objective of the foundation should be closest to:

A 7.92%

B 8.22%

C 5.24%

4 Romano is most accurate with respect to:

A Statement 1 only

B Statement 2 only

C both statements 1 and 2

5 To immunize the balance sheet, the duration of assets should most likely be:

A decreased to 2.32

B decreased to 3.5

C decreased to 5.48

6 Based on the information provided about The Conventional Bank (TCB), the securities

portfolio can most likely take:

A less credit risk and will have a long time horizon

B less credit risk and will have an intermediate term horizon

C more credit risk and will have a short time horizon

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