CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA level 3 finquiz item set answers, study session 13, reading 26

Question ID: 13009 Correct Answer: A The factors which need to be considered when hiring an active manager for managing an institution’s investment portfolio include: The first factor,

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CFA Level III Item-set - Solution

Study Session 13

June 2018

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FinQuiz Level III 2018 – Item-sets Solution

Reading 26: Alternative Investments Portfolio Management

1 Question ID: 13009

Correct Answer: A

The factors which need to be considered when hiring an active manager for managing an institution’s investment portfolio include:

The first factor, ‘market opportunity’, involves identifying market opportunities/inefficiencies and evaluating the cause of these opportunities Property 1 addresses this factor as the chief executive highlights the need for the prospective manager to be able to capture and size market opportunities (‘big market fish’) when market inefficiencies exist (‘the situation permits’)

The second factor, ‘investment process’, involves studying the investment process of the active manager or management firm Property 1 does not address this factor

The fourth factor, ‘people’, involves assessing the experience, intelligence, and integrity of the

candidate’s staff Property 1 does not address this factor

Correct Answer: C

By stressing on how they would like their prospective active manager to manage the pension fund’s investment portfolio, the chief executive is addressing the importance of evaluating the investment process of the active manager or management firm

In general, the issue of the suitability of an investment to a client’s portfolio is more acute for an individual client as opposed to an institutional client

Relative to investment suitability, institutional clients such as Jiah Noyce Inc should be more

concerned with the quality of the asset management firm’s service providers and any documents concerning the asset management firm These documents include audit reports or reports on internal controls

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An investment in a real estate operating company represents an indirect form of real estate

investment Thus the most appropriate benchmark for an indirect real estate investment is the

NAREIT index

The NCREIF index represents a benchmark for direct real estate investments The NCREIF index represents unleveraged investments However this benchmark is not a suitable performance

benchmark for a leveraged indirect real estate investment like the investment made in Propertex (60%

of the investment is funded by debt)

Since REITs, underlying the NAREIT index, represent a leveraged form of real estate investment, the volatility of the NAREIT index is higher compared to the unsmoothed NCREIF index The extremely low standard deviation of NCREIF index returns is indicative of the volatility dampening associated with smoothing because of stale valuations After correction for smoothing, the volatility of the NCREIF index doubles

Based on the data provided, benchmark A appears to be a NAREIT index This is because the

benchmark has the highest volatility, relative to B and C, indicating that investments underlying the benchmark are leveraged

Benchmark B represents a smoothed NCREIF index This is because B’s volatility is extremely low relative to benchmark A and relative to its returns (indicating that the index components have been smoothed) Benchmark C represents an unsmoothed NCREIF index as its volatility is higher relative

to B and lower to A indicating smoothed returns has been corrected

Thus benchmark A, representing a NAREIT index, is the most appropriate performance benchmark for an investment made in Propertex

Issuers of venture capital include:

companies beginning their product development, to companies just beginning to sell a product

to established companies with significant revenues, to companies preparing an IPO for their stock

Based on the details provided on Respiro, it is a formative stage company as they are in the process of developing their drug

The financing stages of venture capital firms include:

1) The early-stage financing – this stage includes the following stages:

company and prove that the idea has a reasonable chance of commercial success

needs money to bring its product into commercialization This is a pre-revenue stage

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First Stage – at this stage, the company may have exhausted their seed and start-up funds and may seek additional funds

2) Later-stage financing: This stage involves the financing of those companies which need funds to expand their sales

Respiro is currently in the start-up financing stage as it has proved its idea to develop the drug by having its research approved Presently, Respiro requires funds to develop its drug providing further evidence that it is in this financing stage

Correct Answer: B

Direct investment in commodities involves directly investing in the physical commodity whereas an indirect commodity investment involves investing in the stock of a firm whose principal business deals with the commodity

An investment in Felopia Inc.’s stock (investment A) and an investment in the commodity ETF both represent indirect forms of commodity investment

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