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2018 Level III Mocks

2018 CFA® Exam Prep

IFT Mock Exams

Level III

Document Version: 1.5


Publish Date: May 13, 2018
Errata information can be found at: https://goo.gl/UVXdAv

This document should be used in conjunction with the corresponding reading in the 2018
Level III CFA® Program curriculum. Some of the graphs, charts, tables, examples, and figures
are copyright 2017, CFA Institute. Reproduced and republished with permission from CFA
Institute. All rights reserved.

Required disclaimer: CFA Institute does not endorse, promote, or warrant the accuracy or
quality of the products or services offered by IFT. CFA Institute, CFA®, and Chartered
Financial Analyst® are trademarks owned by CFA Institute.

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2018 Level III Mocks

Table of Contents
Exam 1 Morning Session .................................................................................................................................... 3
Exam 1 Afternoon Session .............................................................................................................................. 60
Exam 2 Morning Session .................................................................................................................................. 88
Exam 2 Afternoon Session ........................................................................................................................... 140
Exam 3 Morning Session ............................................................................................................................... 165
Exam 3 Afternoon Session ........................................................................................................................... 205
Exam 1 Morning Session Solutions ........................................................................................................... 228
Exam 1 Afternoon Session Solutions ....................................................................................................... 262
Exam 2 Morning Session Solutions ........................................................................................................... 276
Exam 2 Afternoon Session Solutions ....................................................................................................... 302
Exam 3 Morning Session Solutions ........................................................................................................... 314
Exam 3 Afternoon Session Solutions ....................................................................................................... 336

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Exam 1 Morning Session 2018 Level III Mocks

Exam 1 Morning Session

Questions Topic Minutes


1 Portfolio Management – Behavioral 10
2 Portfolio Management – Individual 25
3 Portfolio Management – Individual 15
4 Portfolio Management – Institutional 17
5 Portfolio Management – Institutional 18
6 Portfolio Management – Individual 18
7 Portfolio Management – Economics 15
8 Portfolio Management – Fixed Income 14
9 Portfolio Management – Equity 17
10 Portfolio Management – Risk Management 12

11 Portfolio Management – Trading, Monitoring, and 19


Rebalancing
Total: 180

Start time: 9:00 AM

End time: 12:00 PM

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Exam 1 Morning Session 2018 Level III Mocks

QUESTION 1 HAS THREE PARTS (A, B, & C) FOR A TOTAL OF 10 MINUTES.

An advisor for Freans Capital Management is working with a new client, Tom Braidwood.
Prior to meeting with him, the advisor asks Braidwood a series of diagnostic questions to
determine whether he may have any of the following investment behavioral biases:
• Loss aversion
• Endowment
• Regret aversion
• Illusion of control
• Overconfidence
• Framing

Sample diagnostic questions are shown in Exhibit 1.

Exhibit 1
Freans Capital Management
Sample Diagnostic Questions

1. If you are offered two free lottery tickets, would you select your own numbers or
have a machine do it?
2. At what price are you willing to sell off your investment holdings that you received as
inheritance?
3. How do you generally attribute the success of your decisions?

A. Identify the behavioral bias that each diagnostic question in Exhibit 1 is most likely to
reveal.
Note: Each diagnostic question is designed to reveal a different bias.
ANSWER QUESTION 1-A IN THE TEMPLATE PROVIDED.

(3 Minutes)

Tom Braidwood informs his advisor that he has always been willing to take a small chance of
losing up to 7 percent of the portfolio annually. He says that he can accept any asset classes
to meet his financial goals if the following constraint is considered.
“Expected return – 1.645 × Expected standard deviation ≥ –7%.”

After listening to him, the advisor concludes that he is actually striving for a mean- variance
efficient portfolio.

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Exam 1 Morning Session 2018 Level III Mocks

Braidwood tells the advisor that his previous Wealth Advisor, Andy, made following
statements to him.

Statement 1: It is always recommended to know the historical performance of the CEO of


the company before investing in a company. Based on this belief, you should own shares of
Frio Industries as Frio’s CEO used to run APCO’s operations and he did a wonderful job
there.

Statement 2: Global Equity Funds have increased 1.5 – 2.0 times the historical average over
the past two years. Based on this information, I expect global equity funds to face a reversal
in near future. As a result, it is preferred to reallocate funds from equities to fixed-rate
portfolio assets.

B. Comment on the conclusion made by the Advisor regarding Braidwood’s portfolio


preference.

(2 Minutes)

C. Select the behavioral finance concept (availability, confirmation, framing, gambler’s


fallacy, representativeness, overconfidence, hot hand fallacy) best exhibited in each of
Andy’s two statements. Justify your response with one reason.
ANSWER QUESTION 1-C IN THE TEMPLATE PROVIDED.

(5 Minutes)

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Exam 1 Morning Session 2018 Level III Mocks

Answer Question 1 on This Page


1-A. Identify the behavioral bias that each diagnostic question in Exhibit 1 is most likely to
reveal.

Note: Each diagnostic question is designed to reveal a different bias.

Diagnostic Question Identify the behavioral bias that each


diagnostic question in Exhibit 1 is most
likely to reveal.
(circle one)
1. If you are offered two free lottery
• Loss aversion
tickets. You may either select your own
numbers or have a machine do it. What
• Endowment
would you do?
• Regret aversion

• Illusion of control

• Overconfidence

• Framing

2. How would you describe your


• Loss aversion
emotional attachment to possessions or
investment holdings?
• Endowment

• Regret aversion

• Illusion of control

• Overconfidence

• Framing

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Exam 1 Morning Session 2018 Level III Mocks

3. How do you generally attribute the


• Loss aversion
success of your decisions?
• Endowment

• Regret aversion

• Illusion of control

• Overconfidence

• Framing

1-B. Comment on the conclusion made by the Advisor regarding Braidwood’s portfolio
preference.

1-C. Select the behavioral finance concept (availability, confirmation, framing, gambler’s
fallacy, representativeness, overconfidence, hot hand fallacy) best exhibited in each of Andy’s
two statements. Justify your response with one reason.

Andy’s statement Select the behavioral Justification


finance concept best
exhibited in each of
Advisor’s two
statements.
Note: No behavioral finance
concept can be used more than
once.
(circle one)

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Exam 1 Morning Session 2018 Level III Mocks

1. It is always recommended • Availability


to know the historical
track record of the CEO of • Confirmation
the company before
investing in a company. • Framing
Based on this belief, you
should own shares of Frio • Gambler’s fallacy
Industries as Frio’s CEO
was previously in charge • Representativeness
of APCO’s operations
where he did a wonderful • Overconfidence
job.
• Hot hand fallacy

2. Global Equity Funds have • Availability


increased 1.5 – 2.0 times
the historical average • Confirmation
over the past two years.
Based on this • Framing
information, I expect
global equity funds to face • Gambler’s fallacy
a reversal in near future.
As a result, it is preferred • Representativeness
to reallocate funds from
equities to fixed-rate • Overconfidence
portfolio assets.
• Hot hand fallacy

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Exam 1 Morning Session 2018 Level III Mocks

QUESTION 2 HAS FOUR PARTS (A, B, C, & D) FOR A TOTAL OF 25 MINUTES.

Robert and Mary Puentes are meeting with John Mesa, CFA, their long-time advisor, to
discuss financial planning issues. Robert and Mary Puentes, both age 50, live in U.S. Robert is
retired. He ran an advertising company which he recently sold off. The Puentes will rely on
their investment portfolio to meet future expenses in excess of Robert’s retirement income.
Mary is not employed. Puentes will receive retirement payments of USD 110,000 per year for
his lifetime from the business he sold. The retirement payments are not indexed for future
inflation and are fully taxable as ordinary income.

The Puentes’ total living expenses last year were USD 200,000, and they are expected to
grow each year at the inflation rate. The tax rate on ordinary income and all investment
returns is 30%. The inflation rate is expected to be 3% per year.

The Puentes live in a house with a market value of USD 1,250,000, mortgage-free. They have
a taxable investment portfolio with a current market value of USD 5,500,000. The Puentes’
plan to purchase a second home worth approximately USD 1,150,000 to be used for holidays,
in around five years’ time.

Their goals are to grow the asset base of the portfolio over time to maintain its after-tax
purchasing power and to establish and maintain a cash reserve of USD 200,000. Upon his
death, Robert wishes to provide for his wife, but intends to donate the majority of his assets
to charity.

John has gathered following information about the Puentes to determine their personality
types i.e. cautious, methodical, spontaneous, or individualist.

A summary of this information is presented below.


• Robert often reads the CEO’s statement about the company in annual reports while
analyzing stocks rather than doing a detailed analysis.
• Robert prefers riskier stocks, and sometimes trades excessively so as not to miss an
investment trend.
• Mary is less concerned with market sentiment or analysts’ recommendations of stocks.
• Mary’s investment decisions are made based on detailed analysis and investment
research.
• Mary follows a very disciplined approach to stock selection and she is always on the
quest for new information.

The Puentes live in a community property regime. The community property regime entitles

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Exam 1 Morning Session 2018 Level III Mocks

a surviving spouse to receive one-half of the community property after the first spouse’s
death. Only 15% of Robert’s assets are community property. Exhibit 1 summarizes gift and
inheritance tax rates applicable to the Puentes Family.

Exhibit 1
Gift and Inheritance Tax Rates
Tax Type Tax Rate
Spousal inheritance tax 25%
Spousal gift tax 30%
Non-spousal inheritance tax 50%
Non-spousal gift tax 30%
Note: All taxes are due immediately at the time of the transfer and are paid for by the
recipient.

Robert feels that Mary’s legal entitlement under the community property rules will not be
sufficient to meet her financial needs. John estimates that if Robert were to die today, Mary
would need to inherit USD 750,000 net of any taxes to meet her needs.

A. Determine the Puentes’ nominal after-tax required rate of return for the coming year.
Show your calculations.

(10 minutes)

B. Characterize the Puentes’ as below-average, average, or above-average in their ability to


take risk. Justify your response with two reasons based on the Puentes’ specific
circumstances.
ANSWER QUESTION 2-B IN THE TEMPLATE PROVIDED.

(6 minutes)

C. Select the investor personality type for:


i. Robert
ii. Mary
Justify each selection with one fact from the information about the Puentes’ provided in
vignette.
ANSWER QUESTION 2-C IN THE TEMPLATE PROVIDED.

(4 minutes)

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Exam 1 Morning Session 2018 Level III Mocks

D. Calculate the minimum bequest (in USD) from Robert’s estate to Mary in order to meet
her spending needs and taxes. Show your calculations.

(5 minutes)

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Exam 1 Morning Session 2018 Level III Mocks

Answer Question 2 on This Page


2-A. Determine the Puentes’ nominal after-tax required rate of return for the coming year.
Show your calculations.

2-B. Characterize the Puentes’ as below-average, average, or above-average in their ability


to take risk. Justify your response with two reasons based on the Puentes’ specific
circumstances.

Characterize the
Puentes as below average,
average, or Justify your response with two reasons
above-average in based on the Puentes’ specific
their ability to take circumstances.
risk.
(circle one)

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Exam 1 Morning Session 2018 Level III Mocks

Below-average

Average

Above-average

2-C. Select the investor personality type for:


i. Robert
ii. Mary
Justify each selection with one fact from the information about the Puentes’ provided in
vignette.
Justify each selection with
Select the investor one fact from the
personality type for i. Robert and ii. Mary. information
(circle one for each) about the Puentes’
presented in vignette.

Cautious

i. Robert Methodical

Spontaneous

Individualist

Cautious

Methodical
ii. Mary
Spontaneous

Individualist

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Exam 1 Morning Session 2018 Level III Mocks

2-D. Calculate the minimum bequest (in USD) from Robert’s estate to Mary in order to meet
her spending needs and taxes. Show your calculations.

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Exam 1 Morning Session 2018 Level III Mocks

QUESTION 3 HAS FOUR PARTS (A, B, C, & D) FOR A TOTAL OF 15 MINUTES.

Gus Weaver is the owner of a privately traded manufacturing concern which is currently
worth $25 million and was established twenty-five years ago. Weaver is 65 years of age and
has approached his financial advisor, Kyle Lucas, to discuss his goals and investment
portfolio. Weaver’s is concerned about minimizing the downside risk and wants to maintain
a minimum net worth of $5 million at all times. Exhibit 1 shows Weaver other assets details.

Exhibit 1
“Aspirational” Risk
“Personal” Risk Bucket “Market” Risk Bucket Bucket
Home $2,000,000 Equities $3,000,000 Family $25,000,000
Business
Mortgage on $0 Intermediate- $2,500,000 Private $5,000,000
Primary and Long- Equity
Residence Term Fixed
Income
Cash/Short- $1,500,000
Term
Treasury
Bonds and
Notes
Total $3,500,000 Total $5,500,000 Total $30,000,000

Lucas thinks that current asset allocation seems very aggressive for someone his age. Lucas
suggests Weaver to consider diversifying his current portfolio by selling a portion of his
family business. Weaver agrees to Lucas’ suggestion but requests him to consider following
near term objectives while deciding for monetization strategies.
• Maximize the amount of cash up front at the time of sale;
• Remain actively involved in the company for near future;
• Retain some upside exposure to the value of the business;

Weaver presents the following three potential monetization strategies:


i. Full sale to the senior management team in a management buyout;
ii. Full sale to the Family or Next Generation;
iii. Partial sale through an initial public offering;

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Exam 1 Morning Session 2018 Level III Mocks

A. Using a goal-based planning framework (i.e., personal, market, and aspirational risk
buckets), identify the significant risk(s) that Weaver is currently facing.

(3 minutes)

B. Select the monetization strategy that will most likely achieve all of Weaver’s objectives.
Identify, for each strategy not selected, one objective it fails to achieve.
ANSWER QUESTION 3-B IN THE TEMPLATE PROVIDED.

(4 minutes)

Weaver’s brother, Mattios, is also Kyle Lucas’ client. Mattios recently retired from
DigitalTime, Inc., a technology company where he experienced a long and successful tenure
as a senior executive. During his 30-year career with DigitalTime. Mattios received a
considerable portion of his compensation in the form of employee stock options. Lucas
recommended Mattios to hedge the risk of his employee stock options using an option-based
cash less collar. The underlying stock increases by $5 million above the strike price of the
call options while the hedge is in place.

During his career, Mattios accumulated one million shares of a company named Lakson Inc.
These shares are currently valued at USD 30 million and represent the majority of his
wealth. These shares do not pay a dividend. Lucas notes that Mattios’ Lakson shares have a
very low cost basis. The jurisdiction in which Mattios resides levies capital gains taxes only
on the sale or disposal of a security. Therefore, any outright sales of shares would result in
significant long-term capital gains which would be taxed at 30%.

Lucas suggests to Mattios to consider tax-free stock swap to diversify his concentrated
position in Lakson’s stocks. Tax–free swap would involve $35 million in Maple shares in
exchange for all of Lakson’s shares, with no cash consideration. The tax cost basis that
Mattios has in Lakson shares, essentially zero, would become his tax cost basis in Maple
shares transferred to the Maple shares. If Mattios accepts a tax-free stock swap, he is able to
sell the Maple shares short against the box. He would realize 95% of the value of the Maple
shares with no limitations on the use of proceeds. The after-tax cost to access the proceeds
would be locked in at 15 bps per year. Mattios would be able to keep the position in place
indefinitely.

Mattios asks Lucas about cashless collar strategy as it sounds easier to implement. Lucas
determines that the pairs of options shown in Exhibit 2 are available, all with the same
expiration dates. Lakson’s share price is currently USD 30.00.

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Exam 1 Morning Session 2018 Level III Mocks

Exhibit 2
Strike Prices of Available Lakson Options (in USD)
Option Pair Put Call
A 32.50 32.50
B 27.50 33.50
C 33.50 27.50

C. Describe the mismatch in character that potentially affects Mattios with regard to use of
option-based collar for hedging his employee stock options.

(2 minutes)

D. Determine the value of the tax-free stock swap offer with a short sale against the box
and with immediate sale of the Maple shares. Show your calculations.

(3 minutes)

E. Identify which option pair is most likely to create a cashless collar position for Mattios.
Justify your response.
Note: No calculations are required.

(3 minutes)

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Exam 1 Morning Session 2018 Level III Mocks

Answer Question 3 on This Page

3-A. Using a goal-based planning framework (i.e., personal, market, and aspirational risk
buckets), identify the significant risk(s) that Weaver is currently facing.

3-B. Select the monetization strategy that will most likely achieve all of Weaver’s objectives.
Identify, for each strategy not selected, one objective it fails to achieve.

Select the monetization strategy that


Identify, for each strategy not selected,
will most likely achieve all of Weaver’s
one objective it fails to achieve.
objectives.
(circle one)
i. Full sale to the senior management
team in a management buyout;

ii. Full sale to the Family or Next


Generation;

iii. Partial sale through an initial public


offering;

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Exam 1 Morning Session 2018 Level III Mocks

3-C. Describe the mismatch in character that potentially affects Mattios with regard to use
of option-based collar for hedging his employee stock options.

3-D. Determine the value of the tax-free stock swap offer with a short sale against the box
and with immediate sale of the Maple shares. Show your calculations.

3-E. Identify which option pair is most likely to create a cashless collar position for Mattios.
Justify your response.

Note: No calculations are required.

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Exam 1 Morning Session 2018 Level III Mocks

QUESTION 4 HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 17 MINUTES

Link Bank is a commercial bank operating in the U.S. The Bank’s Board of Directors (the
“Board”) is responsible for formulating and implementing investment policies. The Board
delegates authority for making specific investments to the Bank’s officers (“Management”)
that are consistent with this IPS. The Board has appointed an Investment Committee (the
“Committee”) who is responsible for monitoring and reviewing all investment decisions for
compliance with the IPS and with federal and state regulations. The Committee also
recommends changes to IPS to the Board when appropriate.

The Committee, in its last meeting, discussed the following different scenarios with respect
to its loan portfolio and requested the Management to apprise the Committee in next
meeting the effect of each of the suggested changes on the bank’s investment objectives,
constraints, or risk-taking ability.
I. The Bank has decided to restrict lending to customers with a credit rating of A or
higher although the Bank’s overall risk tolerance is unchanged.
II. The Bank decides to increase the holdings of long-term mortgage-backed securities.
III. The target average maturity of loans is decreased, with overall risk tolerance
unchanged.
IV. Fewer opportunities exist for expanding net interest margins with low risk in Link
Bank’s loan portfolio than in its securities portfolio.
The Chairman of the Bank’s ALCO Committee, Mr. Samuel Miller, is analyzing the
implications of the recent unexpected fall in interest rates on the bank’s market value of
equity.

The current structure of the bank’s balance sheet is as follows:


• Market value of Assets: $ 150 MN
• Market Value of Liabilities: $ 170 MN
• Duration of Assets: 7.5
• Duration of Liabilities: 4.5

Mr. Miller states to other member that besides earning a positive return on invested capital,
we should maximize the duration of Bank’s Equity.

A. Explain the impact of each of the scenarios on the bank’s objectives and constraints, or
risk-taking ability. Your response should consider each policy in isolation.
ANSWER QUESTION 4-A IN THE TEMPLATE PROVIDED

(4 minutes)

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Exam 1 Morning Session 2018 Level III Mocks

B. Discuss one implication of a negative interest rate shock on the bank’s balance sheet.

(3 minutes)

C. Determine the course of action that should most likely be taken if the duration of Bank’s
Equity is lower than desired.

(2 minutes)

D. Determine whether Link Bank has below-average, average, or above average ability to
take risk regarding their securities portfolio. Justify your response.
ANSWER QUESTION 4-D IN THE TEMPLATE PROVIDED.

(2 minutes)

E. Formulate each of the following constraints for Link Bank’s IPS:


i. time horizon
ii. liquidity
iii. tax concerns

(6 minutes)

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Exam 1 Morning Session 2018 Level III Mocks

Answer Question 4 on This Page


4-A. Explain the impact of each of the scenarios on the bank’s objectives and constraints, or
risk-taking ability. Your response should consider each policy in isolation.

Scenario Evaluate the Impact of the scenario on the


Bank’s Objectives and Constraints, or
risk-taking ability. Consider each Policy
in Isolation
I. The Bank has decided to restrict lending
to customers with a credit rating of A or
higher although the Bank’s overall risk
tolerance is unchanged

II. The Bank decides to increase the


holdings of long-term mortgage-backed
securities

III. The target average maturity of loans is


decreased, with overall risk tolerance
unchanged.

IV. Fewer opportunities exist for expanding


net interest margins with low risk in
Link Bank’s loan portfolio than in its
securities portfolio.

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Exam 1 Morning Session 2018 Level III Mocks

4-B. Discuss one implication of a negative interest rate shock on the bank’s balance sheet.

4-C. Determine the course of action that should most likely be taken if the duration of Bank’s
Equity is lower than desired.

4-D. Determine whether Link Bank has below-average, average, or above average ability to
take risk regarding their securities portfolio. Justify your response.

Ability to take risk: Circle one.

Below-average Average Above-average

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Exam 1 Morning Session 2018 Level III Mocks

4-E. Formulate each of the following constraints for Link Bank’s IPS:
I. time horizon
II. liquidity
III. tax concerns

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Exam 1 Morning Session 2018 Level III Mocks

QUESTION 5 HAS FOUR PARTS (A, B, C, D, E) FOR A TOTAL OF 18 MINUTES.

Theo Radcliff is Head of Finance at Network Solutions (NS). NS is solely responsible for
funding its Defined Benefit (DB) plan by making annual contributions. Management of NS
asks Radcliff to compare NS’s DB plan against the DB plan of its two main competitors, Tyler
Technologies (TT) and Munis Support (MS). He summarizes financial data and plan
characteristics for the three companies.

NS TT MS
Sales 21,000,000 38,000,000 29,500,000
Profit margin 29% 35% 35%
Projected benefit obligations 23,500,000 34,000,000 27,600,000
Long term debt-to-capital ratio 47% 43% 53%
Provision allowing lump-sum
YES YES NO
distribution
Provision allowing early retirement NO YES NO
Proportion of active lives 43% 28% 64%
Plan funded status Deficit Surplus Surplus

A. Determine which company’s pension plan has the highest risk tolerance based on:
i. Financial position.
ii. Plan features.

(4 minutes)

Magnus Capital Management provides asset management services to a diverse pool of


clients. Among its clientele is the endowment associated with University of Brussels (UB).
• Endowment currently has a planned time horizon till 2035.
• All returns on the investments made by endowment are tax exempt.
• UB currently receives enough funds from the endowment to meet its spending needs
and in recent years it has actually had a budget surplus.
• UB’s board is confident that it could raise funds through donor contributions, if
necessary.

Magnus Capital Management also manages a large fund for Hassler Insurance Corp (HIC), a

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Exam 1 Morning Session 2018 Level III Mocks

non-life insurance company.


• The timing and amount of claims by HIC’s clients are uncertain but HIC has a policy of
settling all its liabilities within a span of 3 years.
• Return requirement for HIC is calculated every year based on its forecast for expected
claims, capital market expectations and the MV of its portfolios.

B. Compare the following components of IPS for HIC and UB’s endowment:
i. Risk tolerance.
ii. Liquidity requirement.

(4 minutes)

Safeway International (SI), a US based company, operates a DB pension plan for its
employees. It is a financially health, fast growing trading company with a higher percentage
of active lives than retired lives. Currently SI’s DB pension plan is in surplus. SI’s
management wants to maintain the plan’s funded status (pension surplus) relative to plan
liabilities without making additional contributions to the plan. SI hires a pension consultant
who presents to the board the asset liability management approaches to portfolio
construction.

C. Explain why the asset liability management approach is appropriate for achieving SI’s
objective related to its DB pension plan.

(4 minutes)

SI hired the pension consultant on a permanent basis. After a year, the consultant must
explain to the board of directors why the surplus declined in a year when the actual
investment return was 150 basis points more than the long-term objective stated by the
board. Information regarding SI’s defined-benefit pension plan is provided below.

Asset Class Actual & Target Allocation Weighted Prior-Year Total


(%) Return (%)
Equities 50 5.83
US Treasury Bills & 26 0.65
intermediate bonds
US 10 Year bonds 24 5.52%*
Total 100 12.00
*Income element 9.0%, price gain element 14.0%. Total return = 23.0%

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Exam 1 Morning Session 2018 Level III Mocks

Surplus USD 1.5 million


Duration of liabilities 10 years
Actuarial return assumption 9.00%
SI board’s long-term total return objective 10.50%

Currently SI’s DB plan equities include: domestic equities and emerging market equities. SI
plan to discount its liabilities at the market interest rate for bonds with the same duration.
SI’s risk objectives include a limitation on volatility of surplus.

Currently SI’s DB plan has the following asset classes: real rate bonds, domestic equities,
emerging market equities, nominal bonds, hedge funds.

D. Explain how the plan surplus declined in a given year despite an actual return in excess
of the board’s stated objective. Justify with two reasons.

(4 minutes)

E. Recommend an investment time horizon (short-term or long-term) appropriate for the


investment policy of SI’s pension plan. Support with one reason.

(2 minutes)

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Exam 1 Morning Session 2018 Level III Mocks

Answer Question 5 on This Page

5-A. Determine which company’s pension plan has the highest risk tolerance based on:
i. Financial position.
ii. Plan features.

5-B. Compare the following components of IPS for HIC and UB’s endowment:
i. Risk tolerance.
ii. Liquidity requirement.

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Exam 1 Morning Session 2018 Level III Mocks

5-C. Explain why the asset liability management approach is appropriate for achieving SI’s
objective related to its DB pension plan.

5-D. Explain how the plan surplus declined in a given year despite an actual return in excess
of the board’s stated objective. Justify with two reasons.

5-E. Recommend an investment horizon (short-term or long-term) appropriate for the


investment policy of SI’s pension plan. Support with one reason.

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Exam 1 Morning Session 2018 Level III Mocks

QUESTION 6 HAS FIVE PARTS (A, B, C, D, & E) FOR A TOTAL OF 18 MINUTES

Kasia Robert is a wealth adviser for individuals. She works at Three Stars Wealth Advisory
Firm. Robert’s first meeting of the day is with David Nicholls, age 58 years, and plans on
retiring in 2 years. Nicholls’ annual wage is currently $35,000 and is expected to grow 2.5%
per year. The risk-free rate is 3.5%. Nicholls works in a job with a moderate degree of
occupational risk; therefore, we assume a risk adjustment based on occupational income
volatility of 3%. There is a 99% probability that Nicholls’ survives the first year, a 98%
probability that he survives the second year.
In the afternoon, Robert has a meeting with her other clients, Peter Elam and Darek Dorman.
Elam is 35 years old and works for capital market newsletter. He is largely financially
independent and his income is increasing rapidly. Dorman, age 45, is a dentist and works in a
local hospital. Dorman is a single parent of a child who lives independently. He is discussing
estate planning with Robert. His major concern is immediate liquidity to his child after his
death. Robert recommends Dorman to use a life insurance policy that provides a range of
investment options. Dorman selects a policy and asks Roberts to calculate the Surrender
Cost Index (per $1,000 of face value, per year), using a life expectancy of 25 years and a
discount rate of 6%. Exhibit 1 provides information about Dorman’s policy.

Exhibit 1 Dorman’s Life Insurance Policy


Face value $100,000
Annual premium (paid at beginning of $10,000
the year)
Policy dividends anticipated per year $2,500
(paid at end of the year)
Cash value protected at the end of 20 $50,000
years

A. Calculate the present value of Nicholls’ human capital?

(2 Minutes)

B. Identify the financial stage of the life cycle of Peter Elam. Justify your response with two
reasons. State the appropriate financial advice for him.

(5 Minutes)

C. Identify whether income volatility adjustment of Peter Elam’s human capital would be

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