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CFA Level III Mock Exam 2
June, 2018
Revision 1
Wilshire Investment (WI) is a U.S. based investment management firm providing wealth
management services to institutional clients. The firm primarily invests in traditional
asset classes such as equity and fixed income.
Holme’s Trust Foundation (HTF) is WI’s institutional client. Its portfolio is being
managed by Tony Monroe. Monroe is evaluating commodity futures in Rigea, an Eastern
European country, for HTF’s investment portfolio. WI does not have expertise with
commodity futures. Therefore, Monroe has made arrangements with an external portfolio
manager, Raul Davis. Under the arrangement Davis and WI will share any commissions
generated.
In addition to their agreement, Davis has invited Monroe to Rigea. As a signal of good
gesture, Davis’s firm has offered Monroe to pay for commercial transport and hotel
accommodation. Monroe has declined the hotel accommodation offered but has not
responded to the transport offer.
Jean Lowe is a research analyst serving WI’s research wing. Lowe is currently analyzing
hedge funds in Rigea. Monroe has asked Lowe to avoid hedge funds in Rigea because he
believes they will not generate attractive returns. Lowe remains convinced that the hedge
funds are attractive investment opportunities. After thorough research and analysis, Lowe
recommends the assets class and compels Monroe to invest his clients’ funds. Six months
later, the investment generates a strong alpha.
Prior to serving WI, Monroe served another portfolio management firm at which he was
extremely popular. In order to generate the same level of popularity at WI, Monroe
decides to contact a fellow portfolio manager at his previous workplace to provide
contact details of clients who are no longer invested with the firm. The firm continues to
store client details on its database.
After his successful yet uncertain venture into hedge funds, Monroe contemplates
increasing client portfolio allocations to modern alternative investment classes,
particularly buyout funds and venture capital funds. In describing the new investment
opportunity to his clients, he states:
Statement: “Buyout fund investments are virtually risk-free as the associated funds
are established companies; the latter category is highly risky but will
generate substantial returns if the associated venture survives.”
Octavia Richards, CFA, is a broker serving East End Brokers (EEB). On behalf of EEB,
she is forming an arrangement whereby any requested research will be directed to EEB in
exchange for providing new clients to Monroe. The commission charged by Richards is
higher than average; however, he believes doing business through Richards will allow WI
to gain access to investment funds with very high investment requirements and improve
client accounts’ results as well as meet their investment needs. He intends to disclose the
arrangement to clients if successful.
Curious about the success of the hedge fund, Monroe decides to investigate the source of
the outperformance. During his analysis and discussions with local analysts, Monroe
comes to the conclusion that the fund may be victim to survivorship bias. He presses fund
management who refuse to provide any information on the matter.
2. By issuing the research report, has Lowe violated any Standards of Professional
Conduct?
A. No.
B. Yes, she has violated IV (A) Loyalty by not respecting Monroe’s
instructions.
C. Yes, she has violated VI (A) Disclosure of conflicts by failing to disclose
the difference in opinion.
A. No.
B. Yes, he has violated IV (A) Loyalty.
C. Yes, he has violated III (E) Preservation of Confidentiality.
4. In describing the proposed investment classes to his clients, Monroe has most
likely violated:
A. I (C) Misrepresentation.
B. III (D) Performance Presentation.
C. V (B) Communication with Clients and Prospective Clients.
5. By undertaking the brokerage arrangement with EEB and Richards, Monroe has:
6. Based on Monroe’s suspicions regarding the hedge fund, his best course of action
would be to:
Personal Trading: Any employee intending to trade a security on AL’s watch list must
seek prior approval from the compliance officer if the trade exceeds the $1,000 limit.
Backup records: To ensure the safety of account information, all pertinent information
will be stored on a backup computer system in electronic form only.
The system will be located in AL’s headquarters; an offsite system is
currently not within the firm’s budget.
Fee Disclosures: All managers are encouraged to disclose all actual gross- and net-of-
fees performance results as well as an itemization of charges. The
procedure used to determine contingent fees must be disclosed upon
request.
After drafting the policies, Reza engages in a discussion with AL’s senior portfolio
manager, Rob Martin. Martin manages the account of Martha Flower, a wealthy real
estate developer who is operating in Florida. Martin has long suspected Flower of
embezzling her clients’ funds. After thorough investigation, Martin is now certain and
fears a substantial portion of her portfolio may be funded with these funds. He is
uncertain of what action to take.
Sylvia Bath, CFA, a portfolio manager serving AL, manages the investment account of
Peter Blake. Blake is one year away from retirement and will depend entirely on his
retirement income to provide for his modest lifestyle. His investment portfolio has a
current equity allocation of 10%, comprising entirely of domestic large-cap value stocks,
with the remainder in fixed income securities. Due to the current cyclicality of the U.S.
economy and to protect her client’s portfolio, Bath has decided to sell the value stocks
and purchase large-cap growth stocks in the same proportion. Since this action was taken
to protect Blake’s portfolio, she does not believe informing Blake was necessary.
Later that evening, Bath receives an invitation to attend a charitable event from Blake.
Among the invitees include professionals from the investment industry. Believing that the
event will provide the opportunity to bring more business to AL, she accepts the
invitation after informing her supervisor in writing. At the event, the attendees engage in
various activities for cash prizes. Blake wins two cash prizes worth $50 each, which she
intends to disclose to her supervisor.
The following day Bath has been asked to review the performance record and resume of
Ramos Davis, a candidate applying for the position of computer systems technician.
Davis was fired from Cappa Inc., a large investment bank, after being wrongly accused of
negligent supervision of the bank’s backup computer system, which subsequently led to
its destruction in a site fire.
7. Which of the following policies is most likely consistent with both the required
and recommended standards of the CFA Institute Asset Manager Code? The
policy concerning:
8. Which of the following statements is most likely correct with respect to the Fee
Disclosures policy?
10. By diverting Blake’s funds to large-cap growth stocks, has Bath violated the
Asset Manager Code?
A. No.
B. Yes, she should have informed Blake after implementing the change.
C. Yes, she should have informed Blake of the proposed change before
taking investment action.
11. With respect to informing her supervisor of the invitation and accepting the cash
prizes, are Bath’s actions consistent with the Asset Manager Code?
A. No.
B. Yes.
C. Only with respect to the cash prizes.
12. When hiring Davis as systems technician, which of the following actions will be
required by AL to comply with the Asset Manager Code?
Dmitri Anderson, portfolio manager at NAM, asks Moreno to justify each of the three
proposed asset classes. Moreno shares the following knowledge with Anderson:
Real estate: Although both types of real estate investments, direct and indirect, offer
diversification benefits, direct real estate is a suitable asset class for both
the informational advantaged and disadvantaged investor.
Private equity: They are similar to seasoned public equity as they exhibit similar return
dispersion and help enhance long-term return.
Anderson has heard that private equity investments can be direct or indirect. He asks
Moreno to describe the indirect venture capital form to him. Moreno responds by
describing the structure, process and drawbacks of the asset class to Anderson.
Process: Investors deposit their funds in a centralized pool which are subsequently
deployed by a managing director for investments.
Anderson has also heard of dividend recapitalization often being associated with buyout
funds. He asks Moreno what is meant by the term.
venture which has managed to receive financing from two external parties. It intends to
use the funds to develop its products. DL will commence commercial manufacturing in
two days time. It has sold product samples to a selected number of customers, who are
extremely pleased with their design and quality.
Moreno estimates that if DL were publically traded, its value would have been $320
million. On behalf of NAM, Moreno intends to acquire a 15% non-marketable minority
stake in DL. A minority interest and a marketability discount of 28% and 36%,
respectively, are deemed appropriate for the manufacturer.
13. Based on the justifications provided for the three asset classes, Moreno is most
likely accurate with respect to:
A. commodities only.
B. real estate and commodities only.
C. neither of the three asset classes.
14. When describing indirect venture capital funds, Moreno is correct with respect to
their:
A. structure.
B. process.
C. drawbacks.
15. With respect to Anderson’s query, the most appropriate response is that dividend
recapitalizations:
A. enable buyout funds to recoup their acquisition costs in a few years time.
B. allow for the restructuring of operations and improvement of management.
C. are used as an exit route for private equity funds, buyout and venture
capital.
16. Based on the information provided on DL, the private equity firm is most likely in
its:
A. seed stage.
B. early stage.
C. second stage.
17. The value of the marketability discount applied to NAM’s minority stake in DL is
closest to (in $ millions):
A. 12.44.
B. 13.44.
C. 17.28.
18. Which of the following does not reflect an advantage of Armstrong’s proposed
ETF investment?
Selena Roberts, CFA, is the risk management head at RX Associates, a U.S. based asset
management firm. Roberts has currently three tasks on hand.
Swami exports lumber and cotton on a global scale. Roberts is particularly interested in
Rivia Ltd., a local cotton exporter. A majority of Rivia’s local sales are on credit while
50% of its foreign sales are on credit. Rivia does not believe in credit financing and its
assets and supplies are purchased using cash. To hedge it foreign currency exposures,
Rivia engages in currency swaps and utilizes currency options traded on informal trading
platforms. Swami’s debt to foreign currency reserves is currently 2:1 and the country has
a significant level of foreign debt outstanding.
Task 2: Analyzing the Impact of the Investment on Portfolio Risk and Return and
Determining the Degree/Emphasis of Currency Hedging
For her analysis of the impact of the investment on portfolio risk and return, Roberts
collects information concerning a hypothetical portfolio held by a U.S. investor. The
portfolio’s performance is measured in terms of the Swami Pound (SWP) and the
portfolio comprises 40% of the SWP-denominated asset and 60% of the USD
denominated asset. The firm has little expertise in managing currency exposures. To
ascertain the degree/emphasis of currency hedging, Roberts has devised two alternative
strategies:
Strategy 1: Select a benchmark which has no foreign exchange exposure and if the
manager holds a view concerning the SWP, allow currency exposure to drift
±15% from the benchmark. If the manager lacks market conviction, avoid
currency exposures.
Strategy 2: Add alpha to client portfolios by taking currency risks and avoid
maintaining neutral currency exposures for extensive time periods.
Exhibit 1
Performance of a Hypothetical Portfolio Comprising
40:60 Swami- and US-Denominated Assets
Expected (Next
Current Year)
SWP/USD 85.60 82.90
SWP-denominated asset value* 45.60 50.20
USD-denominated asset value* 10.00 8.50
s (RFX ) 3% 4%
s (RFC ) 2% 1%
P[s (RFX ), s (RFC )] 0.4 0.4
*In tens of thousands of units of foreign currency
After evaluating the two strategies, she joins Jeremy Watson, specialist at RX, for lunch
and discusses the second one with him. Watson makes the following comment:
Comment: I believe we are better leaving out exposure to the SWP unhedged. This is
because adding unhedged foreign currency exposure should not affect
portfolio returns in the long run.
Rodriguez often takes positions in options and specializes in creating synthetic products.
In response to Rodriguez’s impressive performance, Roberts has decided to increase the
specialist’s capital allocation. She will utilize either notional position limits or VAR-
based position limits for the task. However, she is concerned that the two methodologies
may not be suitable for Rodriguez.
A. sovereign risk.
B. settlement risk.
C. interest rate risk.
20. Using Exhibit 1, the expected return on the hypothetical portfolio is closest to:
A. – 3.53%.
B. + 6.62%
C. + 13.67%.
21. Using Exhibit 1, the expected risk of the domestic currency return associated with
the Swami investment is closest to:
A. 2.00%.
B. 4.22%.
C. 4.49%.
A. mean reversion.
B. regret minimization.
C. purchasing power parity (PPP).
24. Which of the following statements least accurately explains why the
methodologies selected by Roberts are unsuitable for Rodriguez?
Monica Jose, CFA, is a risk manager at Alpha&Ceta Wealth Management (ACWM). She
is currently addressing the concerns of four clients, Dallas Inc.; Walsh & Peters
Associates (WPA); Tamara Berg; and Frank O’Conner.
2. WPA is a consultancy firm managing its own defined benefit pension plan. In light of
the plan’s strong overfunded position, Donna Marshall, the plan’s investment officer,
has expressed an interest in international equities. After extensive research, Jose
drafts a proposal to Marshall.
3. Tamara Berg is a wealthy entrepreneur. She has expressed her desire for exposure to
securities with inverse feature. Jose recommends investment in an inverse floater with
a coupon rate of 15% – Libor. Berg is concerned about the possibility of a rise in
interest rates resulting in a zero cash flow. In response to Berg’s concerns, Jose makes
the following comments:
Comment 2: If you want to ensure that the interest rate you receive is positive at all
times, the 15% rate on the floater will need to be reduced to a lower
level.
Jose recommends the purchase of a series of 6-month caplets with expiration dates of 15
October and 15 April for the next year, and so on for the next five years, and an exercise
rate of 11%. The number of days in and LIBOR during the first three settlement periods
has been compiled by Jose (Exhibit 1). Current LIBOR is 10% and the cap premium is
$65,000.
Exhibit 1
Number of Days in Settlement Period
And LIBOR Term Structure
LIBOR
Settlement Period Number of Days
(%)
15 October 183 9.25
15 April 182 11.50
15 October 183 11.80
25. Under the currency swap, Dallas Inc. will pay interest of (in millions):
26. Dallas Inc. is concerned that the transaction will increase its exposure to credit
risk. Which of the following parties will expose the manufacturer to credit risk?
27. One year into the dual currency bond agreement, the Yen starts to rise sharply.
Dallas Inc. would like to exit its position using a synthetic transaction. The exit
transaction will most likely involve:
A. the sale of a dual currency bond paying interest in dollars and principal in
Yen.
B. the purchase of a yen denominated bond and the purchase of a currency
swap.
C. the purchase of a dollar denominated bond and the purchase of a currency
swap.
28. The options strategy being recommended to WPA is most likely known as a:
A. collar.
B. straddle.
C. butterfly spread.
A. Yes.
B. Only with respect to Comment 1.
C. Only with respect to Comment 2.
30. The effective interest due on the first caplet payoff date is closest to:
A. $564,250.
B. $682,500.
C. $712,833.
Exhibit 1:
Equity Portion of LLE’s Policy Portfolio
Eco Smith Morris Akhtar
Asset under management ($ millions) 5.0 2.5 3.5 2.0
Expected alpha 0.0 5.5% 7.2% 10.1%
Expected tracking risk 0.0 3.6% 6.5% 8.1%
Dividend yield 0.0 2.1 1.3 1.6
P/E 16 10 14 25
P/B 6.0 4.3 0.7 15.8
5-year consensus expected earnings growth 5.0% 3.1% 6.8% 10.5%
Annualized manager’s return 15.1% 22.1% 12.7% 17.0%
Annualized manager’s normal benchmark
return* 15.1% 18.0% 13.7% 16.1%
Annualized investor benchmark return* 15.1% 12.1% 11.6% 17.3%
Equity investment style N/A Value Value Growth
*All returns are gross of management fees
Justification 2: The distinction allows for the performance appraisal of active managers.
Following Alexei’s advice, Walker compiles details concerning the benchmarks used for
each of the four managers (Exhibit 2).
Exhibit 2:
Portfolio and Investor Benchmarks
Eco Smith Morris Akhtar
MSCI US MSCI World MSCI World
Manager’s normal Broad Market ex-US Value ex-US Value MSCI World
benchmark Index Index index ex-US index
Investor’s benchmark MSCI US MSCI World
Broad Market MSCI World MSCI World ex-US
Index ex-US index ex-US index Growth index
Following his analysis of the equity allocation, Walker holds a meeting with LLE’s chief
executive. During the meeting the executive entrusts Walker with the management of $10
million which the fund has received from a wealthy donor. The executive shares his
desire for an active equity exposure to emerging market equities. However Walker has
little expertise with respect to this equity category.
Walker is of the opinion that exposure to the U.S. equity market can be highly profitable
and devises a strategy to manage the $10 million by undertaking a long futures position
in the S&P500 equity index. For the emerging market equity allocation, he narrows down
his selection to Octavia Wilde, an active manager benchmarked to the MSCI Emerging
Markets Index (EMI). Wilde undertakes a short futures position in the MSCI EMI.
31. Based on the information presented in Exhibit 1, Morris’s value investment style
can most likely be classified as:
A. low P/E.
B. contrarian.
C. high dividend yield.
32. The information ratio earned on LIE’s equity allocation is closest to:
A. 0.9.
B. 1.2.
C. 2.0.
33. Using the information presented in Exhibit 1, which manager has outperformed
his or her asset class benchmark by the highest margin?
A. Smith
B. Morris
C. Akhtar
34. With respect to the benefits of a true/misfit distinction, Alexei is least accurate
with respect to:
A. Justification 1 only.
B. Justification 2 only.
C. both of his justifications.
35. Based on the information provided in Exhibits 1 and 2 and the vignette, Alexei
has correctly defined the normal benchmark for:
A. Eco.
B. Smith.
C. Akhtar.
36. The strategy employed by Walker to manage the $10 million entrusted by LLE’s
chief executive is most likely classified as:
A. completeness fund
B. equitized market neutral.
C. alpha and beta separation.
Fund A: “A portfolio that has a duration that equals the duration of the debt portfolio.
The matching would be achieved by using Treasury zeros, each maturing at the
dates of respective cash outflows. At the current interest rate of 7.5%, the
present value of the investment portfolio will slightly exceed that of the debt
portfolio. “
Fund B: “A portfolio consisting of interest rate futures and bonds that mature at dates that
precisely match the dates of the future liability payouts. Cash inflows precisely
equal cash outflows.”
The firm’s CEO seems more comfortable with Fund B’s investment mandate and
instructs Cross to structure the investment portfolio accordingly. In doing so, Cross
shortlists three bonds to include in the fund. The characteristics of the bonds are given in
Exhibit 1.
The bond selected would be used to cover liabilities that would be due in five quarters
from now. Smith states that liquidity is of a prime concern.
C&D owns commercial real estate that it does not use in the normal course of its
business. While talking to Cross about it, Smith expresses the desire to invest the locked
up real estate value in a fixed-income fund. Since the focus is to enhance returns, Cross
recommends using leverage to invest part of the value in fixed-income securities. She
suggests investing $15 million for five years in a bond portfolio worth $22 million. Cross
believes that this investment would earn them a return premium of 9.5%. A loan, taken
for five years, costs 11.5% before taxes, and the risk-free rate equals 5.5%. Smith is not
sure if this investment would add to the returns especially because of the additional risk
added by the loan. He is also unsure whether taking a loan would be the most suitable
approach. This is because he anticipates interest rates to decrease by 2-4% in the coming
years and by 90 bps in the coming month.
Cross states that, to take advantage of the rate decrease, the firm could invest $2 million
in a corporate bond using a repurchase agreement. C&D would have to buy back the
position in 1 day at a price of $2.0836 million and keep collateral worth $2.0257 million
with the lender. Smith is still contemplating whether the profit on the short sale warrants
the costs incurred.
37. With regards to the immunization of the single liability, which of the following is
most accurate about the risks involved in the two strategies?
38. Which of the following about the effectiveness of the immunization strategy of
the funds is most accurate?
A. Unlike Fund B, Fund A would only work in case of parallel yield curve
shifts.
B. Unlike Fund A, Fund B would only work in case of parallel yield curve
shifts.
C. Both funds would work regardless of the type of yield curve change.
39. Using only the information given in Exhibit 1, which of the following bonds
should Cross add to the fund?
A. Bond A.
B. Bond B.
C. Bond C.
40. How much value is Cross’s suggestion to use leverage to invest in the bond
portfolio likely to add in percentage terms?
A. 1.63%.
B. -0.93%.
C. 1.03%.
41. Based on Smith’s expectations of interest rate movements, the least appropriate
way of adding leverage to the fixed-income portfolio would be to:
42. The size of the credit protection in the repurchase agreement is closest to:
A. 1.284%.
B. 2.209%.
C. 4.178%.
George Pena, CFA, is a portfolio manager at Aqua Wealth Management (AWM), LLC.
Pena has extensive experience with managing private wealth accounts. Karen Lawrence
and Joseph Smith are Pena’s newest clients. With respect to each client’s portfolio, Pena
has a task on hand.
Task B: Determine the optimal corridor width for each asset class in Smith’s portfolio.
Lawrence has recently inherited $300,000 from her deceased father’s estate. She is 35
years old and practices dentistry privately. Last year, Lawrence’s house was destroyed in
a domestic fire. 15% of the inheritance amount as well as insurance claims have enabled
her to seek new accommodation. Despite the incident, her living expenses are being
comfortably met.
During a meeting with Lawrence, she shares with Pena her desire to maintain a minimum
cash balance during economic downturns. However, she would like to maximize
portfolio returns when the opportunity arises and is willing to utilize her cash balance to
increase equity exposure.
Upon the conclusion of their meeting, Pena collects data from several economic reports
each of which forecast a sustained upward trend in equity markets. Pena estimates that
Lawrence’s stocks will generate a return of 5%. Her portfolio value and stock/cash
allocation, prior to any changes, is $2 million and 55/45, respectively.
Lewis Wise is an intern at AWM. He is being trained by Pena and is assisting him in the
management of Lawrence’s portfolio. During his training session, he asks the following
questions:
Question 2: Is it correct to state that the buy-and-hold strategy is consistent with a risk
tolerance which has a positive relation to wealth at all levels of stock
return?
For this task, Pena compiles volatility, return, transaction cost, and correlation data on the
three asset classes held in Smith’s (Exhibit 1) portfolio.
Exhibit 1
Expected Return, Volatility, Transaction Cost, and Correlation Data
Volatility
Expected
(Annualized Transaction Correlation with the
Asset Class Return
Standard Costs rest of the portfolio
(Annualized)
Deviation)
Domestic Equity 12.5% 14.2% 0.20% 0.25
Domestic Bonds 7.8 11.8 0.45 0.18
Commodities 11.3 11.9 0.19 0.09
Mildred Jones, CFA, is AWM’s Human Resource Manager. She has recently
implemented a policy which mandates firing any underperforming managers. Some
managers have complained that the policy is too stringent and has resulted in the
company losing promising managers which have underperformed due to uncontrollable
external factors.
A. CPPI
B. Buy-and-hold
C. Constant-mix
A. 53.5/46.5
B. 55.0/45.0
C. 56.2/43.8
Question 1 Question 2
A. No No
B. No Yes
C. Yes No
46. Based only on the transaction cost and volatility information presented in Exhibit
1, which asset classes will have the narrowest corridor width?
A. Commodities
B. Domestic bonds
C. Domestic equity
47. Considering the correlation data in isolation, Pena will conclude that the asset
class with the narrowest corridor width is:
A. Commodities
B. Domestic bonds
C. Domestic equity
A. Type I error.
B. Type II error.
C. adequate manager continuation policy.
To secure the purchase price of raw corn, Kyote Inc. plans to enter into a derivative
contract. TSMDT’s senior derivatives trader, Josef Silos, recommends the manufacturer
enter into a three year commodity swap contract on corn. The 1-year, 2-year, and 3-year
corn forward prices are £125, £150, and £165, respectively. The 1-year, 2-year, and 3-
year interest rates are 7.5%, 8.0%, and 9.5%, respectively.
During an initial meeting with Kyote Inc.’s head of risk management, Silos makes the
following statements:
Statement 1: “Entering into the commodity swap contract on corn will give your firm
(Kyote Inc.) a position equivalent to three forward contracts.
Statement 2: “Another way to look at it is, by entering into the commodity swap
contract, your firm will effectively be making a 2-year loan to TSMDT.”
Statement 3: “The benefit of entering into a commodity swap contract is that your firm’s
counterparty credit risk becomes virtually non-existent.”
The head of risk management responds to Silos’ statements by asking the following two
questions.
Question 1: “If forward prices and interest rates change following contract initiation,
will it have an impact on the value of our firm’s swap contract?”
Question 2: “If, in the future, our demand for corn needs to be increased (decreased) to
accommodate an unexpected demand rise (fall) for cornmeal and we are
met with seasonally high corn prices, is there a way to accommodate corn
price and demand changes when pricing commodity corn swap contracts?”
49. If Kyote Inc. decides to enter into the three-year commodity swap contract on corn, it
will most likely:
50. The effective unit price on the 3-year swap is closest to:
A. £119.51/bushel
B. £145.56/bushel
C. £165.55/bushel
51. TSMDT has entered into a three-year swap contract with Kyote Inc. as a dealer and
swap counterparty. Assuming TSMDT hedges corn price risk on the swap contract
by entering into three forward contracts, the derivative group’s net cash flow
position on the swap and forward contract in the second year is closest to:
A. – £4.44
B. + £4.44
C. + £15.55
52. In context of the statements made by Silos to Kyote Inc.’s head of risk management,
which of the following statements is most likely incorrect?
53. The most appropriate response to the risk management head’s first question is:
A. Yes.
B. No, commodity swap contracts may only accommodate forward price changes.
C. No, commodity swap contracts may not be able to accommodate either variable
commodity demand or forward prices.
Brooks Wealth Management (BWM) is an asset advisory firm situated in Brooklyn, New
York. BWM manages the accounts of individual clients. Its subsidiary, Thuraiya
Associates, handles institutional client accounts. Each firm has its own team of portfolio
managers, trading desks, and marketing staff. Managers from both departments base their
investment decisions on research reports issued by a centralized in-house research
department. Access to this department is shared.
BWM is currently in the process of seeking compliance with the Global Investment
Performance Standards (GIPS). Three of its policies are believed to comply with the
requirements of these standards.
Large External Cash Flows: Portfolios belonging to the developed market equity
composite are revalued when capital equal to 10% of the fair value is contributed or
withdrawn. Portfolios belonging to the emerging market equity composite are revalued
when capital equal to 30% of the fair value is contributed or withdrawn. This policy is
documented.
James Marco, BWM’s client, has requested BWM to demonstrate how his account’s
performance is calculated in accordance with the GIPS standards. Dmitri Solvang, CFA,
Marco’s portfolio manager, compiles relevant portfolio information (Exhibit 1).
Exhibit 1
Marco’s Portfolio Activity for the
Month of January, 2011 (in $)
January 1 (Beginning value) 180,000
External cash flows:
12 January + 4,500
27 January ─ 3,450
Value on 12 January* 197,500
Value on 27 January* 220,000
January 31, 2010 (Ending value) 222,000
*Portfolio values include the relevant cash flows
Gene Davis is another client of BWM. Her contract with the firm expires on August 31,
2011. Unsatisfied with her account’s performance, she instructs her portfolio manager to
cease trading and liquidate her holdings with immediate effect on August 12. Her
account’s performance is calculated on a monthly basis.
55. Which of the following entities meets the definition of a firm as outlined by the GIPS
standards?
A. both entities.
B. BWM only.
C. Thuraiya Associates only.
56. BWM’s Large External Cash Flows policy most likely satisfies the requirements of
the GIPS standards with respect to:
A. both composites.
B. the developed market equity composite only.
C. the emerging market equity composite only.
Portfolio Valuation
Valuation Frequency
A. No No
B. No Yes
C. Yes No
58. The true time-weighted rate of return on Marco’s portfolio is closest to:
A. 13.1%.
B. 18.6%.
C. 22.4%.
59. Does BWM’s internal dispersion policy satisfy the GIPS standards?
A. Yes.
B. No, firms are required to report VAR on a monthly basis.
C. No, VAR is not an acceptable measure of internal dispersion.
60. In order to comply with the requirements of the standards, BWM’s best course of
action with respect to Davis’s account at a minimum, is to: