CFA Level III Mock Exam 5 June, 2018 Revision 1

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CFA Level III Mock Exam 5
June, 2018
Revision 1
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CFA Level III Mock Exam 5 – Questions (PM)
FinQuiz.com – 5th Mock Exam 2018 (PM Session)
Questions Topic Minutes
1-6 Ethical and Professional Standards 18
7-12 Ethical and Professional Standards 18
13-18 Economic Analysis 18
19-24 Equity Investments 18
25-30 Fixed-Income Portfolio Management 18
31-36 Fixed-Income Portfolio Management 18
37-42 Alternative Investments 18
43-48 Performance & Evaluation 18
49-54 Derivatives 18
55-60 Global Investment Performance Standards 18
Total 180
FinQuiz.com © 2018 - All rights reserved. 2

Questions 1 to 6 relate to Ethical and Professional Standards
Sun Davidson, CFA, Case Scenario
Sun Davidson, CFA, is a sell side energy research analyst. Davidson maintains an equity
investment blog which is actively followed by over 5,000 investors spread across
numerous countries. The investors are from various financial backgrounds with differing
risk appetites.
In the current year, Davidson decides to change the layout of the blog. Instead of placing
announcements concerning investment recommendations at the bottom of the screen, as
has been the case since she started the blog, recommendations can now be accessed by
clicking on a highlighted (in bold) ‘Recommendations’ tab located at the top left of the
screen. Davidson does not feel it is necessary to make any announcement with respect to
the change.
For her next entry, Davidson will be preparing an investment recommendation on Energy
Fund, a hedge fund which undertakes long and short positions in equity securities from
the energy sector. Due to her limited expertise with the alternative asset class, Davidson
seeks the advice of Earl Ramos, a leading hedge fund manager at Carlton, a hedge fund
management firm.
During their initial meeting, Ramos informs Davidson that, with the knowledge of his
employer, he is invested in the Energy Fund (EF) and maintains a working relationship
with the fund’s manager from whom he has learnt that the fund will be expanding to
include highly risky energy stocks issued in less developed countries. Upon Ramos’s
advice, Davison issues a buy recommendation but does not disclose Ramos’s holding in
EF or his relationship with the fund manager.
Pleased with their professional relationship, Davidson invites Ramos to become a regular
contributor to the blog which he accepts. Ramos’s compensation will be in the form of
commission generated for the recommendations he issues. However, he will not be paid
by Davidson. Ramos informs his supervisor of the offer after acceptance and has decided
to contribute to the blog during the weekends so as not to disrupt his routine work
activities.

The same evening, both professionals attend an investment conference at which Ramos
collides into Wilson Clark. Clark maintains an investment in the Carlton hedge fund
along with his brother, Ridley. Wilson praises Ramos for his exemplary performance
results achieved during the current year on both their holdings. Wilson invites Ramos to
vacation with him in Morocco.
Upon the conclusion of their conversation, Ramos shares the details of the offer with
Davidson stating, “I manage the hedge fund investments of the Clark brothers and both
are equally pleased with my performance. This calls for a celebration.”
1. By changing the layout of the blog Davidson is in violation of the CFA Institute
Standards of Professional Conduct with respect to:
A. loyalty to clients.
B. diligence and reasonable basis.
C. communication with clients and prospects.
2. By issuing the purchase recommendation, Davidson is in violation of the CFA

Institute Standards of Professional Conduct because she has failed to:
A. conduct a suitability analysis.

B. disclose that she has employed the expertise of Ramos.
C. disclose her reliance on material nonpublic information.
3. In order to avoid violation of the CFA Institute Standards of Professional

Conduct, Davidson is required to disclose to investors:
A. Ramos’s investment in the EF only.

B. Ramos’s relationship with the manager of the EF only.
C. Both Ramos’s investment in and relationship with the manager of the EF.
4. By accepting Davidson’s offer to contribute to the blog, is Ramos in violation?
A. No, he will not be disrupting the activities of his employer.

B. Yes, he should have sought permission prior to acceptance.
C. Yes, he has not disclosed the commission income which he will earn.

5. Ramos’s best course of action with respect to Clark’s offer is to:
A. decline the offer.

B. disclose the offer to his employer only.
C. disclose the offer to his clients and employer.
6. With respect to the statement made to Davidson at the investment conference, is

Ramos in violation of the CFA Institute Standards of Professional Conduct?
A. No.
B. Yes, by mentioning that he manages Ridley’s portfolio only.
C. Yes, by mentioning that he manages the investment portfolios of the Clark
brothers.

Questions 7 to 12 relate to Ethical and Professional Standards
Riverside Asset Management Case Scenario
Riverside Asset Management (RAM) is a privately owned, small-scaled investment

advisory firm. The firm’s client base exclusively includes institutional clients. Roger
Marquez, the firm’s compliance officer, has made necessary modifications to RAM’s
policies and procedures to ensure they are consistent with the Asset Manager Code.
Once he is reasonably satisfied with RAM’s level of compliance, Marquez sends an

investment letter to clients and prospective clients which includes the compliance
statement, “RAM claims compliance with the CFA Institute Asset Manager Code of
Professional Conduct. This claim has not been verified by the CFA Institute.”
Thomas Nash manages RAM’s global equity fund which in benchmarked to the MSCI
global equity index. Nash employs a passive mandate for the global equity allocation of
Aero Inc’s defined benefit pension plan’s portfolio, which is consistent with the client’s
funding objectives. In the current year, the sponsor reports a surplus following a
profitable financial year. Nash decides to modify his investment strategy and employ a
semi-active approach which will allow him to increase the portfolio’s opportunity to earn
higher returns. He intends to inform the sponsor of the change in their next quarterly
meeting.
Victoria Reed is a junior portfolio manager reporting to Nash. Reed is managing the
investment portfolio of the Legend Foundation. As instructed by the foundation’s chief
executive, Reed allocates 1,000 of Hower Inc’s shares to the portfolio which has
undertaken an IPO. Reed simultaneously purchases 2,000 shares for her personal
investment portfolio. She discloses the amount and quantity of her purchase in a quarterly
trade confirmation and an annual statement of personal holdings which she will email to
Marquez on the respective dates.
Marquez is soon to retire and has been asked by RAM’s chief investment officer to
nominate a successor. Marquez evaluates two candidates one of whom is his brother who
is well-informed on the Code’s compliance policies and procedures. The second
candidate is an investment manager who overlooks RAM’s emerging market equity fund.

Several of the fund’s clients have requested an allocation to commodities. However,

RAM lacks expertise and has selected Fairhole Associates, a commodity trading
specialist to manage the allocation. Upon making the allocation, a letter is sent to clients
which states, “RAM has appointed Fairhole Associates to manage commodity
investments. Fairhole Associates retains liability for the performance of these
investments.”
At the end of the performance year, Nash prepares a performance presentation for the
global equity fund. Although the fund has been in operation for the past eight years, he
decides to present the annual performance for the recent most five years as they represent
its most successful years. He presents gross- and net-of-fees returns and provides a
breakdown of fees charged as management fees, incentive fees and commission. His
disclosure purposely omits a contingent fee component which he deems as too complex
for the understanding of clients.
7. Is RAM’s claim of compliance statement consistent with the Asset Manager

Code?
A. No.
B. Yes, the CFA Institute cannot verify actual compliance with the Code.
C. Yes, the CFA Institute can only verify the Manager’s claim of compliance.
8. By modifying his strategy, is Nash in violation of the Asset Manager Code?
A. No.
B. Yes, he has not undertaken a suitability analysis.
C. Yes, he has not made disclose to clients prior to the change.
9. With respect to the purchase of Hower Inc.’s shares, is Reed in violation of the
Asset Manager Code?
A. No.
B. Yes, she did not seek prior approval.
C. Yes, she did not delay the purchase of shares

10. Which candidate best fits the role of compliance officer in accordance with the
Asset Manager Code?
A. Marquez’s brother
B. The emerging market fund manager.
C. Neither of the two individuals.
11. Is the allocation of client trades to Fairhole Associates consistent with the
requirements and recommendations of the Asset Manager Code?
A. Yes.
B. No, RAM cannot outsource work.
C. No, RAM must retain liability for the outsourced work.
12. Which of the following statements least likely indicates why Nash’s performance
presentation is inconsistent with the requirements and recommendations of the
Asset Manager Code? Nash:
A. has distorted the performance presented.

B. has not explained the commission component.
C. need only present gross- or net-of-fees returns but not both.

Questions 13 to 18 relate to Economics
Dianne Fernandez Case Scenario
Dianne Fernandez is a junior economic analyst serving Thompson Ace (TA), a research
firm providing advisory services to institutions. Fernandez covers emerging markets. TA
has been engaged by Blake Asset Management (BAM), a U.S. based asset advisory firm,
to analyze the firm’s asset allocation and recommend changes based on capital market
projections.
Fernandez will be responsible for developing capital market projections for the country of
Rica with currency RIC. Rica is currently enjoying a period of strong economic growth.
Fernandez, however, projects that this economic strength will accelerate inflation in the
months to come. Based on preliminary economic analysis, Fernandez learns that bond
investors expect the central bank to maintain its inflation target by raising short-term
rates. BAM has allocated a total of 30% of client funds to securities (fixed income and
equity) issued in Rica (Exhibit 1).
Exhibit:
BAM’s Current Asset Allocation
Allocation
Asset Class (%)
Domestic equities 35
Emerging market equities 10
Long-term government bonds - Rica 15
U.S. Treasuries 10
AA-rated Domestic Corporate Bonds 25
Real estate 5
Total 100
Next, Fernandez meets with BAM’s senior investment officer who informs her that 40%
of the holdings to long-term government bonds belong to those investors with a short-
term time horizon while the remaining 60% has a long-term holding period.
Gillian Moore, a senior emerging market analyst serving TA, evaluates Fernandez’s
findings and suspects that the analyst’s projections as well as market expectations with
respect to inflation may be conservative.

After discussing her forecasts with the analyst, Moore urges Fernandez to analyze Rica’s
economy in more detail paying specific attention to long-term growth forecasts. Paying
heed to Moore’s advice, Fernandez decomposes long-term GDP growth into four factors
and develops projections for each. She compares her findings with another analyst who
has decomposed GDP growth into three factors and summarizes both sets of projections
in an Exhibit for her research report (Exhibit 2).
Exhibit 2:
Decomposition of Rica’s Long-term GDP Growth Forecast
Fernandez’s Analyst’s
Projections Projections
(%) (%)
Growth in potential labor force size 3.4 3.0

Growth from capital inputs 2.1
Growth in actual labor force participation rate 0.5
Growth from labor inputs 4.8
TFP growth 5.2
Growth from labor productivity 8.4
Fernandez then reads an article on the current state of Rica’s economy which is titled as,
‘Rica’s Economy – Today and Tomorrow’. She is analyzing the implications of the
following excerpt on BAM’s holding of the country’s equities:
Excerpt: “Rica’s rapid rate of economic growth has been due to a surge in capital
investments.”
Fernandez concludes her analysis by evaluating the current value of the RIC/USD
exchange rate. She would like to determine whether the RIC is correctly valued based on
the purchasing power parity. She has collected data relevant for her analysis in an exhibit
(Exhibit 3).
Exhibit 3:
Data Relevant for Analysis of RIC’s Value
Current RIC/USD exchange rate 70.52
1-year Rica risk-free rate 13.00%
1-year U.S. risk-free rate 2.50%
Expected inflation rate – Rica 5.00%
Expected inflation rate – U.S. - 0.02%

13. In light of Fernandez’s original economic projections of Rica, he will most likely
advise a reduction of an allocation to 30-year government bonds for investors
with:
A. short-term time horizons only.

B. long-term time horizons only.
C. short- and long-term time horizons.
14. Based on Moore’s findings with respect to inflation projections and expectations,
the senior analyst will most likely conclude that the total allocation (both short-
and long-term investors) to 30-year government bonds should be:
A. reduced.
B. increased.
C. held constant.
15. Using the data in Exhibit 2, relative to the analyst’s projections, Fernandez’s long-
term economic growth forecast is:
A. 0.2% higher.
B. 0.9% higher.
C. 0.7% lower.
16. In context of the data presented in Exhibit 2 and considering Fernandez’s

projections in isolation, she least likely expects that:
A. the death rate to decline.

B. number of immigrants will increase.
C. Rica’s government will encourage competition in the private sector.
17. Based on the excerpt in the news article, which of the following conclusions most
likely represents a valid implication?
A. TFP growth will be boosted.

B. Labor productivity will remain unaffected.
C. BAM will need to reduce its allocation to Rican equities.

18. Using the data in Exhibit 3, Fernandez will conclude that the RIC is:
A. overvalued
B. undervalued
C. fairly valued.

Question 19 to 24 relate Equity Investments
Trone Wealth Advisory Case Scenario
Trone Wealth Advisory’s (TRA) is an asset management firm with an institutional client
base. The Start Endowment Fund (SEF) is one of TRA’s clients and the equity portion of
its investment portfolio solely holds US equities and is being managed by Fran Davis, a
senior TRA equity manager. Davis has learned that SEF has received a further $20
million in donations in the current year which it intends to invest. SEF’s chief executive
officer (CEO) requests Davis to add active exposure to its portfolio using developed
market foreign equities and has specified an equal-weighted global index comprising
2,000 foreign equities as a benchmark. The CEO has instructed Davis to add exposure in
a way which does not require adjusting the strategic asset allocation. Davis maintains
strong negative and positive views with respect to the index’s stocks.
The CEO asks Davis to demonstrate how an equal-weighted index is valued. Davis
demonstrates the calculation using a hypothetical index comprising five stocks and a
valuation period starting on January 1, 2013 and ending on January 1, 2014. He estimates
the price change of the constituent stocks between the two dates and presents the data in
the exhibit below (Exhibit 1).
Exhibit 1:
Hypothetical Equal-Weighted Index
Stocks Price Change (%)
A 30.8
B - 12.7
C 9.3
D 2.1
E 20.5
The CEO has heard that there are certain drawbacks in using an equal-weighted index as
a benchmark. He asks Davis which of these drawbacks SEF should be most concerned
about given its foreign equity mandate.

The policy portfolio of Green Inc is being managed by Lance Young, one of TRA’s
wealth advisors. The equity portion of the portfolio is being managed using a value
approach and is benchmarked to the Russell 3000 index, a large-cap index. Young has
received a request by the plan sponsor to sell $2 million of Proctor and Gamble (P&G)
shares, a pharmaceutical, from the policy portfolio for the purposes of raising cash for
fund expansion. Young will implement a valuation-level sell discipline for executing the
transaction.
Details concerning Green Inc.’s portfolio and P&G holding prior to the sales transaction
are summarized in the exhibit below (Exhibit 2).
Exhibit 2:
Green Inc.’s Policy Portfolio and P&G Holding Information
P/E multiple at the time of P&G stock purchase 8.6
Current P/E multiple of P&G stock 12.5
Historical average P/E multiple of P&G stock 12.5
Actual dividend yield of P&G stock 5%
Average industry dividend yield of pharmaceutical stocks 3%
Purchase price $125.00
Current market price $150.00
Average annual portfolio turnover 135%
Proportion of consumer discretionary equities in portfolio 60%
TRA’s management has decided to devise a formal equity securities selection policy for
its global equity fund. It has tasked Carl Douglas, TRA’s senior global fund manager, to
devise the policy. Douglas sets to work by drafting the following policy:
“Above average earnings growth, P/E ratios in the lowest quartile, strong dividend paying
ability, and sound environmental conservation policies are the four factors used to screen
issuers of global equities. Companies passing the screen will be subject to further
evaluation in light of collected financial information. From the list of screened
companies, an investment will be made in the shares of those with strong corporate
governance practices.”

19. In light of the information provided on SEF and Davis, which of the following
strategies will most likely be used to add active exposure?
A. Long-only
B. Short extension
C. Equitized market neutral long-short
20. Assuming initial value of a hypothetical index is 100, using the information in
Exhibit 1, the value of the index on January 1, 2014 is closest to:
A. 110.0.
B. 150.0.
C. 153.5.
21. Which of the following represents a valid concern when using an equal-weighted
index as benchmark specifically for the foreign equity portion of SEF’s portfolio?
A. Small-company bias
B. High rebalancing costs
C. Illiquidity of index constituent securities
22. Using the information in Exhibit 2, a decision to sell the P&G holding will be
made as the:
A. dividend yield exceeds the average industry yield.

B. P/E multiple has reached its average historical level.
C. current market price has declined by more than 15% below purchase price.
23. Which of the following factors presented in Exhibit 2 is least consistent with the
style being used to manage Green Inc’s policy portfolio?
A. Portfolio turnover
B. Dividend yield of P&G stock
C. Proportion of consumer discretionary equities
24. The drafted security selection policy most likely represents:
A. the top-down approach.

B. the bottom-up approach.
C. a combination of the top-down and bottom-up approach.

Question 25 to 30 relate to Fixed Income
Link-up Communications Network (LUCN) Case Scenario
Link-up Communications Network (LUCN) is a nation-wide, telecom firm with

headquarters in New York USA. LUCN has more than fifteen branches and benefits from
a large client base and huge economies of scale. Over five years ago, LUCN offered its
employees a defined benefit pension plan in an attempt to retain skillful human resource.
This helped in retention of employees and so, the company has no immediate disposition
of closing the defined plan. The current balance sheet shows a projected benefit
obligation of $27.403953 million, estimated by using a discount rate of 5.5%. The
accumulated benefit obligation, using the same discount rate, is $19.504931 million. To
actively manage its pension liabilities, LUCN’s board of directors has hired Unified Fund
Managers (UFM), a licensed financial firm, proficient in institutional fund management.
Kylie Jack, a financial analyst at UFM, is heading the pension management team of
LUCN. Jack determines that the market value of pension plan assets is $27.603920. Even
though the plan is currently overfunded, Jack is concerned how movements in interest
rates could change the funded status of the plan. She requests her colleague to measure
the effective duration of the pension liabilities by raising and lowering the yield curve in
the valuation model and recalculating the present values. The estimated effective duration
is calculated to be 9.5.
Kylie has asked the research department at her firm to prepare a report on the future
outlook of market interest rates. The final report declares that unemployment is expected
to decrease, sales to rise, and inventories to build up. As the economy lifts up, spreads are
expected to tighten, as credit quality improves and default rates decrease. After reading
the report, Kylie becomes particularly concerned with how this interest rate scenario
could alter the funded status as reported on LUCN’s current balance sheet. Even though
the asset portfolio has only a 35% allocation to bonds, Kylie, nonetheless, anticipates an
adverse effect on plan assets, since their duration equals 6.0. The effective durations of
the remaining allocations to equity and alternative investments are assumed to be zero.
After careful deliberation and a comprehensive discussion with the portfolio management
team, Kylie suggests to the board of LUCN to consider the use of a derivatives overlay
strategy to manage the difference in durations between the assets and liabilities. In a
meeting with the board, she elaborates the following four derivative options:
Strategy 1: “The use of a 10-year Treasury futures contract with a BPV of $11,055
estimated using the cheapest to deliver bond.”

Strategy 2: “A 25-year, swap contract that has a fixed rate of 4.50% against three-month
Libor. The swap’s effective duration is 17.88. The BPV is calculated per
$100 of notional principal.”
Strategy 3: “A swaption with a strike rate of 3.75% and a premium of $75,000. The
swaption gives the right to enter into the swap described in strategy 2 and
expires on a date that coincides with LUCN’s next financial reporting date.”
Strategy 4: “A swaption collar that involves the swaption in strategy 3 as well as an

additional one with a strike rate of 5.50%. The swaption premium on this
swaption equals that of the previous one.”
As further clarification, Kylie states that a hedging ratio of 100% would not be feasible
even though it would completely eliminate the duration gap. She suggests that a ratio of
60% is a practical approach to managing the interest rate risk of the portfolio.
25. To actively hedge the pension liabilities using a derivatives overlay, LUCN
should least likely:
A. enter the swap as a floating-rate payer.

B. Buy a payer swaption.
C. Buy a receiver swaption and write a payer swaption.
26. The notional principal of the swap in strategy 2 will be closest to:
A. $11.32 million.
B. $6.79 million.
C. $5.30 million.
27. Given that LUCN takes the right side of the swap, if Kylie anticipates interest
rates to be higher than the research department has estimated, the optimal hedging
ratio is most likely to:
A. decrease.
B. Increase.
C. Remain unchanged.

28. Given that LUCN takes the right hedging position, if swap rates are expected to
equal 4.3%, which of the following strategies would be preferred?
A. Strategy 1.
B. Strategy 2.
C. Strategy 3.
29. Given that LUCN takes the right hedging position and considering that the swap
is annual-pay, if swap rates rise to 5.65% which of the following strategies would
most likely be the preferred option?
A. Strategy 2.
B. Strategy 3.
C. Strategy 4.
30. Assuming that the swap is semi-annual pay, if rates are expected to equal 4.35%,
the gain or loss on Strategy 2 will be closest to:
A. $5093.
B. $8,535.
C. -$9,209.

Questions 31 to 36 relate to Fixed Income
Martin Alexander Case Scenario

Martin Alexander works for a renowned credit rating agency as a security appraiser &
research analyst. Alexander has worked with his colleagues in the bond appraisal of
numerous US-based, as well as international issuers. Consequently, he has become adept
at performing a comprehensive analysis of the factors that influence the financial
standing of a firm. For his latest assignment, Alexander is studying how a country’s
interest rate is affected by currency exchange rate changes. In particular, he is assessing
the following:
§ Changes in the level of long-term interest rates relative to short-term rates as

expressed in the yield curve.
§ The correlation between economic growth and defaults, and between defaults and
credit spreads.
§ The relationship of total debt as a multiple of EBITDA for different market
sectors of interest.
Alexander uses this method to determine how investment-grade bonds would perform
relative to high-yield bonds. He gathers the data presented in Exhibit 1 to perform an
accurate comparative analysis. The data describes the two sectors as a whole, and does
not focus on any one particular issue.
Exhibit 1: Investment grade vs. High-yield Bonds (for the year ended 2015)
Investment Grade
High-Yield Bonds
Bonds
Assets Under Management $55.95 billion $43 billion
Total US$ withdrawn $11.29 billion $10.32 billion
Spread before withdrawal 8.5% 4.5%
Spread after withdrawal 9.3% 5.7%
Bid-ask spread in bps

(measured in $price for high-
14 16
yield bonds and determined
an equivalence in bps)
Expected rise in net

33% 41%
debt/EBITDA

After gathering this data, Alexander also made the following observations about the US
fixed-income market:
Observation 1: “Heterogeneity in market views and assumptions has increased

significantly. Over the past few years, individual as well as institutional
investors have shown varying interest in fixed-income issuers.”
Observation 2: “Total assets under management, of both high yield and investment grade
bonds, decreased reasonably over the same time period.”
Observation 3: “The balance sheet size of any one particular issue on dealers’ balance
sheets decreased considerably.”
Observation 4: “Risk-averseness amongst market makers decreased.”
In addition to the US fixed-income market, Alexander is also aware about the benefits of
including emerging market bonds to a US bond portfolio. For this, he is considering three
emerging markets. He has accumulated some preliminary information about the structure
of their credit markets using data of their respective popular fixed-income indices.
Exhibit 2 expresses these details.
Exhibit 2: Emerging Market Data

Market A Market B Market C
% of government
ownership of bond 55% 23% 65%
issuers
Highest % of bonds
in the index w.r.t BBB BB CCC
credit rating
Increase in supply
High Low High
of corporate bonds
Average interest
4.0% 7.0% 9.0%
rates
As a continuation to the data gathered, Alexander also jotted down the following
expectations:
Expectation 1: The market will be bullish in all three countries.

Expectation 2: Debt restructuring will remain low.

While Alexander is concerned about the performance of these markets, and the risks
involved, he is somewhat at ease with investing in the US market because he believes that
interest rate volatility will remain low in the coming future. To offset the risks taken in
international bonds, Alexander wants to invest locally such, that liquidity is high and
default risk is low.
31. The most prominent drawback of the analytical approach used by Alexander is
that:
A. a sizable portion of credit returns may not be identified.

B. A semi-strong form efficient market would erode any competitive
advantage.
C. The effect of financial indicators on security prices will be difficult to
measure.
32. Based on the data given in Exhibit 1, which sector of the fixed-income market
appears to be more liquid?
A. High-Yield.
B. Investment Grade.
C. Either high-yield or investment grade.
33. Which of the following observations made by Alexander are most likely to
indicate an increase in liquidity in the fixed-income market?
A. Observations 1 and 4 only.

B. Observation 2, 3 and 4 only.
C. Observations 1, 3 and 4 only.
34. Assuming an unhedged position, using the data in Exhibit 2, the most attractive
investment for a US investor will be:
A. corporate bonds in Market C.

B. Investment-grade bonds in Market A and investment-grade bonds in
Market B.
C. Investment-grade bonds in Market C and corporate bonds in Market A.

35. Assuming all other factors are the same, currency risk will be highest for:
A. Market A.
B. Market B.
C. Market C.
36. In the US market, the most appropriate investment given Alexander’s expectations
will be:
A. Corporate bonds.
B. Agency MBS.
C. Investment grade bonds.

Questions 37 to 42 relate to Alternative Investments
Howard Corp Case Scenario
The board of trustees of Howard Corp’s defined benefit pension plan is seeking to expand
the $200 million investment portfolio which is currently allocated to Russell 3000 equity
index stocks and the Lehman Corporate Bond Index. The board is particularly interested
in an allocation to commodities due to their inflation hedging potential and low
correlation with existing portfolio holdings. The board is seeking the advice of Diego
Miller, an investment manager, serving a wealth management firm.
Miller deems that a direct exposure to futures based on the GSCI is suitable for HC’s
portfolio. To justify his choice of asset class, Miller collects historical performance on the
commodity index performance. He breaks down the performance of the index into four
components (Exhibit).
Exhibit:
Components of the GSCI Return Index (2000-2014)
GSCI Total GSCI Collateral GSCI Roll GSCI Spot
Annual Return Yield Return/Yield Annual Return
Year (%) (%) (%) (%)
1 25.1 4.5 ? 14.8
2 ? 18.8 12.7 6.1
Jill Travis is a board trustee representative at Howard Corp. She is concerned about the
limitations associated with an investment in GSCI futures. She asks Miller whether her
concerns are valid.
Miller proceeds to forecast the future performance of commodity index futures if Howard
Corp decides to undertake the investment. He reads an analyst’s report which presents
forecasts concerning the future economic outlook. Miller focuses on two forecasts:
Forecast 1: Economic and business conditions are likely to worsen.
Forecast 2: Due to a decline in the profitability of businesses, in general, inventory levels

will be reduced to cut down costs thereby increasing the supply of
commodities in the market.

Miller discusses these forecasts with Travis emphasizing on what they imply for spot
returns. Travis asks Miller whether Forecast 2 signals that Howard Corp will be exposed
to positive event risk.
While the GSCI futures investment will provide a passive long-only exposure to the
portfolio, Miller determines that the pension plan’s characteristics provide room for risk
taking. The manager proceeds to explore an active program using managed futures. He
prepares a report for Howard Corp’s board proposing the investment strategy. In his
report, Miller presents the investment characteristics of managed futures:
Characteristic 1: Seek active returns from inefficiencies in the pricing of individual stocks
and bonds.
Characteristic 2: Investment requires a stringent due diligence process.
Characteristic 3: Are absolute return strategies as returns depend on the skill and/or
strategy of the individual trader.
37. Using the data in the Exhibit, which of the following reasons least likely explains
the roll return observed in Year 2?
A. Market volatility has decreased.

B. Convenience yields have increased.
C. There is an excess supply of commodities.
38. Based on the data in the Exhibit, the roll return in Year 1 is closest to:
A. 5.8%.
B. 10.3%.
C. 12.7%.
39. The most appropriate response to Travis is that an investment in the GSCI futures
will:
A. increase liquidity risk.

B. increase rebalancing costs.
C. decrease the degree of investability.

40. The implication of Forecast 1 and 2 on projected spot returns respectively is:
Forecast 1: Forecast 2:
A. positive negative.
B. negative no effect.
C. no effect positive.
Correct Answer: A
Reference:
CFA Level III, Volume 5, Study Session 13, Reading 24, LOS n
In periods of financial and economic distress, commodity prices tend to increase

in value.
An expected increase in the supply of commodities will lead to a decrease in

commodity prices and spot returns and business will reduce their inventory levels
(commodities) Therefore, Forecast 2 has a negative impact on spot returns.
41. The most appropriate response to Travis’ query concerning Forecast 2 implying
high positive event risk for the pension plan is a:
A. no.
B. yes, there is an excess supply of commodities.
C. yes, the volatility of commodity prices will increase.
42. In context of his research report covering managed futures, Miller is least accurate
with respect to Characteristic:
A. 1.
B. 2.
C. 3.

Question 43 to 48 relate to Performance and Evaluation
Vault Corp Case Scenario
The equity portion of Vault Corp’s investment portfolio is being managed by Reliable
Financials (RF), a brokerage firm with a trust department. Vault’s CEO, Carla Smith, has
recently fired their investment advisor because he failed to outperform his performance
benchmark for two consecutive years.
Judith Spencer, CFA, is an investment advisor at RF who will be managing the ex-North
American developed equity market segment of VC’s portfolio. These securities are issued
in Europe, Australasia and the Far East (EAFE). Under the previous advisor the portfolio
was managed with a long-only active, market-oriented, large-cap equity mandate. The
current performance benchmark is a returns-based index with an equal allocation to large-
cap growth and large-cap value EAFE equities.
Spencer is of the opinion that the existing benchmark is inappropriate and is seeking to
replace it with one which is valid. The portfolio will continue to be managed under its
original mandate.
One year after assigning a suitable performance benchmark, Spencer’s supervisor, Eric
Daniels, tests the benchmark’s quality by collecting relevant information concerning
VC’s investment portfolio (P), benchmark (B), and the broad MSCI EAFE market index
(M) in an exhibit (Exhibit). After carefully examining the performance results of the
portfolio, Daniels notes that Spencer has maintained strong negative and positive views
concerning the EAFE securities.

Exhibit:
Testing Spencer’s Benchmark Quality
Volatility of E* σE 18.7%
Volatility of Active Return σA 9.5%
Correlation Coefficient between - 0.5
S and E (pS,E)
Correlation Coefficient between 0.0
A and B (pA, B)
B* – M* Positive
Benchmark turnover 10.5x
Benchmark coverage 0.7
Average annual active position - 0.8%
*E = Account performance (P) – Market index performance (M)
S = Return attributable to manager’s style
B = Benchmark performance
A small portion of VA’s investment portfolio is invested in a hedge fund employing a

long-short equity strategy with respect to stocks included in the Russell 2,000 index.
Smith would like to evaluate the performance of the fund over the most recent
performance year. She is evaluating three different options:
!"# $!"%
Option 1: Compute the fund’s rate of return ( !"%
) over the performance period.
Option 2: Compare the hedge fund’s Sharpe ratio to a universe of hedge funds with a
long/short investment mandate.
Option 3: Evaluate the fund’s performance relative to a custom-based benchmark by

combining separate long and short equity benchmarks.
Based on limited knowledge on hedge funds, Smith concludes that option 1 can lead to
nonsensically extreme returns; the Sharpe ratio relevant to the hedge fund universe
identified in option 2 is not measurable as the investment strategy includes a high degree
of skewness; and option 3 will produce a benchmark which lacks transparency.

43. The most likely implication of Smith’s decision to fire the previous investment
advisor is that:
A. Type I error will decrease.

B. Type I error will increase.
C. Type II error will decrease.
44. One limitation of the benchmark based on the returns-based index is that:
A. it is ambiguous.
B. it is not investable.
C. tracking error is increased.
45. The most appropriate benchmark for VA’s EAFE segment is a:
A. style index.
B. broad market index.
C. custom security-based index.
46. Based on the data in the Exhibit and considering each factor in isolation, Daniels
will conclude that the benchmark is of low quality based on the fact that the:
A. the proportion of active positions is low.

B. benchmark is not reflective of Spencer’s investment style.
C. benchmark bears little resemblance to the opportunity set of Spencer’s
investment process.
47. Using the correlation data in the Exhibit, Spencer will conclude that systematic
bias in the benchmark relative to the account is:
A. minimal based on correlation coefficient of E and M (pE,M).

B. minimal based on correlation coefficient of A and B (pA,B).
C. significant based on correlation coefficient of E and M (pE,M).
48. Regarding hedge fund performance evaluation, Smith is most accurate regarding
her conclusions with respect to:
A. 2 only.
B. 1 and 2 only.
C. all three options.

Question 49 to 54 relate to Derivatives
Gus Weaver Case Scenario
Gus Weaver holds a $30 million portfolio invested in Arc Limited’s shares of a stock
which is indexed to the DJIA 30. Weaver would like to reduce his exposure to the shares
in anticipation of a profit squeeze which is forecasted to decrease Arc’s share price over
the course of the coming months. Weaver asks his portfolio manager, Eric Cox, to devise
a suitable strategy which does not involve liquidating his holding.
Cox designs two alternative strategies using DJIA 30 equity index futures contracts and
options, respectively. The strategies he has devised include:
Strategy 1: Synthetically reducing the exposure using 1-month DJIA 30 equity index
futures
Strategy 2: Employing equity call and/or put options written on the Arc Limited stock
Cox explains to Weaver that should Strategy 1 be implemented, the position will need to
be rolled over each month until protection is no longer desired. He collects details with
respect to the instruments used for the strategy (Exhibit 1).
Exhibit 1:
Details Concerning Strategy 1
Current market price per share $51.50
Futures price 1,860.50
Multiplier 25.00
Index dividend yield 0.50%
One- month risk-free rate 2.30%
After studying the strategy, Weaver asks Cox how an alternative strategy involving the
liquidation of portfolio holdings and subsequent investment of the proceeds in a risk-free
asset would compare to Strategy 1 in terms of relative liquidity, transaction costs, and
success in reducing portfolio beta to zero.

Next, Cox proceeds to explore Strategy 2. He collects details relevant to three one-month
put options (Exhibit 2) written on the Arc Limited stock. He expects the stock to be worth
$51.80 at option expiration. The designed strategy will greatly depend on whether
Weaver would like to:
i. maximize loss protection or

ii. retain upside potential but hedge losses.
Exhibit 2:
One-Month Put-Option Prices
Option 1 2 3
Exercise price ($) 49.70 51.00 54.30
Option price ($) 1.10 1.70 2.40
Cox believes that a protective put strategy will be most suitable if Weaver decides to
maximize loss protection and selects the 54.30 put to achieve this purpose.
Cox concludes his analysis by exploring the most suitable option structure should Weaver
choose to retain upside potential. Cox strongly believes that market volatility will remain
low over the next three months and intends to incorporate this projection in his selection
decision.
49. The number of futures contracts required to be sold and the effective amount of
money needed to be invested in risk-free bonds to implement Strategy 1 is,
respectively, closest to:
number of futures effective investment

contracts to be in risk-free bonds:
sold:
A. 645 $29,998,096.00.
B. 646 $29,990,190.99.
C. 646 $29,999,940.12.

50. order to establish an effective hedge using Strategy 1, Cox must ensure that
relative to the index beta, portfolio beta is:
A. lower.
B. higher.
C. identical.
51. Cox’s most appropriate response to Weaver’s query concerning the comparison of
Strategy 1 to a liquidation of and reinvestment of portfolio proceeds in the context
of liquidity and success of eliminating beta exposure is that:
A. neither of the two strategies will guarantee a zero beta exposure.

B. strategy 1 will be more effective in guaranteeing a zero beta exposure.
C. investing the liquidation proceeds in risk-free securities is the more liquid
alternative.
52. Using the data in Exhibit 2 and assuming the share price expectation is realized,
the value of the protective put strategy, on a per share basis, is closest to:
A. $0.00.
B. $51.90.
C. $54.30.
53. Using the data in Exhibits 1 and 2, the breakeven price per share on the proposed
protective put strategy is closest to:
A. $49.10.
B. $51.90.
C. $53.90.
54. Which of the following strategies is most suitable for maximizing upside potential
on the Arc stock position?
A. Straddle
B. Long position in a butterfly spread
C. Bear spread using put options 2 and 3

Questions 55 to 60 relate to Global Investment Performance Standards
Walk Associates Case Scenario
Walk Associates (WA) is a firm providing brokerage and asset management services. The
firm is seeking to present its financial statements in compliance with the requirements
and recommendations of the Global Investment Performance Standards (GIPS). Clarence
Long is WA’s senior compliance officer who will be overseeing the conversion process.
Long evaluates the performance presentation of WA’s large-cap equity composite whose
equity holdings are benchmarked to the Russell 3000 index (Exhibit 1). The composite
commenced on January 1, 2010. The presentation has been prepared by a senior equity
fund manager and includes note disclosures. During his evaluation of the presentation,
Long identifies numerous inconsistencies which require rectification.
Exhibit 1:
Large-Cap Equity Composite Performance Presentation and Note Disclosures
Composite Benchmark Value of Value of
Gross-of- Gross-of- Total Cash Non- Composite
Fees Fees Firm Holdings Discretionary Downside
Returns Returns Assets ($ Assets Deviation
Year (%) (%) ($ Millions) ($ millions) (%)
Millions)
2010 8.9 7.8 2.5 0.1 0.1 - 4.5%
2011 9.1 9.0 2.8 0.2 0.1 - 8.8%
2012 9.5 9.5 3.4 0.1 0.3 - 2.2%
2013 9.0 9.8 3.0 0.3 0.2 - 7.1%
2014 8.9 9.8 3.1 0.3 0.4 - 12.0
Note 1: Gross-of-fees returns represent a return net of an all-in-fee comprising advisory,

custody and administrative fees. The portion of advisory fees including actual
trading expenses has been omitted from return calculations as these expenses are
highly variable and an estimate for trading expenses cannot otherwise be derived
with a reasonable degree of accuracy.
Note 2: Total firm assets include discretionary fee- and non-fee paying portfolios.

Note 3: Cash holdings represent investments in Treasury bills which are being managed
by a client-designated external fixed-income specialist firm. Returns from cash
holdings have been included in portfolio return calculations.
Note 4: The firm routinely employs option strategies such as protective put and bear
spreads to provide downside protection on its equity holdings.
Note 5: Due to the existence of embedded options for hedging purposes, the firm has
elected to present downside deviation as an additional risk measure to standard
deviation, which assumes normal distribution and is thus inappropriate for
evaluating the performance of a skewed return distribution.
Note 6: Non-discretionary portfolios include those managed with an active mandate but
are prohibited by portfolio holders from participating in small-cap equities.
Long would like to evaluate how composite portfolio returns are calculated and thus
breaks down the performance of one portfolio in terms of cash flow activity and market
values for a five month period (Exhibit 2).
Exhibit 2:
Five-Month Portfolio Valuation
and External Cash Flow Activity (2014-2015)
Market Value
Market value External Cash Including Cash
Portfolio Date ($) Flows ($) Flows ($)
31 December 2014 250,000 + 15,000 270,000
25 February 2015 275,000 - 2,000 280,000
29 March 2015 282,000 + 3,500 286,000
16 April 2015 275,000 + 4,000 285,000
30 April 2015 285,000 - 1,000 283,000

55. WA’s fee presentation policy presented in Note 1 is inconsistent with the
requirements of the GIPS standards and requires modification. Which of the
following statements represents an appropriate adjustment?
A. Trading expenses should be included even if they cannot be estimated with

accuracy.
B. Administrative fees must be excluded as they are generally not within the
control of a firm.
C. The portion of advisory fees including actual trading expenses must
represent the sole deduction from gross-of-fees returns.
56. Are Note 2 and Note 3 consistent with the requirements and recommendations of
the GIPS standards?
Note 2? Note 3?
A. Consistent Inconsistent
B. Inconsistent Consistent
C. Inconsistent Inconsistent
57. Note 4 is inconsistent with the requirements and recommendations of the GIPS
standards with respect to WA’s use of derivatives instruments. Which of the
following has been omitted by the disclosure and represents a violation?
A. presence.
B. characteristics.
C. frequency of use.
58. Is the firm’s decision to include downside deviation as a measure of internal

dispersion appropriate (Note 5)?
A. Yes.
B. No, the firm may only present standard deviation as a measure of risk.
C. No, the GIPS glossary does not define downside deviation as a measure of
risk.

59. Has the firm appropriately classified its non-discretionary portfolios (Note 6)?
A. Yes.
B. No, the restriction does not impede the investment process.
C. No, client restrictions on the portfolio manager do not render a portfolio as
non-discretionary.
60. Using the data in Exhibit 2, calculate the rate of return for the portfolio for the 1st
quarter of 2015 using revaluing the large cash flow methodology.
A. 6.21%.
B. 16.32%.
C. 17.42%.

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FinQuiz.com – 5th Mock Exam 2018 (PM Session)

Questions Topic Minutes

1-6 Ethical and Professional Standards 18

7-12 Ethical and Professional Standards 18

13-18 Economic Analysis 18

19-24 Equity Investments 18

25-30 Fixed-Income Portfolio Management 18

31-36 Fixed-Income Portfolio Management 18

37-42 Alternative Investments 18

43-48 Performance & Evaluation 18

55-60 Global Investment Performance Standards 18

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Questions 1 to 6 relate to Ethical and Professional Standards

Sun Davidson, CFA, Case Scenario

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2. By issuing the purchase recommendation, Davidson is in violation of the CFA

A. conduct a suitability analysis.

3. In order to avoid violation of the CFA Institute Standards of Professional

A. Ramos’s investment in the EF only.

4. By accepting Davidson’s offer to contribute to the blog, is Ramos in violation?

A. No, he will not be disrupting the activities of his employer.

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5. Ramos’s best course of action with respect to Clark’s offer is to:

A. decline the offer.

6. With respect to the statement made to Davidson at the investment conference, is

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Questions 7 to 12 relate to Ethical and Professional Standards

Riverside Asset Management Case Scenario

Riverside Asset Management (RAM) is a privately owned, small-scaled investment

Once he is reasonably satisfied with RAM’s level of compliance, Marquez sends an

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Several of the fund’s clients have requested an allocation to commodities. However,

7. Is RAM’s claim of compliance statement consistent with the Asset Manager

8. By modifying his strategy, is Nash in violation of the Asset Manager Code?

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A. has distorted the performance presented.

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Questions 13 to 18 relate to Economics

Dianne Fernandez Case Scenario

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Growth in potential labor force size 3.4 3.0

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A. short-term time horizons only.

16. In context of the data presented in Exhibit 2 and considering Fernandez’s

A. the death rate to decline.

A. TFP growth will be boosted.

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Question 19 to 24 relate Equity Investments

Trone Wealth Advisory Case Scenario

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A. dividend yield exceeds the average industry yield.

24. The drafted security selection policy most likely represents:

A. the top-down approach.

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Question 25 to 30 relate to Fixed Income

Link-up Communications Network (LUCN) Case Scenario

Link-up Communications Network (LUCN) is a nation-wide, telecom firm with

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Strategy 4: “A swaption collar that involves the swaption in strategy 3 as well as an