V1 Exam 1PM

10/9/2020 V1 Exam 1PM
CFA Level III My Activities
Test ID: 146740506
Questions #1-6 of 60
Questions 1–6 relate to Ethical and Professional Standards.
Jamie Blackmore Scenario
Jamie Blackmore, CFA, works for a portfolio management firm. Blackmore is a partner of the firm and is primarily
responsible for managing the accounts of several large pension plans. She is also in a supervisory position with
several research analysts reporting directly to her. Dave Lange is a research analyst who has worked under
Blackmore for the last six years. Lange recently completed the Level III CFA exam and is anxiously awaiting the
results. As a display of confidence, Blackmore shows Lange a box of business cards that have already been printed
up for Lange with the initials "CFA" after his name. She locks them away in a filing cabinet and promises to deliver
them on the day they get the news of his passing the exam and receiving his charter.
Blackmore and Lange have been working closely to service a number of clients. Lange knows that Blackmore
recently met with a prospect named Johnnie Stangle. Based on his investment policy statement, Blackmore made a
recommendation to Stangle to which he agreed. Blackmore then tells Lange to execute the trade. Lange has not
seen the final paperwork outlining the account, but from what he knows the trade is congruent with Stangle's
situation. Lange also knows the recommendation is generally a sound one.
Blackmore has been asked to write a research report on the 7MOD7 Corporation, where she is a member of the
board of directors. Because of her relationship with 7MOD7, she assigned Lange to write the report instead.
Blackmore is Lange's supervisor and requires Lange to show all of his work to her for final approval. As Lange
begins writing the report, he remembers that the trust fund for his children, left to them by the parents of his wife,
has a sizable investment in 7MOD7.
Blackmore also manages a defined benefit (DB) pension fund for Green International. The management of Green
International has just requested that Blackmore increase the portion in international equity funds to 30% of total
assets from its current position of 10% of total assets. The management of Green International believes the
potential for growth in international markets is much greater than the domestic market and would like to see the
pension fund managed more aggressively. Lange watches as Blackmore immediately acts upon the
recommendation of Green International. Blackmore allocates some of the fund's assets to a few stocks in foreign
countries. One of the stocks immediately goes up in price and volatility, and Blackmore sees an opportunity to earn
some extra income for the fund by selling covered calls on that particular stock. Lange asks Blackmore if the
pension fund's charter allows derivative strategies. Blackmore says she does not know but only sells covered calls
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when she sees a really good opportunity and none of her clients has ever complained. Blackmore points out to
Lange that covered calls don't cost a client anything and they earn income for the client.
Despite his close relationship with Blackmore, Lange has been preparing to start his own money management firm.
He has turned a spare bedroom in his house into an office with new furniture and a computer, has had the room
wired with the latest internet service upgrades, has subscribed to financial news services, and has opened a trading
account in the name of his proposed company. Lange told an old friend, who has a large portfolio being managed at
another brokerage firm, about his plans. The friend knows Blackmore and told Lange that he did not like her and
could not let Blackmore's firm handle his portfolio. If Lange was on his own, however, the friend would want Lange
to manage his portfolio. Lange also contacts a cousin who has recently inherited a large portfolio. The cousin says
that he would like to get some help managing the portfolio as soon as possible. Lange instructs his cousin to use
futures contracts to hedge the value of the portfolio cost-free until Lange sets up his business and can take his
cousin on as a client. He sends each of them a copy of his resume where he places "CFA (expected 2020)" after
his name.
Question #1 of 60 Question ID: 1267676
With respect to Blackmore's instruction to execute the trade for Stangle, according to the standards, Lange should:
A) execute the trade immediately.

B) not execute the trade because he has not met Stangle himself.
C) execute the trade only after consulting the firm’s legal counsel.
With respect to the report on the 7MOD7 Corporation that Blackmore asked Lange to write, which of the following
must Lange include in the report?
A) Blackmore is on the board of 7MOD7.

B) The position of 7MOD7 in the trust fund of Lange’s children.
C) Blackmore is on the board of 7MOD7 and the position of 7MOD7 in the trust
fund of Lange’s children.
With respect to the DB pension fund for Green International, Blackmore's fiduciary duty is:
A) owed primarily to the management and stockholders of Green International.

Blackmore should follow management’s direction to potentially increase the
value of the company.
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B) owed to the participants and beneficiaries of the Green International pension

fund. Therefore, Blackmore should continue to manage the fund in their best
interest, regardless of the management’s request.
C) owed equally to the participants and beneficiaries of the fund, and to

management of Green International. Therefore, Blackmore should increase
the portion in international equities as long as it is within policy statement
guidelines.
With respect to the pension fund for Green International, after Lange becomes aware of Blackmore's actions in
response to management's instructions and the sale of the call options, he should:
A) disassociate from Blackmore’s activities.

B) report Blackmore’s activities to the appropriate regulatory authority.
C) do nothing, because he knows what Blackmore said about the covered call
strategy is true.
With respect to Lange preparing to set up his own business, Lange violated the standards:
A) in his communication with his friend.
B) in his communication with his cousin.

C) by setting up trading accounts in the name of his company.
Violations, with respect to the use of the CFA designation, occurred with:
A) the printing of the business cards by Blackmore, but not the letters sent by
Lange to his friend and cousin.
B) both the printing of the business cards by Blackmore and the letters sent by
Lange to his friend and cousin.
C) the letters sent by Lange to his friend and cousin, but not with the printing of
the business cards by Blackmore.
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Questions 7–10 relate to Ethical and Professional Standards.
Lewis Smithers Scenario
Lewis Smithers, CFA, is the lead portfolio manager for Fundamental Investments Corp., a money manager serving
individual investors. He has researched Pineda Canyon Development (PCD), an owner of mountainside real estate
perfect for the development of ski resorts. However, he concludes PCD lacks the cash to build the resorts.
Smithers has lunch with a friend, Judith Carson. Carson is managing partner of a land-developer that owns
thousands of acres of prime real estate. During the course of their conversation, Carson asked Smithers to invest in
one of their limited partnerships, which is about to buy a land developer and its acreage near Sassy River.
Smithers talks with Liam O'Toole, his largest client. O'Toole is a knowledgeable real estate investor. When asked,
O'Toole mentions that he saw in a newsletter that a large Arizona real estate developer is expected to soon sell
property in the Sassy River Valley. The article only mentions the amount of acreage and rumored sale price, not the
buyer and seller. O'Toole offers to make Smithers a participant in the deal. O'Toole also mentions he would like to
use Smithers' condo for a week this summer.
Smithers suspects these are the same transaction and PCD is the seller. He calls Carson and asks if this is true.
Carson will neither confirm nor deny it. Later Smithers sees Carson having dinner at a public restaurant with two
PCD senior executives. From public records he determines PCD is the only plausible large land seller in Sassy
River and Carson's firm is the only plausible buyer.
That afternoon, Smithers prepares a purchase recommendation for PCD stock. He cites the expected sale of Sassy
River Valley land for a very attractive price. He includes projected revenue and profit numbers and details the
location of the property. As required by firm policy, he submits the report to his supervisor for approval before
issuance.
In gathering information for the PCD purchase recommendation and in regard to the Code and Standards, Smithers
most likely:
A) committed no violations.
B) violated his obligations of Loyalty, Prudence, and Care.
C) violated his obligations for a Diligent and Reasonable Basis.
After submitting his stock recommendation to his boss and before receiving a response, Smithers takes three
actions. The action least likely to violate the Code and Standards is:
A) advising a few family and friends to purchase Pineda stock.

B) downgrading two other related stocks on the basis of general industry trends.
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C) discussing his views and information with Fundamental Investment’s bond

department.
When Carson asks Smithers to personally invest in a partnership, it is most accurate to say Smithers may:
A) invest.
B) not invest.
C) may invest if it is not detrimental to his clients.
Regarding Smithers' discussion with O'Toole, it is most likely that:
A) Smithers may not participate in the deal O’Toole offers.
B) Smithers may not let O’Toole use Smithers’ condo.

C) both actions could be acceptable with sufficient disclosures.
Questions 11–16 relate to Economic Analysis.
Olli Nava Scenario
Olli Nava is a junior economist for Globofunds Asset Management, a large investment management company. She
has been asked to produce capital market expectations for asset classes in several different markets relevant to the
Diversified Absolute Return Strategies Fund (DARS), the company's largest fund.
Nava is aware that long-term GDP trend forecasting is considered the starting point to form capital market
expectations at Globofunds, but she is unsure why this is the case. She asks a colleague, Jedd Wiggins to explain
why long-term trend GDP growth is considered so important when forecasting asset class returns. Wiggins makes
the following two statements.
Statement 1: There is both theoretical and empirical support for the case that the average level of real
government bond yields is directly linked to the trend rate of growth in the economy.
Statement 2: Over the long run, the total return of an equity market is directly linked to the growth rate of
GDP.
In order to make a forecast of trend GDP growth in the domestic economy, Nava collates the following Globofunds
data displayed in Exhibit 1.
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Exhibit 1: Information on Domestic Economy
Annual labor input growth 0.8%
Annual labor productivity growth 1.2%
Annual inflation 2.5%
Dividend yield 3.0%
Long-term change in profits as a share of GDP 0%
Long-term change in PE multiples 0%
Nava has the view that increased levels of globalization will lead to the current account playing a larger role in
growth rate of economies. She considers the macroeconomic linkages between the three main economies which
the fund is exposed to. Macroeconomic data relating to these economies is displayed in Exhibit 2.
Exhibit 2: Macroeconomic Data Relating to Three Economies
Economy Savings Investment Taxation Government Spending
1 Increasing Decreasing Increasing Decreasing
2 Decreasing Increasing Decreasing Increasing
3 Increasing Increasing Increasing Increasing
Nava also considers the movement in foreign exchange to be a key determinant of the medium term performance
of DARS. She considers the macroeconomic policy of the three main developing markets which the fund is exposed
to and collates the data as shown in Exhibit 3.
Exhibit 3: Macroeconomic Data Relating to Three Developing Markets
Developing Market Capital Flows Exchange Rate
A Restricted Fixed
B Unrestricted Fixed
C Unrestricted Floating
Nava attempts to forecast the likely foreign exchange rate movements that will affect the fund. She notes that the
largest foreign currency exposure is in Country X. The current spot rate of the domestic currency of the fund (DOM)
versus the foreign currency of Country X (FOR) is DOM/FOR = 1.3020. Data related to the expected returns in the
domestic and foreign markets is displayed below in Exhibit 4.
Exhibit 4: Expected Returns in Domestic Markets and Foreign Country X
Return Domestic Country X
Short-term interest rates 0.75% 1.25%
Term premium 0.00% 0.50%
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Credit premium 1.10% 0.60%
Equity premium 3.00% 4.00%
Liquidity premium 0.00% 0.00%
Nava also considers purchasing power parity as a tool for long-term foreign exchange rate forecasting. She notes
that expected inflation in the domestic country is higher than the expected inflation in Country X.
How many of the statements made by Wiggins are accurate?
A) Zero.
B) One.
C) Two.
Based on the data in Exhibit 1, the projected long-term domestic market equity return is closest to:
A) 4.5%.
B) 5.0%.
C) 7.5%.
Based on the data in Exhibit 2, the economy that is most likely to experience an increase in its current account is:
A) Economy 1.
B) Economy 2.
C) Economy 3.
Based on the information in Exhibit 3, the market that is least likely to be able to pursue an independent monetary
policy is developing:
A) Market A.
B) Market B.
C) Market C.
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Based in the data in Exhibit 4, the forecast one-year DOM/FOR foreign exchange rate, based on capital flows using
the Dornbusch overshooting, is closest to:
A) 1.2825.
B) 1.2889.
C) 1.3215.
Based on purchasing power parity, Nava should forecast that, relative to the current spot rate, the DOM/FOR
exchange rate is forecast to:
A) fall.
B) rise.
C) remain unchanged.
Questions 17–20 relate to Derivatives and Currency Management.
Garrison Investments Scenario
Garrison Investments is a money management firm focusing on endowment management for small colleges and
universities. Over the past 20 years, the firm has primarily invested in U.S. securities with small allocations to high
quality long-term foreign government bonds. Garrison's largest account, Point University, has a market value of
$800 million and an asset allocation as detailed in Point University Asset Allocation.
Point University Asset Allocation
Asset Class Allocation Dividend/Coupon* Beta
Large cap equities 40% 2.0% 1.0
Mid cap equities 25% 1.2% 1.3
Small cap equities 15% 0.9% 1.5
U.S. Bonds 10% 5.0% 0
U.K. Bonds 5% 4.7% 0
German Bonds 5% 4.0% 0
European Index 0% 1.8% 1.2
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*Bond coupon payments are all semiannual.
Garrison recently convinced the board of trustees at Point University that the endowment should allocate a portion
of the portfolio to European equities. The board has agreed to the plan but wants the allocation to international
equities to be a short-term tactical move. Managers at Garrison have put together the following proposal for the
reallocation:
To minimize trading costs while gaining exposure to international equities, the portfolio can use futures
contracts on the domestic 12-month mid-cap equity index and on the 12-month European equity index.
This strategy will temporarily exchange $80 million of U.S. mid-cap exposure for European equity
index exposure. Relevant data on the futures contracts are provided in Mid-cap Index and European
Index Futures Data.
Mid-cap Index and European Index Futures Data
Futures Contract Price Beta Multiplier
Mid-cap Index $908 1.10 250
European Index $2,351 1.05 50
Three months after proposing the international diversification plan, Garrison was able to persuade Point University
to make a direct short-term investment in Haikuza International (HI), a Japanese electronics firm. Analysts at
Garrison have regressed the historical returns of the HI stock with changes in value of the yen. When the HI returns
are measured in U.S. dollars, the regression slope coefficient is +0.80.
The managers at Garrison are discussing other factors that may be considered if they continue to diversify into
foreign markets. The following statements are made:
Statement 1: The minimum variance hedge ratio is riskier than a simple direct one-for-one hedge ratio
because it depends on the correlation between asset and currency returns.
Statement 2: An alternative to selling the yen forward to implement the HI currency hedge would be to buy
calls on the USD. This would protect the portfolio from currency risk while still retaining
potential currency upside. Unfortunately, it will have a higher initial cost.
With regard to Garrison's proposal to generate temporary exposure to European equities in the Point University
portfolio, determine the appropriate position in the mid-cap equity index futures.
A) Buy 417 contracts.

B) Sell 298 contracts.
C) Sell 417 contracts.
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Garrison's analysis to determine a hedge ratio for the HI exposure is best described as producing a:
A) cross hedge.
B) transaction hedge.
C) minimum variance hedge.
Which of the following is the correct short position in yen the managers at Garrison will execute to implement a
minimum variance hedge for a JPY 200,000,000 currency exposure?
A) 40 million.
B) 160 million.
C) 240 million.
Which of the statements regarding diversifying into foreign markets is most accurate?
A) Statement 1.
B) Statement 2.
C) Both statements.
Questions 21–26 relate to Fixed Income Portfolio Management.
White Mountain Capital Scenario
Raphael Leupi is a fixed income portfolio manager at White Mountain Capital (WMC), an established multi-asset
investment management firm based in Geneva, Switzerland. WMC has seen strong growth in new institutional
clients and assets under management over the past five years, with help from a strong fixed-income performance.
Leupi meets with WMC fixed-income analysts Claudia Wolff and Filippo Berio to discuss yield curve expectations
and strategy.
Their first issue is to review the results of decisions made 12 months earlier. At that time, the yield curve was
upward sloping and the investment team consensus was that it would remain stable. Based on that outlook:
Wolff made a series of recommendations for convexity trades.

Berio proposed investing solely in a 20-year U.S. Treasury bond with a coupon of 4.25% and a price of
USD101.8327. Now, one year later, that bond is priced at USD110.0218 and the USD has depreciated by
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1.27% relative to the Swiss Franc.
Next, the team turns to discussing new strategies. Current Treasury Yield Curve and Forecasted Yields
summarizes current market conditions and the team's projections for the coming year (i.e., projections of the market
condition 12 months from today).
Current Treasury Yield Curve and Forecasted Yields
Maturity (Years) Starting Yield (Current) Forecasted Change in Yield Ending Yield
2 NA +0.03% NA
5 1.45% +0.60% 1.95%
10 2.85% +0.40% 3.45%
30 NA +0.00% NA
Berio notices that some of the data items in the table are missing and promises to fill it in later, if needed.
The team agrees it is likely that interest rate volatility will increase compared to the previous year. Leupi asks the
team to recommend a portfolio strategy based upon these interest rate expectations. Berio identifies the following
three options:
Bullet portfolio: Invest only in 10-year Treasury bonds
Barbell portfolio: Invest equally in 2-year and 30-year Treasury bonds
Laddered portfolio: Invest equally in 2-year, 5-year, 10-year, and 30-year Treasury bonds
Wolff recommends that using a duration neutral long/short structure would enhance portfolio return using a
combination of maturities in a butterfly trade.
The first three questions are based on the forecast made 12 months ago, of an upward sloping and stable yield
curve.
Which of the following portfolio strategies is Wolff most likely to have recommended last year?
A) Buy convexity.
B) Sell convexity.
C) Convexity neutral.
Which of the following trades is Wolff least likely to have recommended last year?
A) Sell calls on bonds held in the portfolio.
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B) Sell puts on bonds she would be willing to own if the put was exercised.
C) Sell callable bonds.
The realized return earned on Berio's strategy of investing solely in the 20-year U.S. Treasury bonds is closest to:
A) 8.04%.
B) 10.94%.
C) 12.21%.
The next three questions are based on the forecast in Current Treasury Yield Curve and Forecasted Yields.
Which portfolio strategy should Berio recommend for the year ahead?
A) Bullet portfolio.
B) Barbell portfolio.
C) Laddered portfolio.
If Leupi implements Wolff's recommendation of a long/short butterfly, which of the following trade combinations
would be most appropriate?
A) Long a bullet, short a barbell.

B) Short a ladder, long a bullet.
C) Long a barbell, short a bullet.
To implement Wolff's long/short butterfly trade, what are the most suitable bonds to use for the short positions in the
trade? You may select either one or two bonds to answer this question. Base your answer only on the information
available in Current Treasury Yield Curve and Forecasted Yields.
A) 5-year only.
B) 10-year only.
C) Both the 5-year and 10-year.
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Questions 27–30 relate to Fixed Income Portfolio Management.
Olamide Shopido Scenario
Olamide Shopido is an intern at Quantum Asset Managers and has recently been sent to a fixed-income seminar.
As part of his internship, he has been asked to write up the key points highlighted by the seminar and distribute
them to the team. Quantum Asset Managers is a U.K.-based discretionary fund manager.
Olamide has asked for help checking content before the document is distributed.
Decomposing Expected Returns
Rolling yield is the sum of income yield and rolldown return.
1. Income yield is the annual coupon over the bond price. Because there is no reinvestment assumption, the
periodicity of the bond coupon payments has no effect on the yield calculated.
2. Rolldown return is the expected price change of the bond based on the manager interest rate forecast.
Exhibit 1 provides a full example of the data required to project expected or decompose ex-post return using this
approach.
Exhibit 1: Components of Expected Return
Notional principal €100
Coupon 6%
Periodicity Annual
Investment horizon 1 year
Average current bond price €95.04
Expected average bond price in one year* €98.24
Price in one year based on constant yield trajectory €96.57
Modified duration 2.62
Convexity 9.52
Expected yield and spread change +0.34%
Expected credit losses 0.02%
Expected currency gains (appreciation of euro) 2%
*assuming an unchanged yield curve
Use of Leverage
Leverage can be used to enhance a portfolio's return, provided that the borrowing rate is lower than the expected
return on invested funds, as seen in Exhibit 2:
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Exhibit 2: Using Leverage
Figures in millions
Notional principal £170
Present value of portfolio assets £154.65
Value of equity £92.79
Value of debt £61.86
Average modified duration 4.15
Borrowing rate 2.05%
Expected return on invested funds 3.55%
Leveraged portfolio return
There are a number of methods available to take a leveraged position in our bond portfolios, three of which are
identified below:
1. Futures on fixed-income securities: Taking long positions in fixed income futures allows us all the upside of
buying that notional amount of bonds with no initial outlay.
2. Interest rate swaps: Entering a pay fixed, receive floating swap will increase our exposure to the fixed coupon
bond market and increase the portfolio's duration.
3. Repo transactions: Using our existing holdings of fixed-income securities as collateral, we can borrow funds
using the repo market. While a repo is often referred to as being the sale and repurchase of securities, the
actual substance of the transaction is borrowing money using our securities as collateral for the loan.
Which of Olamide's comments on rolling yield is least accurate?
A) The definition of rolling yield.

B) The definition of income yield.
C) The definition of rolldown return.
The expected return for the bond detailed in Exhibit 1 is closest to:
A) 9.05%.
B) 10.50%.
C) 10.81%.
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The leveraged return for the bond portfolio in Exhibit 2 is closest to:
A) 4.55%.
B) 5.13%.
C) 5.55%.
Which of the methods of leveraging a bond portfolio described by Olamide is most accurate?
A) The use of futures contracts.

B) The use of interest rate swaps.
C) The use of repo transactions.
Questions 31–34 relate to Trade Strategy and Execution.
Kim Simpson and Janet Long Scenario
Kim Simpson, CFA, manages a $75 million multi-cap growth portfolio. Simpson follows a growth investment
strategy and her investment universe consists of small, medium, and large capitalization stocks. She turns the
entire portfolio over once each year. Simpson is concerned about the amount of trading costs she has generated
through the implementation of her investment strategy and decides to conduct a trade cost analysis with the
cooperation of her trader, Janet Long, CFA.
Simpson and Long review a trade in Nano Corporation, a small biotechnology company. To capture both explicit
and implicit trading costs, Simpson measures execution costs using implementation shortfall. The buy order of
Nano Corporation has the following details:
Simpson decided to buy 100,000 shares of Nano Corp. at 9:00 am when the stock price was $35.00 per share.
She sets a price limit of $35.50 per share.
Long did not release the order to the market until 9:40 am when the share price was $35.15.
By the end of the trading day, 90,000 shares of the order had been purchased at an average price of $35.41,
and the share price closed at $35.65 per share.
The commission paid was $0.02 per share.
The beta of Nano Corp is equal to 1.
Long suggests to Simpson that a market-adjusted cost should be used to assess trading cost. She notes that
VWAP for a relevant stock index over the trade horizon is lower than the index arrival price for the trade.
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Long suggests reviewing the trade policy document of the firm. She makes the following suggestions to improve the
trade governance of the firm:
Restrict the list of eligible brokers to only those who transact at the lowest trading costs in order to ensure best
execution is being attained.
Restrict the list of execution venues disclosed in the document to only lit exchanges so it does not compromise
anonymity when trading on dark pool trading venues.
Include a trade aggregation and allocation policy for trades executed across multiple accounts.
The total implementation shortfall for the trade in Nano Corporation is closest to:
A) –$45,200.
B) $43,400.
C) $45,200.
The arrival cost for the trade in Nano Corporation is closest to:
A) 50 bps.
B) 74 bps.
C) 117 bps.
The market-adjusted cost for the Nano Corporation trade, relative to the arrival cost, is most likely to be:
A) lower.
B) higher.
C) the same.
Which of the suggestions by Lang would most likely improve the trade governance of the firm?
A) Restricting the list of eligible brokers.

B) Restricting the list of execution venues.
C) Including a trade aggregation and allocation policy.
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Declan Kaufman Scenario
Declan Kaufman is an investment manager working at New Wave Advisers, an investment firm specializing in
providing innovative derivatives solutions to institutional investors and sophisticated individuals.
Ariadne Burch is corporate treasurer of a large European retailer, looking to expand operations into the United
States. She is exploring ways of borrowing USD, which is required for the expansion, and has presented Kaufman
with the following information:
The rate on USD loan direct from a U.S. bank is the USD reference rate +100 bps.
The rate on EUR loan direct from European bank is the EUR reference rate +70 bps.
The EUR-USD cross-currency basis swap is quoted at –20 bps.
Burch would like to know what the effective cost of borrowing USD would be if this were conducted through a cross-
currency basis swap rather than directly borrowing USD.
Another client of Kaufman, Beatrice Rutledge, has asked Kaufman for advice on derivatives based on volatility.
Rutledge is aware that volatility is a key input when pricing options; however, she is not familiar with other
derivatives used to trade volatility.
Kaufman prepares a short presentation on variance swaps. He bases his presentation on data displayed below in
Exhibit 1.
Exhibit 1: Variance Swap Example Data
Volatility strike on swap (quoted as annual volatility) 19%
Variance notional $263
Realized volatility at end of swap 21%
During Kaufman's presentation, Rutledge asks Kaufman how the payoff of a variance swap is likely to behave.
Kaufman replies with the following comments:
Comment The sensitivity of the value of a variance swap to changes in implied volatility falls over the life of the
1: swap.
Comment
The payoff of a variance swap is convex with respect to changes in volatility.
2:
If Burch's firm raises USD financing through a cross currency basis swap, the cost of borrowing verses a direct USD
loan would be:
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A) 20 bps lower.
B) 10 bps lower.
C) 20 bps higher.
Using the data in Exhibit 1, the approximate gain or loss for a 1% change in volatility, under the variance swap, is
closest to:
A) $14.
B) $263.
C) $10,000.
Using the data in Exhibit 1, the payoff to the variance buyer, from the variance swap, at the end of its life is closest
to:
A) $526.
B) $21,000.
C) $800,000.
How many of Kaufman's comments regarding the payoff behavior of a variance swap are most accurate?
A) Zero.
B) One.
C) Two.
Questions 39–42 relate to Fixed Income.
Fabio Greer Scenario
Fabio Greer is a fixed income analyst at A4G Advisers. He is preparing a factsheet for prospective clients which
aims to demonstrate the reasons for holding fixed income in a multi-asset portfolio. Greer begins the factsheet with
the excerpt displayed in Exhibit 1.
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Exhibit 1: Role of Fixed Income in a Portfolio Context

There are three main benefits from including fixed-income securities within a portfolio: regular cash
flows, diversification, and inflation hedging.
1. Regular cash flows: The scheduled nature of fixed-income securities cash flows allows investors
to plan with a degree of predictability to meet known future liabilities.
2. Diversification: Empirical evidence suggests that fixed-income securities have low correlations
with equity markets. But, during times of financial distress, the correlations of equity to high-quality
government bonds tend to increase.
3. Inflation hedging: Standard fixed-coupon bonds and floating-rate notes offer no protection if
inflation rises above the expected value that was priced in at the time of purchase.
Greer dedicates a section of the factsheet to the use of fixed income securities to immunize liabilities. To
demonstrate an application of the immunization of multiple liabilities, he presents a scenario in his report displayed
in Exhibit 2.
Exhibit 2: Multiple Liability Immunization Scenario

Scenario:
Liabilities with maturities ranging from 4 to 10 years need to be hedged. The value of the liabilities is
currently £30m, with a cash flow yield of 4.3%, Macaulay duration of 7.25 years, convexity of 42.15,
and a basis point value of £20,853. The three portfolios are all of sufficient size to fund the liabilities, as
long as interest rates are stable.
Potential Duration Matching Asset Portfolio
Portfolio P Portfolio Q Portfolio R
4 year 3.5%
2 year 2.25% 6 year 3.8%
Bond maturity and coupon 7 year 2.25%
15 year 5.85% 8 year 4.9%
10 year 4.5%
Macaulay duration (years) 7.2 7.3 7.35
Convexity 62.43 42.75 41.85
Cash flow yield 4.65% 4.66% 4.62%
BPV £20,780 £20,925 £20,915
Greer goes on to discuss structural risk, making the following statement from the factsheet:
Structural risk is the risk that the immunization strategy does not work due to non-parallel shifts and
twists of the yield curve. Structural risk is directly related to the convexity of the immunizing portfolio
when its convexity is higher than the convexity of the liabilities being immunized. When immunizing a
single liability, structural risk is lowest when a zero-coupon bond portfolio is used to immunize the
portfolio; however, the risk can never be totally removed from the portfolio.
10/9/2020 V1 Exam 1PM
A colleague of Greer's reads this note and points out an error contained therein.
Greer also discusses derivatives-based interest rate hedging techniques using swaps and swaptions. He provides
the following scenario as a discussion point:
Take as an example an investment grade corporation that had a fixed cost of funds—this company will
be concerned about falling rates due to the fixed coupon nature of its liabilities. However, the company
believes there is a strong chance that rates could rise a significant amount, which would benefit the
company. The company could express this view through the instrument they use to hedge their interest
rate exposure.
Which of Greer's benefits as described in Exhibit 1 on the role of fixed-income securities in a portfolio context are
mostaccurate?
A) Diversification.
B) Inflation hedging.
C) Regular cash flows.
Which portfolio in Exhibit 2 should be selected to immunize the multiple liabilities scenario described by Greer?
A) Portfolio P.
B) Portfolio Q.
C) Portfolio R.
The error in the statement Greer made, regarding structural risk, is contained in the:
A) first sentence.
B) second sentence.
C) third sentence.
The corporation described in the derivatives-based interest rate hedging scenario would most likely choose which of
the following contracts to hedge? (Note you should assume that rates rising a significant amount means they are
expected to rise above the higher strike of a swaption collar by more than the receiver swaption premium.)
10/9/2020 V1 Exam 1PM
A) Swaption collar.
B) Long receiver swaption.
C) Receive-fixed swap.
Questions 43–46 relate to GIPS.
Barth Group Scenario
Sue Gano and Tony Cismesia are performance analysts for the Barth Group (BG). BG provides consulting and
compliance verification for investment firms wishing to adhere to the Global Investment Performance Standards
(GIPS®). The firm also provides global performance evaluation and attribution services for portfolio managers. BG
recommends the use of GIPS to its clients due to its prominence as the standard for investment performance
presentation.
One of BG's clients, Nigel Investment Advisors (NIA), has a composite that specializes in exploiting patterns in
stock prices. This Contrarian composite goes long "loser" stocks and short "winner" stocks. The "loser" stocks are
those that have experienced severe price declines over the past three years, while the "winner" stocks are those
that have had a tremendous surge in price over the past three years. The Contrarian composite has a mixed record
of success and is rather small. It contains only four portfolios. Gano and Cismesia debate the requirements for the
Contrarian composite under the Global Investment Performance Standards.
NIA's Global Equity Growth composite invests in growth stocks internationally and is tilted when appropriate to
small cap stocks. One of NIA's clients in the Global Equity Growth composite is Cypress University. The university
has recently decided that it would like to implement ethical investing criteria in its endowment holdings. Specifically,
Cypress does not want to hold the stocks from any countries that are deemed human rights violators. Cypress has
notified NIA of the change, but NIA does not hold any stocks in these countries. Gano is concerned, however, that
this restriction may limit investment manager freedom going forward.
Gano and Cismesia are discussing the valuation and return calculation principles for portfolios and composites,
which they believe have changed over time. In order to comply with GIPS, Gano states the firm will:
Statement 1: "Value portfolios at least monthly and on the dates of large external cash flows. The
valuations are based on market value and not book value or cost."
Statement 2: "Composites are groups of portfolios that represent a specific investment strategy or
objective, and a definition must be made available upon request. Only accounts for which
the firm has investment discretion are included in the composite. If account cash flows are
large enough to disrupt the ability of the firm to implement the intended style for even a
portion of a month, that account's performance is exclude from the composite for the year."
Historically, BG has not provided services to managers of real estate portfolios; however, the firm is considering an
expansion of services into this area. Gano and Cismesia have also been asked to review the GIPS provisions
10/9/2020 V1 Exam 1PM
regarding real estate. They have prepared the following summary points:
Statement 3: GIPS contains special provisions that go beyond the basic provisions of GIPS and these
special provisions exclude publicly traded real estate such as REITs and mortgage-backed
securities. Instead, they apply to private real estate such as direct holdings of real estate
property, limited partnerships, and private debt financing.
Statement 4: Verifying real estate fair value is likely to be more difficult than it is for marketable securities.
Valuation will often depend on appraisals. In addition to internal valuation estimates, firms
must have an external valuation done every 36 months.
Statement 5: GIPS real estate provisions require a minimum of quarterly return calculations reporting both
total return and component returns (typically income and capital return).
What are the GIPS requirements for the Contrarian composite of Nigel Investment Advisors?
A) The composite can be formed and the composite must report all performance
statistics.
B) The composite can be formed; however, the number of portfolios and
dispersion does not have to be reported.
C) The composite cannot be formed because it has less than six portfolios in it,
so there are no presentation requirements.
What are the GIPS requirements for the Cypress University portfolio in the Global Equity Growth composite of Nigel
Investment Advisors?
A) The historical and future record of performance of the Cypress University

portfolio should be kept in the Global Equity Growth composite.
B) Because the Cypress University portfolio is nondiscretionary, its future record
of performance must be removed from the Global Equity Growth composite.
C) Because the Cypress University portfolio is nondiscretionary, its historical and
future record of performance must be removed from the Global Equity Growth
composite.
Are the statements made by Gano consistent with the requirements of GIPS?
A) Yes.
10/9/2020 V1 Exam 1PM
B) No, only statement 1 is correct.

C) No, both statements are incorrect.
Which of the summary points regarding real estate provisions is correct?
A) Statement 3.
B) Statement 4.
C) Statement 5.
Questions 47–52 relate to Equity.
Luke Taylor Scenario
Luke Taylor is an equity analyst for Briars George Asset Management. He uses quantitative methods to identify
rewarded fundamental risk factors in the domestic stock market with abnormal risk premiums.
Taylor regresses standardized factor scores against subsequent month performance for three different factors. He
is concerned about outliers in the data causing a bias in correlation metrics, hence calculates both the Pearson and
Spearman Rank correlation information coefficients for each factor based on monthly data. The results of the
regression are displayed in Exhibit 1.
Exhibit 1: Regression of Standardized Factor Scores vs. Subsequent Month Performance
Information Coefficient
Factor Pearson Spearman Rank
1 0.19 –0.03
2 –0.01 0.12
3 0.09 0.10
Taylor uses the hedged portfolio approach to construct factor-based portfolios. Taylor identifies a rewarded factor,
Factor 4, which has an attractive risk premium in the domestic large-cap liquid stock market. Taylor has been asked
to investigate whether investing based on this Factor 4 can be implemented in domestic small-cap markets. Taylor
notes that the costs of short selling are considerably higher in domestic small-cap markets than they are in
domestic-large cap markets.
Taylor is interested in using factor timing when investing in Factor 4. He investigates whether there is a lagged
relationship between normalized unexpected inflation and the returns to the factor. He specifies his regression
10/9/2020 V1 Exam 1PM
model as follows:
ft+1 = β0 + β1 NUIt + εt
where:
ft = return of factor at time t
NUIt = normalized unexpected inflation at time t
Taylor concludes that he can use the results of his regression model to engage in factor timing with Factor 4. He is
concerned however, about the impact of slippage on the actual returns he will receive from trading the factor. He
considers the impact of volatility, commissions, and order size on likely slippage costs.
Taylor is analyzing the contribution to risk of the market factor and the value factor on his existing portfolio. He
collates the data displayed in Exhibit 2.
Exhibit 2: Selected Data for Existing Portfolio
Covariance
Coefficient Market Size
Market 1.53 0.021025 0.000095
Value –0.25 0.000095 0.00027
Taylor has been asked by a large prospective client about the capacity of his factor-based approach. Taylor lists the
following constraints that apply to his funds in order to avoid capacity issues:
With liquidity constraint, the maximum position size is 3% of average daily volume.
The smallest shares in the permissible universe trade on average 1% of shares outstanding each day.
With benchmark weight size minimums, no positions are allowed in securities that make up less than 0.5% of
the benchmark index.
With benchmark weight size maximums, no positions are allowed that are greater than 5 times the benchmark
weight.
The total capitalization of the benchmark index is $1 trillion.
Based on the data in Exhibit 1, the number of factors offering a positive rewarded risk premium is:
A) one.
B) two.
C) three.
The returns of a factor-based portfolio in domestic small-cap markets are most likely to be:
10/9/2020 V1 Exam 1PM
A) unaffected by differences in short selling costs.

B) higher than the returns would be if short selling costs in small-cap markets
were the same as domestic large-cap markets.
C) lower than the returns would be if short selling costs in small-cap markets were
the same as domestic large-cap markets.
Taylor's factor timing model for Factor 4 is:
A) incorrectly specified.
B) correctly specified and factor timing would be evidenced by a significant β0
coefficient.
C) correctly specified and factor timing would be evidenced by a significant β1
coefficient.
An increase in slippage costs would least likely occur due to an increase in:
A) volatility.
B) order size.
C) commissions.
Based on the data in Exhibit 2, the contribution to variance of the market factor is closest to:
A) 0.032.
B) 0.049.
C) 0.222.
Based on the constraints relating to capacity issues, the fund size at which Taylor's approach is likely to be impaired
by liquidity issues is closest to:
A) $50m.
B) $60m.
10/9/2020 V1 Exam 1PM
C) $5,000m.
Gari Dimeola Scenario
Gari Dimeola is an investment advisor specializing in derivatives strategies in equity, fixed income, and currency
markets.
Dimeola is approached by his client, Ryan Karunathilike, for advice regarding option strategies. Karunathilike is a
U.K. domiciled client who wants to hedge a short position in Euros (EUR) over the coming month. The current spot
EUR/GBP exchange rate is 1.1523. Dimeola advises Karunathilike that he has three strategies using derivatives on
the EUR/GBP exchange rate available to him, which are displayed in Exhibit 1.
Exhibit 1: Hedging Strategies Recommended by Dimeola
Strategy Position
1 Sell one month EUR/GBP forward
2 Buy one month GBP/EUR call option
3 Buy one-month EUR/GBP put option
Karunathilike asks Dimeola to review his existing options strategies. He presents the signs of the Greek exposures
of his strategies as displayed in Exhibit 2.
Exhibit 2: Greek Exposures of Dimeola's Existing Option Strategies
Strategy Delta Gamma Theta Vega
A Positive Positive Positive Positive
B Positive Negative Positive Negative
C Small Negative Positive Negative
Karunathilike has identified a stock, GHS Corp., which historically has had options exhibiting a volatility skew. The
options of GHS currently exhibit a volatility smile, and Karunathilike believes that within the next days implied
volatility will revert back to a more usual profile. Karunathilike asks Dimeola to design an options strategy to allow
him to profit from this view.
How many of the strategies in Exhibit 1: Hedging Strategies Recommended by Dimeola meet the objective of
Karunathilike?
10/9/2020 V1 Exam 1PM
A) Zero.
B) Two.
C) All three.
Which of Karunathilike's options strategies in Exhibit 2 is most likely a short straddle position?
A) Strategy A.
B) Strategy B.
C) Strategy C.
Based on the Greek exposures displayed in Exhibit 2: Greek Exposures of Dimeola's Existing Option
Strategies, Strategy B is most likely a:
A) short straddle.
B) short put.
C) bull spread.
The most appropriate options strategy, given Karunathilike's view on the implied volatility profile of GHS Corp, is to
sell:
A) out-the-money calls and buy out-the-money puts.

B) out-the-money puts and buy in-the-money puts.
C) at-the-money calls and buy at-the-money puts.
Questions 57–60 relate to Investment Manager Selection.
Education Investment Foundation Scenario
The investment committee (IC) of the Education Investment Foundation (EIF) has recently approved a change in
the fund's IPS to increase its allocation to alternative investments.
10/9/2020 V1 Exam 1PM
The investment staff have drafted manager selection procedures for assessing potential external alternative
investment managers. An excerpt from the policy is displayed below in Exhibit 1.
Exhibit 1: Excerpt from Manager Selection Policy
The investment committee is aware that the costs to the fund of hiring and firing decisions are
significant, and that policy should ensure as much as possible that mistakes are minimized. A central
part of the manager selection policy is a proprietary database with two key purposes:
Purpose 1: record the subsequent performance of managers that met initial screening criteria and
were interviewed by investment staff, but not allocated to by the fund.
Purpose 2: record the subsequent performance of managers that were removed from the fund due
to sub-optimal performance.
The IC is keen to monitor external alternative investment fund managers for style drift. They are contemplating
whether to use returns-based style analysis (RBSA) or holdings-based style analysis (HBSA). The IC lists the
following considerations when choosing which style analysis method to use:
Due to the private nature of most alternative investment structures, the method should not use data that is
potentially difficult to get
The method should mitigate the effect of window dressing by the manager
The IC is also concerned about the higher fee structures that are seen in alternative fund structures verses
traditional fund structures. They ask the investment staff to summarize the different types of fee schedules
employed by managers. This summary is displayed in Exhibit 2.
Exhibit 2: Fee Schedules
Fee Schedule Base Fee Profit-Share Computation
higher of base or base + share of active return.

1 0.50% 30%
maximum fee = 3%
2 0.75% 20% higher of base or base + share of performance net of base
3 1.00% 10% base + share of performance net of base
The IC requests that the investment staff apply the fee schedule to a year where the gross return of the fund is
+10% while the benchmark returns 5%, and secondly where the gross return of the fund is –10% while the
benchmark returns –5%.
With regard to the manager selection policy purposes described in Exhibit 1, which of these is correct?
A) Both Purpose 1 and 2 are designed to minimize Type I errors.

B) Both Purpose 1 and 2 are designed to minimize Type II errors.
10/9/2020 V1 Exam 1PM
C) Purpose 1 is designed to minimize Type I errors, Purpose 2 is designed to

minimize Type II errors.
Based on the IC's considerations regarding style analysis, the most appropriate method to use is:
A) returns-based style analysis.

B) holding-based style analysis.
C) both methods of analysis because both are equally appropriate.
Which of the fee schedules listed in Exhibit 2: Fee Schedules would give rise to the highest investment
management fees given a gross performance of +10% and a benchmark return of 5%?
A) Schedule 1.
B) Schedule 2.
C) Schedule 3.
Which of the fee schedules listed in Exhibit 2 would give rise to the lowest or most negative investment
management fees given a gross performance of –10% and a benchmark return of –5%?
A) Schedule 1.
B) Schedule 2.
C) Schedule 3.

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10/9/2020 V1 Exam 1PM

CFA Level III My Activities

Test ID: 146740506

Questions 1–6 relate to Ethical and Professional Standards.

Jamie Blackmore Scenario

Question #1 of 60 Question ID: 1267676

A) execute the trade immediately.

Question #2 of 60 Question ID: 1267677

A) Blackmore is on the board of 7MOD7.

Question #3 of 60 Question ID: 1267678

A) owed primarily to the management and stockholders of Green International.

B) owed to the participants and beneficiaries of the Green International pension

C) owed equally to the participants and beneficiaries of the fund, and to

Question #4 of 60 Question ID: 1267679

A) disassociate from Blackmore’s activities.

Question #5 of 60 Question ID: 1267680

A) in his communication with his friend.

B) in his communication with his cousin.

Question #6 of 60 Question ID: 1267681

Questions 7–10 relate to Ethical and Professional Standards.

Lewis Smithers Scenario

Question #7 of 60 Question ID: 1267683

Question #8 of 60 Question ID: 1267684

A) advising a few family and friends to purchase Pineda stock.

C) discussing his views and information with Fundamental Investment’s bond

Question #9 of 60 Question ID: 1267685

Question #10 of 60 Question ID: 1267686

Regarding Smithers' discussion with O'Toole, it is most likely that:

A) Smithers may not participate in the deal O’Toole offers.

B) Smithers may not let O’Toole use Smithers’ condo.

Questions 11–16 relate to Economic Analysis.

Olli Nava Scenario

Exhibit 1: Information on Domestic Economy

Annual labor input growth 0.8%

Annual labor productivity growth 1.2%

Annual inflation 2.5%

Dividend yield 3.0%

Long-term change in profits as a share of GDP 0%

Long-term change in PE multiples 0%

Exhibit 2: Macroeconomic Data Relating to Three Economies

Economy Savings Investment Taxation Government Spending

1 Increasing Decreasing Increasing Decreasing

2 Decreasing Increasing Decreasing Increasing

3 Increasing Increasing Increasing Increasing

Exhibit 3: Macroeconomic Data Relating to Three Developing Markets

Developing Market Capital Flows Exchange Rate

Exhibit 4: Expected Returns in Domestic Markets and Foreign Country X

Return Domestic Country X

Short-term interest rates 0.75% 1.25%

Term premium 0.00% 0.50%

Credit premium 1.10% 0.60%

Equity premium 3.00% 4.00%

Liquidity premium 0.00% 0.00%

Question #11 of 60 Question ID: 1267693

How many of the statements made by Wiggins are accurate?

Question #12 of 60 Question ID: 1285901

Question #13 of 60 Question ID: 1285902

Question #14 of 60 Question ID: 1285903

Question #15 of 60 Question ID: 1285904

Question #16 of 60 Question ID: 1267698

Questions 17–20 relate to Derivatives and Currency Management.

Garrison Investments Scenario

Point University Asset Allocation

Asset Class Allocation Dividend/Coupon* Beta