25/11/2024 Tài liệu ôn thi chứng chỉ CFA

Đề số 1 – Mock exam CFA Level 3 Session 1 (đề thi thử CFA level 3)

Dưới đây là Mock exam CFA Level 3 Session 1 của Viện CFA cung cấp cho người học. Ở những giai đoạn cuối, để chuẩn bị tốt cho kỳ thi CFA, một nguồn tài liệu bạn không thể bỏ qua là Mock exam CFA Level 2 (Đề kiểm tra thử). Hãy cùng TACA tìm hiểu nhé!

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Mock exam CFA Level 3 Session 1:

Question 1:

Felix Severin, a senior investment consultant at AJI Finanz, meets with Ann Jaehn, a management trainee. Jaehn has just completed a 10-year monthly performance appraisal for three trading strategies – positive asymmetry, low beta, and negative asymmetry. The results of her analysis are summarized below in Exhibit 1.

Exhibit 1: Return Profile Summary

Strategy	X	Y	Z
Cumulative return	150.00%	35.50%	-16.05%
Annualized return	5.85%	2.05%	-1.30%
Annualized standard deviation	6.35%	5.10%	6.60%
Sharpe ratio	0.61	0.02	-0.50
Capture ratio	2.50	1.00	0.40
Beta	0.63	0.50	0.66
Drawdown (maximum)	-25.0%	-26.4%	-45.4%

Jaehn’s report highlights the differences between the three return profiles. She explains to Severin that a convex return profile can result in higher risk-adjusted returns by not participating during periods when the market is not trending strongly upward. Avoiding large drawdowns is beneficial as it shows the robustness and risk management of the processes.

Severin next looks at an L/S hedge fund’s return profile which AJI Finanz invests in and asks Monika Kruse, an analyst about the benchmark of the fund. Kruse replies that because both broad market indexes and the risk-free rate will be weakly correlated or uncorrelated with hedge fund returns she uses a peer group universe for benchmarking the fund’s returns. Severin is skeptical of the appropriateness of the peer group as a benchmark and wants to know its limitations.

1.1. Compare the return profiles of the positive asymmetry profile, low beta, and negative asymmetry strategies based on the metrics given in Exhibit 1. Based on the capture ratio and drawdown describe the strategy with the highest return performance.

1.2. State three limitations of using hedge fund peer universes as a benchmark for the L/S hedge fund.

Question 2:

Robert and Mary Puentes, both age 62, live in the U.S. Robert recently sold off his advertising company and retired. The Puentes live in a mortgage-free house with a market value of USD 2,250,000. Robert has a taxable investment portfolio with a current market value of USD 7,500,000 invested in traditional assets. The Puentes will rely on their investment portfolio to pay for expenses in excess of Robert’s annual retirement income of USD 110,000 from his business sale. The retirement payments are not indexed to future inflation and are fully taxable as ordinary income.

Robert meets with John Mesa, CFA of Acuva Wealth Managers, to discuss his retirement goals and retirement funding needs. His goals are to grow his portfolio’s asset base over time and maintain its after-tax purchasing power. Robert plans to purchase a vacation home worth approximately USD 1,150,000 in five years. He intends to donate USD 600,000 to his favorite charity in 15 years. Upon his death, Robert wants his wife’s lifestyle needs to be supported. Mesa considers three approaches – mortality tables, annuity method, and Monte Carlo simulation to analyze Robert’s retirement goals.

Mesa gathers the following behavioral considerations related to Puentes’ retirement planning.

• Robert continues to hold stocks that decline in value because he feels he has to break even on losing investments. He often sells winners to realize their gains to avoid any further risk.

• Mary’s investment decisions are based on their expected costs in retirement, so she favors large-cap dividend-paying stocks over riskier stocks. She, like Robert, is also hesitant about selling loss-making investments. She explains her preference by saying that they should be spending less than their current expenditures to cover unforeseen future retirement needs.

The house owned by the Puentes is retained as separate property. The Puentes live in a community property regime. The community property regime entitles a surviving spouse to receive one-half of the community property after the first spouse’s death. Only 15% of Robert’s investable assets are community property. Exhibit 1 summarizes gift and inheritance tax rates applicable to the Puentes family.

Exhibit 1 Gift and Inheritance Tax Rates*

Tax Type	Tax Rate
Spousal inheritance tax	25%
Spousal gift tax	30%
Non-spousal inheritance tax	50%
Non-spousal gift tax	30%

*Note: All taxes are due immediately at the time of the transfer and are paid for by the recipient.

Robert feels that Mary’s legal entitlement under the community property rules will not be sufficient to meet her financial needs. Mesa estimates that if Robert were to die today, Mary would need to inherit USD 950,000 (excluding their current house) net of any taxes to meet her needs. Robert also discusses estate planning tools with Mesa which can produce tax and estate planning benefits for Mary.

2.1. Determine the most appropriate approach Mesa should use to analyze Robert’s retirement goals. Justify your response by giving an advantage of the chosen approach and a disadvantage of each approach not selected.

• Mortality tables

• Annuity Method

• Monte Carlo simulation

2.2. Select the behavioral consideration exhibited by:

i. Robert

ii. Mary

Justify each selection with one fact from the information about the Puentes provided in the vignette.

• Heightened loss aversion

• Consumption gaps

• The “annuity puzzle”

• Preference for investment income over capital appreciation

2.3. Calculate the minimum bequest (in USD) from Robert’s estate to Mary to meet her spending needs and taxes. Identify two likely estate planning objectives that Robert seeks for Mary.

Question 3:

Titan Asset Management Case Scenario

Titan Asset Management is a well-managed firm that offers various kinds of mutual funds and investment plans for private and institutional clients. The board of directors of Titan adopted the CFA Institute Asset Manager Code of Professional Conduct (Asset Manager Code) a year ago to establish and promote ethical behavior within the firm. The board has just instituted a review of each manager’s ability to ensure his department’s compliance with the Asset Manager Code. Amara Bhatia, CFA, the recently appointed chief compliance officer, is responsible for reviewing and evaluating each department’s compliance.

Bhatia meets with Tom Preston, CEO of Titan, to discuss how well the procedures have been implemented over the last year to address the Manager’s responsibility outlined in the Asset Manager Code’s six principles. Preston responds, “We tried to address the following principles while implementing the policies and procedures of the Code:

Principle 1: Act for the benefit of clients and be professional and ethical in all our dealings at all times.

Principle 2: Act with skill, competence, and diligence. Communicate accurately and promptly with our clients while maintaining independence and objectivity.

Principle 3: Stay abreast of all rules of the capital markets.”

Bhatia then reviews three current compliance procedures of the firm that were under Preston’s supervision before her appointment:

Risk management process	The risk profile of a client’s investment matches his risk appetite and ability. A comprehensive risk management process is administered for portfolios and investment strategies, identifying, measuring, and managing risk. The risk management techniques implemented are consistent with the investment style and philosophy of our portfolio managers.
Portfolio information review	Accurate and complete portfolio information is provided to clients. The investment committee regularly reviews to confirm the accuracy of such information.
Business-continuity plan review	Procedures for safeguarding client accounts and handling inquiries in case of emergencies or market disruptions. The current plan requires backing up all of the firm’s computer systems and client records daily. The backups are stored in an offsite storage facility. Titan employs the services of an external recovery firm to carry out specific emergency plans. The recovery firm is responsible for the coverage of critical business functions. It implements plans to communicate with employees, critical vendors, and suppliers in the event of a facility or communication disruption. The same firm also provides plans for contacting and communicating with clients in an extended disruption.

Bhatia next discusses the client disclosure policies with Shiras Nathan, head of customer relations. Nathan states, “Regarding the Asset Manager Code relating to client services, we ensure the following policies: All disclosures are accurate and complete, and we show all our calculations, including the complicated ones. We communicate with clients regularly and provide performance reports whenever they request them. All conflicts of interest arising due to the firm or employee holdings in the same securities as clients, allocation of investments among similar portfolios, use of soft dollars, and directed brokerage arrangements are disclosed.”

Finally, Bhatia asks about disclosures regarding management fees. Nathan responds that the disclosures contain the following information: “Titan charges a 2% asset-based management fee. In addition to the management fee, clients pay distribution and service fees to buy and sell shares in a fund that cannot exceed 0.75 percent of a fund’s average net assets per year. Titan charges fees that may not exceed 0.25 percent for marketing material or prospectuses sent to potential investors.”

After completing her evaluations, Bhatia works on her report suggesting recommendations before presenting them at the upcoming board meeting.

3.1. Which of the principles is inconsistent with the Asset Manager Code of Professional Conduct?

A. Principle 1.

B. Principle 2.

C. Principle 3.

3.2. Which of the three compliance procedures reviewed by Bhatia is consistent with the required and recommended standards of the Asset Manager Code of Professional Conduct?

A. The risk management process.

B. Portfolio information.

C. Business-continuity plan.

3.3. Which of Nathan’s client service policies is consistent with the Asset Manager Code of Professional Conduct?

A. Performance reports frequency.

B. Complete, accurate disclosures, including complex calculations.

C. Conflicts of interest disclosures.

3.4. Are the firm’s disclosures regarding management fees consistent with the required and recommended standards of the Asset Manager Code?

A. Yes.

B. No, because the average or expected expenses or fees clients are likely to incur are not mentioned.

C. No, because complicated language is used.

Question 4:

Alpine Investments Case Scenario

Andrew Baker, a senior portfolio manager at Alpine Investments, evaluates the performance of US equities relative to US investment-grade corporate bonds for future allocations for Alpine’s Balanced Fund. Baker forecasts the following variables given in Exhibit 1.

Exhibit 1: Equity Market Data

Expansion rate for P/E per year	0.20%
Forecasted dividend yield	2.5%
Real GDP growth estimate	3.0%
Premium for corporate earnings growth over nominal GDP	1.0%
Expected inflation	2.5%
Repurchase yield	0.5%
YTM on a long-term government bond	6.0%
Equity risk premium forecast	3.2%

He is considering investing in international equities for his Global Multi-asset Portfolio. He asks Clarke, a research analyst for his capital market expectations for the near future. Clarke collects the data displayed in Exhibit 2.

Exhibit 2: Asset Class (Emerging Market Equities)

Standard deviation 20.50%
Correlation Matrix	U.S. Equities	Emerging Market Equities	GM
U.S. Equities	1.0	0.60	0.85
Emerging Market Equities	0.60	1.0	0.70
GM	0.85	0.70	1.0

Clarke also provides the following facts and estimates:

• The Sharpe ratio of GM Portfolio and the segmented market is estimated to be 0.33.

• The standard deviation of GM is estimated to be 9.5%.

• The risk-free rate of interest is 4.5%.

• The standard deviation of US equities is 23.0%.

• US equities are estimated to be 80% integrated, and Emerging Market Equities are estimated to be 60% integrated.

Baker asks Clarke about the future fiscal and monetary outlook. Clarke makes the following statements:

Statement 1: Given the fiscal and monetary conditions, the nominal rates are expected to be low in the near future.

Statement 2: Due to the emergence of an output gap, the inflation rate is expected to decelerate to a low level.

4.1 Given the data in Exhibit 1, which one of the following statements is most likely correct?

A. The estimate of the expected return on equities is higher using the Grinold-Kroner model.

B. The estimate of the expected return on equities is higher using the bond-yield-plus-risk-premium method.

C. The estimate of the expected return on equities is the same using the Grinold-Kroner model and bond-yield-plus-risk-premium method.

4.2 The Singer-Terhaar risk premium estimate for Emerging Market Equities is closest to:

A. 8.50%

B. 5.55%.

C. 4.28%.

4.3 Regarding Clarke’s statement on the outlook of future economic conditions, an investor should most likely invest in:

A. High-yield bonds.

B. Short-term bonds.

C. High-quality long-term bonds.

4.4 Given Clarke’s view of the nominal rates, which of the following statement (s) is most likely correct?

A. A loose Monetary Policy and a tight Fiscal Policy.

B. A tight Monetary Policy and a tight Fiscal Policy.

C. A tight Monetary Policy and a loose Fiscal Policy.

Question 5:

Shaunna Howell is a portfolio manager at an investment bank. She uses the US Treasury note contract traded at the Chicago Mercantile Exchange (CME) futures exchange for managing the duration mismatch in a portfolio of higher investment-grade bonds used to immunize a portfolio of corporate debt liabilities. The futures contract has a par value of USD 100,000 and a coupon rate of 6%. The U.S. T-notes qualifying for delivery range from 6.5 years and 10 years in maturity.

The corporate debt liabilities have a basis point value (BPV) of USD 118,300, a modified duration of 6.24, and a market value of USD 189,584,000. The immunizing asset portfolio has a market value of USD 186,871,710, a modified duration of 6.08, and a BPV of USD 113,618. The duration drift has arisen because of a parallel shift in the yield curve, whereby all yields shift down by the same amount. Based on the deliverable bond, the asset manager estimates that the BPV for each futures contract is USD 69.20.

Howell has recently established the All Fixed-Income Fund, designed to outperform the Blue Aggregated Bond Index (BABI). The BABI tracks the total return performance of liquid bonds denominated in local currencies in the North American region. The index includes US Treasuries, government agency securities, and corporate bonds, with constituent selection criteria by country and country weights to manage liquidity and stability. Individual bond weightings are based on market capitalization and country weightings, reviewed annually to attract institutional investors. The country weights are driven by local market size and market capitalization, liquidity, development of infrastructure investment, and trading such as credit ratings, yield curves, and derivative products. Given a large number of bonds in the index, Howell chooses a representative sample by selecting bonds that match the Fund’s duration, country weightings, and sector/quality percentage weights with those of the BABI. Given the complexity of managing bond investments, she targets a 1.15% tracking error for the fund.

The bank’s economic research department informs Howell that policymakers may respond to the rising inflation expectations by raising short-term rates. Howell feels short-term rates will rise more than the long-term rates, so she decides to take the following positions with the US Treasury securities:

Exhibit 1

Tenor	Coupon	Yield	Notional ($MM)	Modified Duration	Convexity
Short 2y	0.25%	0.675%	-120	1.994	5.0
Long 10y	2.00%	1.402%	32	9.023	91.0

Femi Adebayo, an active portfolio manager at the bank, manages a portfolio of 2-year, 5-year, and 10-year Treasury securities. He expects a decrease in the butterfly spread over the next six months. Emma Duerre a colleague of Adebayo manages a portfolio with option-free bonds and bonds with embedded options. She expects an upward parallel shift in the yield curve. Duerre can use several stand-alone derivatives strategies to alter the duration of her portfolio if liquid callable or putable bonds are not available. Adebayo advises her to decrease the portfolio duration.

5.1 Calculate the number of futures contracts. Determine whether the portfolio manager should go long or short the futures contract. Justify your answer by giving a reason.

5.2 Howell has been advised to reduce the tracking error by the bank’s chief investment officer. Recommend three steps Howell should take to minimize the risk in the fund.

5.3 Identify Howell’s portfolio strategy to benefit from a yield curve flattening. Calculate the portfolio BPV. Determine the approximate portfolio gain or loss if the 2-year yield-to-maturity and the 10-year yield-to-maturity rise by 25 bps.

5.4 i. Identify the interest rate view and the best strategy to pursue for Adebayo’s portfolio. Active strategy for Adebayo’s Portfolio

• Positive butterfly

• Negative butterfly

• Bull steepening

5.4 ii. Recommend the most profitable position to decrease Duerre’s portfolio duration. Justify your response with a reason.

• Long a callable bond

• Long a receiver swaption

• Long a put option on a futures contract

Question 6:

Myteka Advisers is a registered investment adviser specializing in developing customized investment solutions for their local and international clients. Elena Delgado, senior investment manager at the firm, meets with Selene Luiz, 36, a professional golf player. Selene wants to invest in the ESG US Stock Fund which selects US companies across different sectors that score favorably in the environmental, social, and governance (ESG) space. The ESG US Stock Fund scores companies on a variety of factors weighted according to the sector. The fund then chooses from the list of qualified companies. Selene is interested in sustainable investing and asks Delgado about different types of investment strategies that consider ESG issues. Delgado explains that certain funds invest in assets specifically related to ESG factors, such as clean energy, green technology, sustainable agriculture, gender diversity, etc. “For example, our Clean City Fund invests in companies offering activities or products related to electric vehicles, clean energy, and clean water. It also inspects the ESG characteristics of investee companies within these sectors before investing in them and does not engage in shareholder activism,” adds Delgado. Connie Weitz, the chairman of the investment committee of Zimmerman Endowment Fund, a new client of Myteka Advisers meets with the firm’s head of risk, Rao Varma. Weitz explains that the investment committee is considering following a passive approach for equity allocation. The investment committee is interested in pursuing a risk-reduction strategy for some or part of the equity allocation. Varma suggests risk-oriented factor-based approaches for allocation to international stocks. “These strategies lower downside volatility and overall portfolio risk,” he explains. “We can implement constraints on the index construction such as limits on the sector over/underweights and country selection limits as we have the requisite optimizer software available with us,” Varma adds. An international high-net-worth client of Myteka Adviser calls Dave Coulier the firm’s derivatives trader and tells him of his cash inflow of EUR 2 million in three months. Coulier’s view is that the Euro equity market is likely to rise during this timeframe. To take advantage of his market outlook, he wants to immediately initiate an equity transaction using the Euro STOXX 50 futures contract with a current price of 3,005.00 while maintaining the policy weights of the client’s portfolio. The client prefers passive exposure to equity markets. Coulier explains to the client about the high liquidity of the equity index futures, and the lower commission and execution costs making it easy for investors to modify the equity risk exposure of their portfolios.

6.1 Identify the ESG approach most likely followed by the ESG US Stock Fund. Justify your response.

• positive screening or best-in-class approach

• negative screening (or exclusionary screening)

• social investment

6.2 Identify the approach of the Clean City Fund. Justify your response. State an advantage and a disadvantage of shareholder engagement for the Clean City Fund.

• Impact investment

• Green investment

• Thematic investment

6.3 Identify the international strategy most likely suggested by Varma for the Zimmerman Fund. Justify your response.

• Volatility weighting

• Minimum variance investing

• Momentum strategies

6.4. Describe the disadvantages of investing in equity index futures for Myteka Advisers’ high-net-worth client.

Question 7:

Susan Baranski is a portfolio manager for Cosmo Capital Management. Baranski meets with Cosmo’s client Borsher Trucking Company – a company nearing the maturity stage with low employee turnover. Borsher’s defined benefit (DB) pension plan is underfunded and has assets under management of USD 1 billion. The chief investment officer (CIO) of the plan, Bert Lazarus makes the following two statements while discussing the pension plan’s asset allocation with Baranski:

Statement 1: Borsher’s plan assets and liabilities are large relative to its balance sheet, so there is less risk appetite for the volatility of its contributions.

Statement 2: Borsher’s business revenues are highly cyclical so it will not want plan funded status to deteriorate when the core business suffers in a downturn.

Lazarus reminds Baranski that the plan is subject to the Employee Retirement Income Security Act of 1974 (ERISA) and follows generally accepted accounting principles, including Accounting Standards Codification (ASC) 715, Compensation—Retirement Benefits. Baranski suggests modifying the asset allocation to match assets to liabilities in terms of quantity, timing, and risk by using a Liability Driven Investing (LDI) approach.

7.1 Regarding Lazarus’s Statement 1, Borsher will most likely be:

A. more flexible in taking investment risk.

B. less flexible in taking investment risk.

C. aiming for high risk, high returns investments.

7.2 Regarding Lazarus’s Statement 2, Borsher’s DB plan’s asset allocation should be adequately diversified to ensure that:

A. plan assets are highly correlated with the sponsor’s core business or industry.

B. plan assets have low correlations with the sponsor’s operating liabilities.

C. plan assets have low correlations with the sponsor’s operating assets.

7.3 Based on Lazarus’s reminder concerning ERISA and ASC 715, Borsher’s plan:

A. may not report gains and losses as part of net income.

B. may not be eligible for favorable capital gains tax treatment for investments held over 1 year.

C. must appear as a liability on the balance sheet of Borsher.

7.4 A likely disadvantage of using the LDI approach is:

A. inflation risk may not be hedged.

B. potentially expensive to manage.

C. difficult to implement because of the large plan size.

Question 8:

Carrie Cavell is the managing partner of Cavell Capital, LLC. The firm uses various asset allocation strategies to manage investment portfolios of high-net-worth private clients and institutions. Cavell’s first meeting of the day is with Paris Sheldon, 39, a new client who recently inherited $1.5 million from her grandparents’ estate. Sheldon is single and works as a chief editor of a famous fashion magazine. She wants to fund a comfortable retirement requiring an investment return above inflation over the long term. Sheldon plans to withdraw $82,500 from the investment in one year to help purchase a house. She tells Cavell that she wants to withdraw this amount without reducing the initial $1.5 million principal. Cavell calls Kelly Rowland, a senior analyst who suggests using a risk-adjusted expected return approach in selecting one of the asset allocations shown below in Exhibit 1.

Exhibit 1

Asset Allocation	Return	Standard Deviation
A	8.50%	12.50%
B	12.00%	24.00%
C	6.75%	8.50%
All data are tax adjusted

Cavell discusses the importance of strategic asset allocation with Sheldon. Cavell states that the firm’s practice is to use target weights and a corridor around the target. Rebalancing is triggered when the asset allocations fall outside the corridor. Cavell explains that for a given asset class, the higher the transaction costs and the higher the risk tolerance, the wider the rebalancing corridor. However, the corridor will be narrower the higher the asset class’s correlation with the rest of the portfolio.

Cavell talks at length about a goals-based approach to asset allocation. She tells Sheldon that a goals-based approach is primarily used for individual investors specifying asset allocations for sub-portfolios. Each sub-portfolio is aligned to specified goals with an investment objective of achieving these goals with a certain probability of success. Institutions either focus on the asset or liability side of the balance sheet. A typical objective of some institutions is to maximize their Sharpe ratio for an acceptable level of volatility. While other institutions want to fund liabilities and invest excess assets for growth.

Cavell later meets with George Dickey, the president of the planning and investment committee of the Wilber University (WU) endowment. The following table provides the funds in the endowment (Exhibit 1).

Exhibit 1

Wilber University Endowment Assets and Liabilities ($ Millions)
Cash and short-term investments	60
Large-cap equities and long-term fixed-income securities	150
Short-term borrowing	80
Present value of future university support	400
Present value of future contributions to endowment	405

During the meeting, Dickey tells Cavell about the endowment funding for the extension of the university’s research laboratory for $250 million. Two alumni have agreed to donate $40 million to the laboratory. He asks what the shortfall would be after using the donation.

8.1 Which of the asset allocations in Exhibit 1 has the highest probability of enabling Sheldon to meet her goal for the house?

A. Asset allocation B.

B. Asset allocation C.

C. Asset allocation A.

8.2 When discussing asset allocation corridors with Sheldon, Cavell is least accurate regarding:

A. transaction costs.

B. risk tolerance.

C. correlation.

8.3 Regarding Cavell’s statements about asset allocation approaches, which investment objective relates to the asset-only approach?

A. To fund liabilities and invest excess assets for growth.

B. To maximize the Sharpe ratio for an acceptable level of volatility.

C. To achieve goals with a certain probability of success.

8.4 Based on an economic balance sheet, the endowment’s shortfall (in $ millions) after including the donation is closest to:

A. 115.

B. 35.

C. 75.

Question 9:

James Grant Case Scenario

James Grant, CFA, is the chief investment officer (CIO) of Prima Assets, an investment management company. Grant’s clients – Jenson University Endowment Investment Office is interested in making changes to the asset mix to increase the probability of achieving a long-term total return equal to at least the spending rate of 7.5%, including inflation. Grant asks Prima’s research department about the fixed-income yields and discovers that they are expected to remain low for the foreseeable future.

The Investment Office wants the public equity allocation to remain at 70% but would like to invest 30% in an asset class to achieve the greatest probability of earning the nominal return of 7.5% over a long time horizon. Grant discusses with Carl Dean, the endowment investment office’s director, the possibility of adding different types of bonds, hedge funds, or private equities.

He shares the following information with his client.

Exhibit 1

Portfolio mix	Portfolio X: 70% Equities and 30% Broad Fixed-Income Bonds	Portfolio Y: 70% Equities and 30% Hedge Funds	Portfolio Z: 70% Equities and 30% Private Equity
Volatility	11%	14%	16%
Asset Class	Broad Fixed-Income Bonds	Hedge Funds	Private Equity
Long-term Expected Return	3.0%	5.5%	8.0%
Correlation	-0.40	0.82	0.80
Equity beta	-0.10	0.40	0.70
Probability of achieving 7.5% nominal return target over 10 years	Between 30% to 35%	Between 35% to 44%	>50%

After looking at the portfolio scenarios, Dean remarks, “The combination of fixed-income bonds with equities has the lowest volatility, but we will miss our long-term return targets. Private equity seems to be the most suitable asset class for the 30% allocation, but what is the downside risk of this investment?” Grant explains that private equity investments show a stronger positive correlation to equities and a relatively higher beta besides liquidity risk. He mentions the important limitations of this asset class.

Grant meets with another client – Jim Rivers, the chief investment officer (CIO) of a grant-making foundation. Rivers is interested in adding alternatives to the foundation’s traditional stocks/bonds portfolio. He is particularly curious about deploying the risk factor-based approach for strategic asset allocation.

Grant shows Rivers Portfolio X with risk factor-based allocations to public equities/bonds/commodities/hedge funds, which meets the foundation’s volatility and return investment objectives. He mentions the following caveats for a risk factor-driven approach:

Statement 1: Correlations among risk factors may change under volatile market conditions.

Statement 2: Factor sensitivities are unstable, and should be carefully tested.

Statement 3: Risk factor-based approaches can over-allocate to alternative asset classes because of risk underestimation from stale pricing.

After reviewing asset allocations, Rivers asks Grant to recommend potential hedge fund strategies. Grant presents the performance metrics of three funds (Exhibit 2) analyzed by Prima’s research to Rivers. He also discloses the following due diligence research outcomes.

• Merger Arbitrage Strategy fund has faced significant client turnover but has still managed attractive returns;

• Global Macro Strategy fund has achieved its performance with extensive use of derivatives but has not regularized its risk management framework;

• Long/Short Equity Manager’s successful performance is due to the active involvement of its chief compliance officer and chief investment officer.

Given the qualitative and quantitative factors, Rivers discusses the best hedge fund strategy for investment with Grant.

Hedge Funds	Merger Arbitrage Strategy (Hedge Fund I)	Global Macro Strategy (Hedge Fund II)	Long/Short Equity Manager (Hedge Fund III)
5-year annualized return	6.5%	6.3%	6.2%
Hedge Fund Index 1	7.0%	6.6%	6.3%
Hedge Fund Index 2	6.1%	5.9%	6.0%

9.1 Which one of the following statements regarding broad fixed-income investments is most likely correct? Fixed-income investments:

A. mitigate the inflation risks to the portfolio.

B. mitigate equity risk because of negative equity-bond correlation.

C. mitigate volatility and have a high probability of achieving the return objective.

9.2 The most likely limitations of using private equity to meet the investment return objective are:

A. drawdowns and volatility.

B. drawdowns and lack of capital growth.

C. temporary negative correlation and not achieving the return target.

9.3 Which one of the statements regarding the risk factor-based approach is most likely correct?

A. Statement 1.

B. Statement 2.

C. Statement 3.

9.4 Based on Exhibit 2 and the due diligence findings, the foundation should most likely invest in:

A. Hedge Fund I.

B. Hedge Fund II.

C. Hedge Fund III.

Question 10:

Olivia Miloslav is a derivatives trader at a wealth management firm. She expects the FTSE 100 index to be relatively flat in the short term but bullish long term. The consensus sentiment favors the market languishing around the same level over the next few months. The FTSE 100 index is currently trading at 7,450. The Exhibit below shows prices for two call options with a strike price of 7,450 that are available on the index. Both options have the same implied volatility

Exhibit 1

7,450 Strike Put Options on FTSE 100 Index
	Option A	Option B
Current Price	£65	£150
Time to Maturity	1 month	4 months

Miloslav implements an options trade based on her view. After one month the index has increased and is trading at 7,800. The implied volatility has increased and the four-month call option now sells at £380. Miloslav estimates the gain/loss on her position.

Miloslav discusses implied volatility curves for three-month options on the FTSE 100 index with the Head of Risk of the firm. Miloslav believes there is a sharp increase in the level of the volatility skew, together with a significant rise in the absolute level of implied volatility. She talks about trading strategies to profit from existing implied volatility skew and from changes in its shape over time. She observes that the call implied volatility is too high relative to the put’s implied volatility.

10.1 Discuss the best way Miloslav can implement the option trade to take advantage of her out-of-consensus view. Determine how Miloslav lowers the cost of the trade. Justify your response.

10.2 Determine the gain/loss Based on Miloslav’s options trade after the expiration of the one-month option and selling of the long option to a dealer. Justify your response.

10.3 Discuss the trading strategy Miloslav will likely implement to benefit from her view of call and put implied volatilities.

• long risk reversal

• short risk reversal

Question 11:

West Lodge Management Company (WLM) is a large investment management company that serves individual and institutional investors. WLM uses various trading strategies for its client portfolios and proprietary accounts. The clients have recently complained about the increasing trading costs. Ayla Malik, a senior risk manager at WLM, is asked to review the firm’s trading procedures and strategies.

Malik first evaluates last week’s trade in which WLM bought Amici Holdings (AIH) stock for a client’s portfolio. She first determines the market-adjusted cost of the buy order executed at an average price of $34.52. AIH’s price when the order entered the market was $34.10. The selected index price at the time of order entry was $500, and the market index VWAP over the trade period was $504. AIH stock has a beta to the index of 0.90.

Next Malik speaks to the senior trader Pam Li about Castle Rock Corp. (CRC) stock’s algorithmic trading. Li tells Malik she decided to use an algorithm to purchase some CRC shares because the stock was relatively liquid, and the order size was less than 15% of the traded security volume. According to her research, the prices were expected to move adversely during the trade horizon. The stock had short-term alpha potential, and she expected short-term buying pressure from other traders into the market close as the company’s quarterly earnings report was due later in the day.

Malik looks at the following trades that Li executed for different portfolio managers. The orders were for:

1. A large, urgent buy of OTC options.

2. A large, urgent sale of six emerging market currencies.

Vince Peters, an investment advisor with WLM, evaluates the transaction costs of a buy order for Brian Murphy, a 55-year-old mechanical engineer. The buy order was for the shares of a Pharmaceutical Company, WATT, for Murphy’s account. In establishing the WATT position, Peters considers the following facts:

• On Monday, WATT shares close at USD 15.24.

• On Tuesday afternoon, Peters directs the trader to buy 30,000 shares of WATT.

• The decision price is USD 15.45. The buy-side trading desk releases the order to the market 30 minutes after receiving it when the price is USD 15.47

• The trader purchases 20,000 shares at USD 15.51.

• Trading fees total an additional USD 0.01 per share purchased.

• WATT’s closing price on Tuesday is USD 15.50. No further orders are placed.

• On Wednesday, the trader cancels the buy order for the remaining 10,000 shares.

11.1 Calculate the market-adjusted cost of the AIH trade.

11.2 Determine correctly the execution algorithm used by Li for the CRC trade. Justify your response with two reasons.

• VWAP

• Arrival Price

• POV

• Liquidity-seeking

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