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 (AM)
FinQuiz.com – 5th Mock Exam 2018 (AM Session)
The morning session of the 2018 Level III CFA Examination has 12 questions. For
grading purposes, the maximum point value for each question is equal to the number of
minutes allocated to that question.
Questions Topic Minutes

1 Portfolio Management – Individual 26
4 Portfolio Management – Institutional 18
5 Portfolio Management – Institutional 16
6 Portfolio Management – Asset Allocation 10
8 Portfolio Management – Economics 19
9 Portfolio Management – Equity Investments 17
10 Portfolio Management – Monitoring and Rebalancing 6
11 Portfolio Management – Risk Management 15
12 Portfolio Management – Derivatives 5
Total: 180
FinQuiz.com © 2018 - All rights reserved. 2

QUESTION 1 HAS SIX PARTS (A, B, C, D and E) FOR A TOTAL OF 26

MINUTES
Kyle Lucas is the owner of a small privately traded manufacturing concern which is
currently worth $12 million and was established twenty-five years ago. Lucas is 65 years
of age and intends to sell the business two years from today.
Lucas has approached portfolio manager Gus Weaver to manage his investment portfolio
which is currently worth $8.5 million and is equally allocated to long-term corporate
bonds, domestic and international equities, and alternative asset classes. In response to a
question regarding his investment experience, Lucas states, “I have faced significant
financial crises in the past and now always look to avoid making investment choices
which hold the potential for disastrous consequences.”
Lucas earns annual business income which is fixed at a pre-tax amount of $100,000. His
living expenses are $98,000 in the current year and are expected to increase at the annual
rate of inflation of 5%. Upon retirement, he will no longer earn business income and his
annual living expenses will become constant at $150,000.
If Lucas sells his business at its expected market price, two years from today, he will be
able to purchase his dream house for $8 million and a boat currently sold at a price of
$1.0 million and will donate the remaining amount to a local charity. He has instructed
Weaver to exclude the sale of his business from the investment decision. Lucas intends to
finance his grandson’s college education as well as purchase residential property for him.
Total estimated costs will amount to $30 million and will be required fifteen years from
today.
Lucas is subject to an ordinary income and capital gains tax rate of 25% and 30%
respectively. He always maintains an emergency reserve equal to 3 years of his annual
business income in addition to his portfolio holdings.
A. Formulate each of the following constraints for Lucas’ investment policy

statement (IPS):
I. Time Horizon
II. Unique Circumstances
(4 minutes)

B. Determine whether an increase in inflation rate, reduction in the sales price of the
business, and an increase in the price of his dream house will increase, decrease or
have no impact on risk tolerance. Justify your choice with one reason.
Answer Question 1-B in the template provided on page 6.
(6 minutes)
C. State Lucas’s return objective for his IPS.
(3 minutes)
D. Calculate Lucas’ annual after-tax nominal rate of return for the IPS if his
business is sold at its current market price two years from today. Show your
calculations.
(6 minutes)
Walker strongly feels that incorporating behavioral considerations in an IPS is essential

to fulfilling the client’s long-term goals. To achieve this purpose, he holds a meeting with
Lucas to determine his behavioral investor type (BIT) and associated biases by holding a
meeting with the client.
E. Discuss two benefits of including behavioral finance into the IPS.
(4 minutes)
Lucas is an avid follower of the stock market and makes investment decisions on behalf
of friends and family members. His most recent investment decision involved a $100,000
purchase of French Inc’s stock. The decision was influenced by recent media attention on
the corporation following a ‘brave’ policy shift towards unconventional production
processes promising shorter lead times and a greater focus on organic raw materials as
input. He further justifies his decisions by stating, “Over the course of industry history,
companies who were experimental in setting their policy have been popular amongst
investors.”

F. Identify the bias demonstrated by Lucas and justify your selection with one
reason.
(3 minutes)
Answer Question 1-F in the template provided on page 7.

Template for Question 1-B
Impact on Risk
Tolerance (Circle Justify Your Choice With
Factor the Correct One Reason
Answer)
Increase
Increase in inflation rate Decrease
No impact
Increase
Reduction in sales price of business Decrease
No impact
Increase
Increase in the price of his dream Decrease

house
No impact

Template for Question 1-F
Identify the Bias (Circle the Justify Your Choice with One
Correct Choice) Reason
Regret Aversion
Overconfidence
Availability Bias

QUESTION 2 HAS TWO PARTS (A, B) FOR A TOTAL OF 10 MINUTES
Carl Segal is an asset advisor at Vector Asset Management. Segal is working closely with
a private client, Timothy Allen; aged 45 to ascertain the behavioral investor type (BIT)
exhibited by Allen. Allen has considerable investment experience and often recommends
potential investments for further evaluation to his adviser. During a discussion between
Segal and Allen, the client shares his investment approach:
“I have devoted a significant amount of time to studying security markets and asset
classes. Based on the insight which I have gained over these years, I can comfortably
trust my instincts when making investment decisions for myself as well as acquaintances,
who have entrusted me with the management of their financial wealth. I trust nothing but
my own research and prefer not to let my judgment get influenced by the advice of those
who possess little knowledge about wealth planning.”
A. Classify Carl’s BIT, determine the risk tolerance, and identify one emotional bias
typically associated with the identified behavioral category.
(3 minutes)
Answer Question 2-A in the Template provided on page 10.
B. Carl participates in the defined contribution (DC) offered by his employer. Segal
determines that Carl is fifteen years away from retirement. Segal would like to
compare the client’s current allocation to plan assets with the average allocation
held over the past five years. Segal also determines that:
• Carl’s annual income sufficiently covers his living expenses.

• he is unmarried but finances his brother’s medical care. His brother is
mentally challenged. His salary is not sufficient to cover these expenses.
• he has inherited $1.5 million from his deceased father’s estate in the
beginning of the current year. He intends to employ these funds for
investment purposes.
• he has assigned a risk score of 3.1 to the average company stock, in
comparison with 3.6 to domestic stock funds and 4.1 to global stock funds.

Exhibit:
Carl’s Allocations to the DC Plan Assets
Average
Historical Current
Allocation Allocation
(2009-2013) (2014)
Stocks – Corporate stock 36% 34%
Stocks – Domestic Non-corporate stocks 6 7
Stocks – Global stocks 3 4
Fixed Income 45 48
Short-term income 10 9
Total 100% 100%
I. Using the data collected by Segal, explain one bias exhibited by Carl in his
portfolio selection decisions with respect to the DC plan. Support your response
with two reasons.
(4 minutes)
II. Based on Segal’s findings, he intends to employ an autopilot strategy to align

Carl’s allocations with his circumstances. Explain how such a strategy would
affect the current allocation.
(3 minutes)

Template for Question 2-A
Determine Risk Tolerance

Associated With the Identify One Emotional
Classify Carl’s BIT Behavioral Category Bias Typically Associated
(Circle the Correct Choice) (Circle the correct choice) With the Behavioral
Category
Passive Preserver (PP) Low
Active Accumulator (AA) Low to Medium
Friendly Follower (FF) Medium to High
Independent Individualist (II) High

QUESTION 3 HAS ONE PART FOR A TOTAL OF 3 MINUTES
Mr. and Mrs. Fairview, aged 65 and 60 respectively, are the owners of a hotel chain
which has branches located across the US and has been in establishment for the past
thirty years. Their business is currently worth $60 million and has appreciated by 10% in
the current year leading to an increase in the wealth of its owners. The hotel chain is a
privately traded concern.
The Fairviews are seeking to transfer the business to their daughter, Samantha, but would
like to retain ownership rights. They have approached Kim Young, a tax advisor, for a
solution. Under current tax laws a donor’s annual gift exclusions are limited to $13,000
per donee. Gifts exceeding this allowance are taxed at a rate of 25%. Young discovers
that the couple has consumed this allowance and now sets out to devise a wealth transfer
strategy which will minimize transfer taxes and retain ownership rights.
After considerable evaluation, Young has identified three potential wealth transfer
strategies. She would now like to determine the most appropriate strategy.
Recommend the most suitable wealth transfer strategy. For the choices not selected
provide one reason for their unsuitability.
Answer Question 3 in the template provided on page 12.
(3 minutes)

Template for Question 3
Recommend the most Suitable Wealth Provide One Reason for Why the
Transfer Strategy Choices Not Selected are Unsuitable
Corporate Estate Tax Freeze
Family Limited Partnership
Direct Gifting to Samantha

QUESTION 4 HAS SEVEN PARTS (A, B, C, D, E, F, G) FOR A TOTAL OF 35

MINUTES
Yellow Tires (YT) offers a defined benefit pension plan to its employees. Sean Martin is
managing YT’s investment portfolio and has collected the following details which are
relevant for the analysis:
• The plan is fully funded

• The average age of the participants is 38 years
• The active to retired participants ratio is 3:1
• The company has reported strong financial results in the current year.
• The discount rate used to determine the present value of future obligations is
8.0%.
• The duration of plan liabilities is 22 years
• The sponsor has proposed a return objective of 8.5%
• YT offers a one-for-one inflation indexation via a cost of living allowance
(COLA)
• Future benefits are twice as high relative to accrued benefits and are attributable
to future real wage growth.
• YT is considered the inclusion of an early retirement provision
A. State YT’s return objective.
(2 minutes)
B. Identify one purpose which the sponsor may have in stating a return objective of
8.5%.
(2 minutes)
C. Characterize each of the following components for YT’s IPS:
I. risk tolerance
II. liquidity
III. time horizon
(6 minutes)

D. For each of the following scenarios, determine whether risk tolerance will
increase or decrease. Explain your choice.
Answer 4-D in the Template provided below.
(12 minutes)
Template for Question 4-D
Impact on
Risk
Factor Tolerance Explain Your Choice
Introduction of an early
retirement provision
Increase in discount rate
Decrease in the allocation of

fund assets to YT stock
Increase in bankruptcy risk

QUESTION 5 HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 16 MINUTES
First Bank is a commercial lending institution operating in the U.S. Sasha Wilson is the
bank’s senior investment officer. Wilson would like to implement more stringent risk
management measures with respect to the bank’s liabilities and has convened a meeting
to address the following objectives:
Objective 1: Address the possibility of a positive interest rate shock
Objective 2: Minimize the leveraged-adjusted duration gap
Objective 3: Maximize return-on-invested capital
Wilson is analyzing the implications of the recent unexpected rise in interest rates on the
bank’s market value of equity.
The current structure of the bank’s balance sheet is as follows:
Exhibit:
First Bank’s Balance Sheet
Market value Market value
Duration ($ millions) Duration ($ millions)
Assets Liabilities
Loans 7.4 65
Fixed 4.5 31 Time 3.0 60
assets deposits
Cash 0.0 4 Demand 3.5 40
deposits
Total 6.2* 100 3.2* 100
*Represents weighted average duration
A. Discuss one implication of a positive interest rate shock on the bank’s balance
sheet.
(2 minutes)
B. Determine what course of action should most likely be taken to achieve Objective
2.
(2 minutes)

C.. Formulate the following constraints for First Bank’s IPS:
I. time horizon
II. liquidity
III. unique circumstances
(6 minutes)
D. First Bank has implemented three policy changes with respect to its loan
portfolio. Wilson would like to determine how each policy change will impact the
objectives and constraints for the securities portfolio. The three policies are as
follows:
Policy 1: Expanding lending activities by opening branches in other cities of the

country.
Policy 2: Restricting lending to customers with a credit rating of A or higher.
Policy 3: Increase the holdings of long-term mortgage-backed securities.
Explain the impact of each policy change on the bank’s objectives and constraints. Your
response should consider each policy in isolation.
(6 minutes)
Answer Question 5-D in the template provided on page 17.

Template for Question 5-D
Evaluate the Impact of the Policy

Change on the Bank’s Objectives and
Policy Change Constraints. Consider each Policy in
Isolation
Expanding lending activities by opening

branches in other cities of the country
Restricting lending to customers with a

credit rating of A of higher
Increase the holdings of long-term

mortgage-backed securities

QUESTION 6 HAS TWO PARTS (A & B) FOR A TOTAL OF 10 MINUTES
Becky Sands established the “Sands & Steel Financial Firm (S&S)” with her classmate
and colleague, Linda Steels, around five years ago. S&S is a financial consultancy firm
that assists institutional clients in managing their investment portfolios. Often, the firm
works in coordination with an already established, internal financial team of the clients
they deal with. Over the course of its business, S&S has built a client base of more than
twenty regular and loyal institutional funds. A few days ago, the firm landed consultancy
of three additional funds totaling a net worth of approximately 300 million US dollars.
Sands appointed three of the firm’s most seasoned portfolio managers to meet with the
board of directors of each of the concerned institutions. After their initial meeting with
the clients, Sands met with the managers to inquire about strategic issues relating to the
respective investment strategies and constraints of each of the clients. The managers
presented Sands with the following key summarized information:
§ Insurance fund:
The portfolio is overfunded and offers life insurance policies to individual clients.
It incorporates a very low risk premium in the discount rate used to find the
present value of its liabilities. The discount rate is primarily determined by
regulatory authorities and then adjusted downward to reflect the conservative
nature of the fund’s policy. The board wishes to reduce the need of any additional
contribution over the next year and also, to significantly decrease the risk of not
being able to pay next year’s liabilities.
§ Pension Fund:
The present value of the pension fund’s liabilities equals $550 million whereas the
fund’s assets equal $475 million. The fund’s board of directors has instructed
S&S to maintain a surplus volatility of not more than 8% per year. The fund has
an established risk aversion score of 6.5. The focus has primarily been on the
systematic risk of the asset mix and how it relates to that of the portfolio of
liabilities. The board has directed S&S to achieve a return of 13% over the next
year, while ensuring that the risk objective is not violated.

§ A hospital endowment:
The endowment has sporadic spending needs due to an erratic influx of patients at
irregular intervals. The fund’s board of directors wants to ensure that enough
capital is available at the time liabilities are due. They want to minimize tail risk
and ensure that worst-case outcomes are properly incorporated when constructing
a strategic asset allocation. As such, their main goal is to minimize the probability
of not being able to make future contributions and to keep the 1% VAR at the
desired level.
A. For each of the above funds, determine the most appropriate way to account for
liabilities. Justify your response for each fund with three reasons each.
(6 minutes)
Sands selects the following strategic asset allocation for the insurance fund based on
mean variance optimization:
Exhibit 1: Asset Class Ranges

Asset Class Strategic Target Cost-Benefit Ranges
Corporate Bonds 65% 62%-67%

Domestic Equity 20% 17%-23%
International Equity 10% 6%-15%
International Real Estate 5% 4%-6%
The research analysts at S&S provide Sands with the following information about the
different asset classes:
§ A rising trend in US stock prices has been observed for the past three years, which
is expected to continue. Since the overall market is also expected to rise, the US
stocks will have a correlation between 0.80-0.85 with the rest of the asset classes.
§ Trading stocks in the international market is exceedingly challenging due to a lack
of a properly functional financial market in many countries. However, the
presence of derivatives on international stocks makes it easy to synthetically
create the desired positions.
§ US fixed-income has historically shown little diversion from its base values over
the past 25 years.
§ Taxes on interest income are expected to be lower than taxes on dividend income.

§ The insurance fund has a conservative approach to investing and thus wants to
keep exposure to volatile asset classes to a minimum.
§ International equity, although illiquid, offers significant diversification benefits.
B. For the cost-benefit ranges given, state the asset class for which the range is most
inconsistent. Justify your response with four reasons.
(4 minutes)

QUESTION 7 HAS THREE PARTS (A, B, C) FOR A TOTAL OF 18 MINUTES
Jill Starc is a senior asset manager at RP Financial (RPF), a portfolio management firm.
Starc oversees the Global Equity Fund I (GEF I) which is being offered by the firm. The
fund holds global (Canadian, Mexican and British) and domestic U.S. equities. Foreign
currency exposures are currently unhedged. The exhibit below illustrates the values of the
fund assets, spot exchange rates, and correlations between movements in foreign
currency-asset returns and foreign currency returns.
Exhibit
GEF I Fund Asset Values,
Spot Rates, and Correlations
Last Year Current
(2013) Year
(2014)
CAD-denominated asset value 100 150
in CAD millions
MXN-denominated asset 80 70
value in MXN millions
GBP-denominated asset value 230 300
in GBP millions
USD-denominated asset value 500 450
in USD millions
CAD/USD spot rate 0.7900 0.8100
USD/MXN spot rate 15.2420 15.0050
GBP/USD spot rate 1.4754 1.5000
p(RCAD,RCAD/USD) + 0.7
p(RMXN,RMXN/USD) - 0.3
p(RGBP,RGBP/USD) + 0.2
Gracy Singh is one of Starc’s clients. Singh’s investment portfolio comprises solely of
the securities held in the GEF I fund. Her allocation to CAD-, MXN-, GBP- and USD-
denominated equities is 30%, 40%, 25% and 5% respectively.
A. Calculate the domestic currency return on Singh’s portfolio. Show your

calculations.
(4 minutes)

Based on a discussion with Singh, Starc determines that hedging the client’s foreign
currency risk exposures is essential. However, she is yet to establish the degree to which
currency risk exposures should be hedged.
B. Describe two potential considerations which Starc will need to account for when
determining the degree of currency risk exposures to undertake. Your answer
should focus on Singh’s current portfolio allocation and the information in the
exhibit.
(6 minutes)
To aid her currency hedging decision, Starc collects necessary details with respect to
Singh. She will examine each factor independently to determine whether a full currency
hedge will be required.
Information on Singh:
• Risk averse to portfolio losses

• Has a relatively long time-horizon
• Desire for foreign fixed-income security exposure
• Required to make a down payment for the purchase of a home in three month’s
time and pays for her son’s ongoing medical expenses.
C. For each of the four points collected, determine whether the strategic currency
position of the portfolio should be biased towards a fully hedged currency
management program. Consider each factor independently and support each
answer with one reason.
Answer Question 7-C in the template provided on page 23.
(8 minutes)

Template for Question 7-C
Strategic Currency
Position Biased
Towards a Fully
Hedged Currency Support Each Answer
Point Collected Management with One Reason
Program?
Circle the Correct
Answer.
Yes
Risk averse to portfolio
losses No
Yes
Has a relatively long time-
horizon No
Yes
Desire for foreign fixed-
income security exposure No
Required to make a down

payment for the purchase of Yes
a home in three month’s
time and pays for her son’s No
ongoing medical expenses

QUESTION 8 HAS A TOTAL OF FOUR PARTS (A, B, C, D) FOR A TOTAL OF

19 MINUTES
Simon Weaver is an economic analyst working at Time Analytics. Weaver covers

developed and emerging markets specializing in bonds and equities.
Weaver is making inflation forecasts for Lidon, a country with an emerging market. His
analysis focuses on two historical periods, 1990-1995 and 1996-2001. The first time
period was marked with above average inflation, GDP growth exceeding its target, and
an economy in danger of becoming overheated. The cause of the high inflation was a
global rise in energy prices triggering cost-push inflation in the country. Circumstances
changed in the 1996-2001 period when monetary authorities implemented restrictive
policy measures to cool down the economy.
Based on economic analysis, Weaver projects that Lidon’s economy is once again
expected to overheat due to the rapid supply of money currently being injected by
monetary authorities. To calculate the anticipated increase in inflation, Weaver uses the
average inflation prevailing over the two time periods, assigning a higher probability to
the inflation observed during 1990-1995, as input to his analytical model.
A. Discuss the bias observed demonstrated by Weaver’s analytical methods.
(2 minutes)
B.
i. Identify the psychological trap which Weaver has fallen into. Justify you choice.
Answer B-i in the template provided below.
ii. For the identified bias, discuss two possible measures which can be taken to avoid
this bias.
(5 minutes)
Template for Question 8-B (i) is provided on page 26.

C. Three months later Weaver’s inflation forecast materializes. The analyst

anticipates Lidon’s central bank will deal with this scenario by tightening the
monetary policy and increasing the short-term interest rate to 7.0% from its
current level of 6.0%.
Recommend which asset class will be a suitable investment choice given Weaver’s
expectations. For the asset classes not selected, explain why they are inappropriate.
Answer Question 9-C in the template provided on page 26.
(7 minutes)
D. The authorities in Lidon have announced their intention to peg the local currency,
LDN, to the U.S. dollar (USD). The market is weary of the strategy’s
effectiveness and expects the LDN to be devalued shortly before Lidon
implements the policy. The current interest rate differential between Lidon and
U.S. sovereign bonds is 4.5%.
i. Identify two benefits of maintaining an exchange rate peg.
(2 minutes)
ii. Determine whether the change in interest rate differential will be positive,
negative or neutral based on the information provided on the market’s
views concerning the exchange rate peg. Justify you answer.
(3 minutes)

Template for Question 8-B (i)
Identify the Psychological Trap which

Weaver has Fallen Into (Circle the For the Trap Not Selected, Provide
Correct Answer) one Reason Why it is Inappropriate.
Overconfidence
Confirming evidence
Status Quo
Select the most suitable asset class given Explain why the choices not selected
Weaver’s expectations are inappropriate
Stocks
Cash
7.5% Mortgage-backed securities

QUESTION 9 HAS A TOTAL OF FOUR PARTS (A, B, C, D) FOR A TOTAL OF

17 MINUTES
Melissa Reed manages the equity allocation of institutional client portfolios at Wood-
Carter. The Smithson Foundation (SF) is Reed’s most recent client. During a meeting
with the foundation’s chief executive, Reed deems that the portfolio’s equity allocation
should be indexed to the Russell 3000 index.
In her conversation with the chief executive concerning the portfolio management
strategy, the latter states, “The chosen passive management strategy should minimize
portfolio rebalancing costs and be cost effective in terms of portfolio construction costs.”
A. Select which strategy is most suitable for the passive management of SF

portfolio’s equity allocation. Justify your choice. Your answer should also
explain why the strategies not selected are unsuitable.
(Note: The provided justifications for the three strategies should be distinct.)
Answer Question 9-A in the template provided on page 29.
(7 minutes)
Reed is of the opinion that the investment universe of SF’s portfolio should be expanded
to include global equities. However, she does not wish to undertake the purchase of
individual stocks and so engages in an equity total return swap whereby the SF policy
portfolio will receive the return on the MSCI global equity index in exchange for interest
payments on U.S. Treasury bonds.
B. Discuss two general advantages of Reed’s global equity allocation strategy.
(4 minutes)
Reed also manages the equity portion of Glenn Endowment’s (GE) policy portfolio. The
fund’s prospectus identifies the investment mandate as “active large-cap exposure with a
growth bias.”
Reed’s manager, Carl Edgar, evaluates his subordinate’s performance using a returns-
based style analysis and employs four benchmarks – Russell 1000 Value Index, Russell
1000 Growth Index, Russell 2000 Growth Index, and Russell 2000 Value Index. The
results of the performance evaluation are summarized below.

Exhibit:
Results of Edgar’s Returns-Based Style Analysis
Factor Weights
Russell 1000 Value 0.45
Russell 1000 Growth 0.25
Russell 2000 Value 0.20
Russell 2000 Growth 0.10
Annualized portfolio return 14.50%

Annualized tracking risk 7.85%
Error term 9.58%
C. State one advantage and one disadvantage of the performance evaluation

approach being used by Edgar.
(2 minutes)
D. State and justify whether GE’s portfolio is invested in accordance with the stated
mandate.
(4 minutes)

Template for Question 9-A
Select the most Suitable

Strategy for the Justify Your Response with One Reason.
Passive Management
of SF’s Portfolio
Full Replication
Stratified Sampling
Optimization

Carl Storm is an institutional portfolio manager at Theta Asset Management. Storm

works closely with Green Associates, a broker/dealer firm, to execute trades on behalf of
client accounts. Below are excerpts from her meetings with the chief executives of two of
her clients. Storm needs to determine which type of order will be submitted to Green
Associates based on the details collected.
Smithson Corp’s Defined Benefit Pension Fund:
Smithson has placed an order to purchase 100,000 shares of Reliable Corp, a software
manufacturer. The average day’s volume of the manufacturer’s stock is 400,000. The
firm’s purchase decision is based on earnings growth projections generated by the firm’s
in-house forecasting model. The chief executive has instructed to Storm, “We would not
like to reveal the full extent of our purchase order to the market.”
Thornton Endowment Fund:
The chief executive emphasizes on giving brokers free reign to make purchase decisions
for the fund’s policy portfolio whenever the market presents a favorable opportunity. All
trades must be executed within three trading days of placing the order.
Determine which order is most suitable for the two clients. Explain your choice.
Answer Question 10 in the template provided on page 31.
(6 minutes)

Template for Question 10
Determine which order is

most suitable for the two
clients
Client (Circle the Correct Answer) Explain your Choice
Reserve order
Smithson Corp’s Market-not-held order

Defined Benefit
Pension Fund
Market on open order
Participate order
Thornton Best efforts order

Endowment Fund
Market on open order

QUESTION 11 HAS THREE PARTS (A, B, C) FOR A TOTAL OF 15 MINUTES
Bjore Traders is a shipping company listed on the NYSE. The company has divisions
operating in several states across the U.S. Each divisional manager is responsible for
overseeing the risk management of its exposures.
A. Identify one benefit and one drawback of BT’s risk management system
structure.
(2 minutes)
Jacqueline Andrew is the head of risk management at BT’s Idaho division. Andrew is
preparing a report on the division’s risk exposures in order to determine how to manage
them effectively. She begins her report by discussing the division’s strategy for risk
management:
Statement: “We manage risk strategically by avoiding risk taking in areas in which we do
not have expertise and hedging only tactically in areas in which we have an edge.”
B. Does Andrew’s statement reflect efficient risk management practices? Justify

your response.
(3 minutes)
Answer Question 11-B in the template provided on page 33.
The Idaho Division is BT’s only division delivering orders to customers outside the U.S.
A portion of its sales are on credit. Shipping fuel is procured by paying for 12 months’
fuel in advance using over-the-counter (OTC) prepaid commodity swaps. The firm has
hedged its foreign currency exposures using currency futures.
In the current year, the management is seeking to expand the division’s delivery
destinations and will be purchasing three freight ships from a U.S. supplier. Funds from
the purchase will come from issuing a combination of equities and corporate bonds.
C. Identify five risk exposures faced by the Idaho division. Your answer should
explain each risk exposure by identifying one source.
Answer Question 11-C in the Template provided on page 34.
(10 minutes)

Template for Question 11-B

Does Andrew’s Statement
Reflect Efficient Risk
Andrew’s Statement: Management Practices?
(Circle the Correct Option) Justify Your Response
“We manage risk
strategically by avoiding
risk taking in areas in which Yes
we do not have expertise
and hedging only tactically No
in areas in which we have
an edge.”

Identify Five Risk Exposures Faced by Explain Each Risk Exposure with
the Idaho Division One Identified Source
1.
2.
3.
4.
5.

Capex Asset Management is a U.S. based portfolio management firm which has always
invested in domestic stocks on behalf of client portfolios. Victor Solanki is CAM’s senior
most portfolio manager. Solanki has allocated €100 million for investing in German
stocks with an average beta of 0.75. The spot exchange rate is $0.89. The German interest
rate is 4%.
Solanki will be hedging both German market risk as well as currency risk for a three
month period. A three-month futures contract on the German market is priced at
€200,000 and has a beta of 0.60. The three-month forward rate is $0.9560.
i. Identify the strategy Capex Asset Management will need to undertake for
hedging German local market return.
ii. Calculate the hedged portfolio return. Use a ‘n/360’ days convention and show
your calculations.
(5 minutes)

QUESTION 13 HAS THREE PARTS (A, B, C) FOR A TOTAL OF 17 MINUTES.
Steven Blair, CFA, has been contracted to help Betty Davis put together an Investor
Policy Statement and a strategic allocation for her $2.5 million in assets. The funds are
currently allocated to the asset classes established by a previous advisor
Money Market Instruments 20%

U.S. Large Cap Fund 20%
U.S. Corporate Bonds 20%
U.S. Treasuries 20%
S&P500 Fund 20%
They begin to discuss the asset classes and recommendations in their first meeting.
Steven tells Betty that the previous advisor did not correctly specify the asset classes. He
also recommends treasury-inflation protected securities as a separate asset class from the
nominal bonds currently in the portfolio and provides the table below as evidence.
Historical Correlation of Returns

Asset Class TIPS Corporates Treasuries
Treasury Inflation Protected Securities 1.00
U.S. Corporate Bonds 0.85 1.00
U.S. Treasuries 0.71 0.80 1.00
A. Support Stevens recommendation to add TIPS with two reasons
(2 minutes)
B. Describe three errors that were made in the specification of asset classes
(6 minutes)
Steven has experience developing strategic asset allocations using traditional mean
variance optimization with unadjusted historical returns, variances and covariances. To
construct a strategic allocation for Betty, he is interested in using other approaches like
Black-Litterman and Monte Carlo simulation.
C. Identify one advantage and one limitation for each of the approaches listed in the
case (Mean-Variance, Black-Litterman, and Monte Carlo)
(9 minutes)

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

Questions Topic Minutes

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QUESTION 1 HAS SIX PARTS (A, B, C, D and E) FOR A TOTAL OF 26

A. Formulate each of the following constraints for Lucas’ investment policy

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Answer Question 1-B in the template provided on page 6.

C. State Lucas’s return objective for his IPS.

Walker strongly feels that incorporating behavioral considerations in an IPS is essential

E. Discuss two benefits of including behavioral finance into the IPS.

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Answer Question 1-F in the template provided on page 7.

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Template for Question 1-B

Increase in inflation rate Decrease

Reduction in sales price of business Decrease

Increase in the price of his dream Decrease

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Template for Question 1-F

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QUESTION 2 HAS TWO PARTS (A, B) FOR A TOTAL OF 10 MINUTES

Answer Question 2-A in the Template provided on page 10.

• Carl’s annual income sufficiently covers his living expenses.

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II. Based on Segal’s findings, he intends to employ an autopilot strategy to align

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Template for Question 2-A

Determine Risk Tolerance

Passive Preserver (PP) Low

Active Accumulator (AA) Low to Medium

Friendly Follower (FF) Medium to High

Independent Individualist (II) High

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QUESTION 3 HAS ONE PART FOR A TOTAL OF 3 MINUTES

Answer Question 3 in the template provided on page 12.

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Template for Question 3

Corporate Estate Tax Freeze

Family Limited Partnership

Direct Gifting to Samantha

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QUESTION 4 HAS SEVEN PARTS (A, B, C, D, E, F, G) FOR A TOTAL OF 35

• The plan is fully funded

A. State YT’s return objective.

C. Characterize each of the following components for YT’s IPS:

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Answer 4-D in the Template provided below.

Template for Question 4-D

Increase in discount rate

Decrease in the allocation of

Increase in bankruptcy risk

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QUESTION 5 HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 16 MINUTES

Objective 1: Address the possibility of a positive interest rate shock

Objective 2: Minimize the leveraged-adjusted duration gap