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CFA Institute CFA-Level-III Exam Questions
Provided By: CFA Institute
Exam: CFA Level III Chartered Financial Analyst
Certification: CFA Level III

Total Questions: 365
Updated On: Apr 25, 2025
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Question 1
- Joan Nicholson, CFA, and Kim Fluellen, CFA, sit on the risk management committee for Thomasville Asset
  Management. Although Thomasville manages the majority of its investable assets, it also utilizes outside firms
  for special situations such as market neutral and convertible arbitrage strategies. Thomasville has hired a
  hedge fund, Boston Advisors, for both of these strategies. The managers for the Boston Advisors funds are
  Frank Amato, CFA, and Joseph Garvin, CFA. Amato uses a market neutral strategy and has generated a return
  of S20 million this year on the $100 million Thomasville has invested with him. Garvin uses a convertible
  arbitrage strategy and has lost $15 million this year on the $200 million Thomasville has invested with him, with
  most of the loss coming in the last quarter of the year. Thomasville pays each outside manager an incentive fee
  of 20% on profits. During the risk management committee meeting Nicholson evaluates the characteristics of
  the arrangement with Boston Advisors. Nicholson states that the asymmetric nature of Thomasville's contract
  with Boston Advisors creates adverse consequences for Thomasville's net profits and that the compensation
  contract resembles a put option owned by Boston Advisors.
  Upon request, Fluellen provides a risk assessment for the firm's large cap growth portfolio using a monthly
  dollar VAR. To do so, Fluellen obtains the following statistics from the fund manager. The value of the fund is
  $80 million and has an annual expected return of 14.4%. The annual standard deviation of returns is 21.50%.
  Assuming a standard normal distribution, 5% of the potential portfolio values are 1.65 standard deviations
  below the expected return.
  Thomasville periodically engages in options trading for hedging purposes or when they believe that options are
  mispriced. One of their positions is a long position in a call option for Moffett Corporation. The option is a
  European option with a 3-month maturity. The underlying stock price is $27 and the strike price of the option is
  $25. The option sells for S2.86. Thomasville has also sold a put on the stock of the McNeill Corporation. The
  option is an American option with a 2-month maturity. The underlying stock price is $52 and the strike price of
  the option is $55. The option sells for $3.82. Fluellen assesses the credit risk of these options to Thomasville
  and states that the current credit risk of the Moffett option is $2.86 and the current credit risk of the McNeill
  option is $3.82.
  Thomasville also uses options quite heavily in their Special Strategies Portfolio. This portfolio seeks to exploit
  mispriced assets using the leverage provided by options contracts. Although this fund has achieved some
  spectacular returns, it has also produced some rather large losses on days of high market volatility. Nicholson
  has calculated a 5% VAR for the fund at $13.9 million. In most years, the fund has produced losses exceeding
  $13.9 million in 13 of the 250 trading days in a year, on average. Nicholson is concerned about the accuracy of
  the estimated VAR because when the losses exceed $13.9 million, they are typically much greater than $13.9
  million.
  In addition to using options, Thomasville also uses swap contracts for hedging interest rate risk and currency
  exposures. Fluellen has been assigned the task of evaluating the credit risk of these contracts. The
  characteristics of the swap contracts Thomasville uses are shown in Figure 1.
  
  Fluellen later is asked to describe credit risk in general to the risk management committee. She states that
  cross-default provisions generally protect a creditor because they prevent a debtor from declaring immediate
  default on the obligation owed to the creditor when the debtor defaults on other obligations. Fluellen also states
  that credit risk and credit VAR can be quickly calculated because bond rating firms provide extensive data on
  the defaults for investment grade and junk grade corporate debt at reasonable prices.
  Which of the following best describes the accuracy of the VAR measure calculated for the Special Strategies
  Portfolio?
  
  A : It is accurate but should be supplemented with scenario analysis.
  
  B : It is accurate and provides a complete measure of the fund's risk.
  
  C : It is inaccurate and should be supplemented with comprehensive stress testing.
  
  Answer: C
Question 2
- 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 Figure 1.
  Figure 1: Point University Asset Allocation
  
  *Bond coupon payments are all semiannual. Managers at Garrison are concerned that expectations for a strengthening U.S. dollar relative to the British pound could negatively impact returns to Point University's U.K. bond allocation. Therefore, managers have collected information on swap and exchange rates. Currently, the swap rates in the United States and the United Kingdom are 4.9% and 5.3%, respectively. The spot exchange rate is 0.45 GBP/USD. The U.K. bonds are currently trading at face value. Garrison recently convinced the board of trustees at Point University that the endowment should allocate a portion of the portfolio into international equities, specifically 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 Figure 2. Figure 2: Mid-cap index and European Index Futures Data
  
  Three months after proposing the international diversification plan, Garrison was able to persuade Point
  University to make a direct short-term investment of $2 million in Haikuza Incorporated (HI), a Japanese
  electronics firm. HI exports its products primarily to the United States and Europe, selling only 30% of its
  production in Japan. In order to control the costs of its production inputs, HI uses currency futures to mitigate
  exchange rate fluctuations associated with contractual gold purchases from Australia. In its current contract, HI
  has one remaining purchase of Australian gold that will occur in nine months. The company has hedged the
  purchase with a long 12-month futures contract on the Australian dollar (AUD).
  Managers at Garrison are expecting to sell the HI position in one year, but have become nervous about the
  impact of an expected depreciation in the value of the Yen relative to the U.S. dollar. Thus, they have decided
  to use a currency futures hedge. Analysts at Garrison have estimated that the covariance between the local
  currency returns on HI and changes in the USD/Yen spot rate is -0.184 and that the variance of changes in the
  USD/Yen spot rate is 0.92.
  Which of the following best describes the minimum variance hedge ratio for Garrison's currency futures hedge
  on the Haikuza investment?
  
  A :
  For every futures contract sold to hedge translation risk, 0,2 futures contracts must be purchased to hedge
  economic risk.
  
  B :
  For every futures contract sold to hedge translation risk, 0.8 futures contracts must be purchased to hedge
  economic risk.
  
  C :
  For every futures contract sold to hedge translation risk, 1.2 futures contracts must be purchased to hedge
  economic risk.
  
  Answer: A
Question 3
- Geneva Management (GenM) selects long-only and long-short portfolio managers to develop asset allocation
  recommendations for their institutional clients.
  GenM Advisor Marcus Reinhart recently examined the holdings of one of GenM's long-only portfolios actively
  managed by Jamison Kiley. Reinhart compiled the holdings for two consecutive non-overlapping five year
  periods. The Morningstar Style Boxes for the two periods for Kiley's portfolio are provided in Exhibits 1 and 2.
  Exhibit 1: Morningstar Style Box: Long-Only Manager for Five-Year Period 1
  
  Exhibit 2: Morningstar Style Box: Long-Only Manager for Five-Year Period 2
  
  Reinhart contends that the holdings-based analysis might be flawed because Kiley's portfolio holdings are
  known only at the end of each quarter. Portfolio holdings at the end of the reporting period might misrepresent
  the portfolio's average composition. To compliment his holdings-based analysis, Reinhart also conducts a
  returns-based style analysis on Kiley's portfolio. Reinhart selects four benchmarks:
  1. SCV: a small-cap value index.
  2. SCG: a small-cap growth index.
  3. LCV: a large-cap value index.
  4. LCG: a large-cap growth index.
  Using the benchmarks, Reinhart obtains the following regression results:
  Period 1: Rp = 0.02 + H0.01(SCV) + 0.02(SCG) + 0.36(LCV) + 0.61(LCG)
  Period 2: Rp = 0.02 + 0.01(SCV) + 0.02(SCG) + 0.60(LCV) + 0.38(LCG)
  Kiley's long-only portfolio is benchmarked against the S&P 500 Index. The Index's current sector allocations are
  shown in Exhibit 3.
  Exhibit 3: S&P 500 Index Sector Allocations
  
  GenM strives to select managers whose correlation between forecast alphas and realized alphas has been
  fairly high, and to allocate funds across managers in order to achieve alpha and beta separation. GenM gives
  Reinhart a mandate to pursue a core-satellite strategy with a small number of satellites each focusing on a
  relatively few number of securities.
  In response to the core-satellite mandate, Reinhart explains that a Completeness Fund approach offers two
  advantages:
  Advantage 1: The Completeness Fund approach is designed to capture the stock selecting ability of the active
  manager, while matching the overall portfolio's risk to its benchmark.
  Advantage 2: The Completeness Fund approach allows the Fund to fully capture the value added from active
  managers by eliminating misfit risk.
  Which one of the following statements about Kiley's long-only portfolio is most correct1? Kiley's portfolio:
  
  A : is only exposed to systematic risk.
  
  B :
  is only exposed to unsystematic risk.
  
  C : attempts to earn a positive alpha through security selection.
  
  Answer: C
Question 4
- Smiler Industries is a U.S. manufacturer of machine tools and other capital goods. Dat Ng, the CFO of Smiler,
  feels strongly that Smiler has a competitive advantage in its risk management practices. With this in mind, Ng
  hedges many of the risks associated with Smiler's financial transactions, which include those of a financial
  subsidiary. Ng's knowledge of derivatives is extensive, and he often uses them for hedging and in managing
  Srniler's considerable investment portfolio.
  Smiler has recently completed a sale to Frexa in Italy, and the receivable is denominated in euros. The
  receivable is €10 million to be received in 90 days. Srniler's bank provides the following information:
  
  Smiler borrows short-term funds to meet expenses on a temporary basis and typically makes semiannual
  interest payments based on 180-day LIBOR plus a spread of 150 bp. Smiler will need to borrow S25 million in
  90 days to invest in new equipment. To hedge the interest rate risk on the loan, Ng is considering the purchase
  of a call option on 180-day LIBOR with a term to expiration of 90 days, an exercise rate of 4.8%, and a premium
  of 0.000943443 of the loan amount. Current 90-day LIBOR is 4.8%.
  Smiler also has a diversified portfolio of large cap stocks with a current value of $52,750,000, and Ng wants to
  lower the beta of the portfolio from its current level of 1.25 to 0.9 using S&P 500 futures which have a multiplier
  of 250. The S&P 500 is currently 1,050, and the futures contract exhibits a beta of 0.98 to the underlying.
  Because Ng intends to replace the short-term LIBOR-based loan with long-term financing, he wants to hedge
  the risk of a 50 bp change in the market rate of the 20-year bond Smiler will issue in 270 days. The current
  spread to Treasuries for Smiler's corporate debt is 2.4%. He will use a 270-day, 20-year Treasury bond futures
  contract ($100,000 face value) currently priced at 108.5 for the hedge. The CTD bond for the contract has a
  conversion factor of 1.259 and a dollar duration of $6,932.53. The corporate bond, if issued today, would have
  an effective duration of 9.94 and has an expected effective duration at issuance of 9.90 based on a constant
  spread assumption. A regression of the YTM of 20-year corporate bonds with a rating the same as Smiler's on
  the YTM of the CTD bond yields a beta of 1.05.
  If Ng purchases the interest rate call, and 180-day LIBOR at option expiration is 5.73%, the annualized effective
  rate for the 180-day loan is closest to:
  
  A : 6.6982%.
  
  B : 6.5346%.
  
  C : 6.3785%
  
  Answer: A
Question 5
- Robert Keith, CFA, has begun a new job at CMT Investments as Head of Compliance. Keith has just completed a review of all of CMT's operations, and has interviewed all the firm's portfolio managers. Many are CFA charterholders, but some are not. Keith intends to use the CFA Institute Code and Standards, as well as the Asset Manager Code of Professional Conduct, as ethical guidelines for CMT to follow. In the course of Keith's review of the firm's overall practices, he has noted a few situations which potentially need to be addressed. Situation 1: CMT Investments' policy regarding acceptance of gifts and entertainment is not entirely clear. There is general confusion within the firm regarding what is and is not acceptable practice regarding gifts, entertainment and additional compensation. Situation 2: Keith sees inconsistency regarding fee disclosures to clients. In some cases, information related to fees paid to investment managers for investment services provided are properly disclosed. However, a few of the periodic costs, which will affect investment return, are not disclosed to the clients. Most managers are providing clients with investment returns net of fees, but a few are just providing the gross returns. One of the managers stated "providing gross returns is acceptable, as long as I show the fees such that the client can make their own simple calculation of the returns net of fees." Situation 3: Keith has noticed a few gaps in CMT's procedure regarding use of soft dollars. There have been cases where "directed brokerage" has resulted in less than prompt execution of trades. He also found a few cases where a manager paid a higher commission than normal, in order to obtain goods or services. Keith is considering adding two statements to CMT's policy and procedures manual specifically addressing the primary issues he noted. Statement 1: "Commissions paid, and any corresponding benefits received, are the property of the client. The benefit(s) must directly benefit the client. If a manager's client directs the manager to purchase goods or services that do not provide research services that benefit the client, this violates the duty of loyalty to the client.” Statement 2: "In cases of "directed brokerage," if there is concern that the client is not receiving the best execution, it is acceptable to utilize a less than ideal broker, but it must be disclosed to the client that they may not be obtaining the best execution." Situation 4: Keith is still evaluating his data, but it appears that there may be situations where proxies were not voted. After completing his analysis of proxy voting procedures at CMT, Keith wants to insert the proper language into the procedures manual to address proxy voting. Situation 5: Keith is putting into place a "disaster recovery- plan," in order to ensure business continuity in the event of a localized disaster, and also to protect against any type of disruption in the financial markets. This plan includes the following provisions: • Procedures for communicating with clients, especially in the event of extended disruption of services provided. • Alternate arrangement for monitoring and analyzing investments in the event that primary systems become unavailable. • Plans for internal communication and coverage of crucial business functions in the event of disruption at the primary place of business, or a communications breakdown. Keith is considering adding the following provisions to the disaster recovery plan in order to properly comply with the CFA Institute Asset Manager Code of Professional Conduct: Provision 1: "A provision needs to be added incorporating off-site backup for all pertinent account information." Provision 2: "A provision mandating testing of the plan on a company-wide basis, at periodical intervals, should be added." Situation 6: Keith is spending an incredible amount of time on detailed procedures and company policies that are in compliance with the CFA Institute Code and Standards, and also in compliance with the CFA Institute Asset Manager Code of Professional Conduct. As part of this process, he has had several meetings with CMT senior management, and is second-guessing the process. One of the senior managers is indicating that it might be a
  better idea to just formally adopt both the Code and Standards and the Asset Manager Code of Conduct, which would make a detailed policy and procedure manual redundant. Keith wants to assure CMT's compliance with the requirements of the CFA Institute Code and Standards of Professional Conduct. Which of the following statements most accurately describes CMT's responsibilities in order to assure compliance?
  
  A : CMT must adopt the Asset Manager Code of Conduct, as required by the CFA Institute Code and Standards. The policy manual is acceptable, but not necessary.
  
  B : Although adoption of the CFA Institute Asset Manager Code of Conduct is not a requirement, the Standards of Practice encourage firms to adopt this Code. CMT must adopt supplemental policies and procedures as part of a policy manual in order to properly implement the CFA Institute guidelines
  
  C : The Standards of Practice do not require CMT to adopt the Asset Manager Code of Conduct, nor is there a requirement to publish a detailed procedural manual. Disclosure of policies is required, and any changes or updates to policies must be immediately disseminated.
  
  Answer: B

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