2020/2021 Level III Mock Exam

Level III 2021 Mock Exam #5 Short Answers Page 1

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2020/2021 Level III Mock Exam

Morning Session Exam #5 Short Answers

Page 2 2021 Mock Exam #5 Short Answers Level III



Note to Candidates In this volume, I have attempted to reduce the answers to the minimum that a candidate would have to write to earn full marks on each question. The answers are intended as both an assessment tool and a learning tool. Please use them accordingly. If you believe that there is an error in an answer contained here, please consult my errata page to see if your concern has been addressed:

http://www.financialexamhelp123.com/errata/ If you do not find an erratum addressing your concern, feel free to send me an e-mail at:

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Answer Question 1-A on This Page

Derivative

Given Elcius’ expectations, for each derivative determine the position that he

should take.

(Note: consider each derivative separately)

(Circle one each)

Justify each response.

Six-month VIX call options

Buy

Sell

• Call values increase with increasing underlying price

• Strong, negative correlation between VIX level, equity prices

Falling equity prices imply rising VIX

Six-month VIX put options

Buy

Sell

• Put values decrease with increasing underlying price



Six-month VIX

futures contracts

Long

Short

• Long futures increase with increasing underlying price



Answer Question 1-B on This Page Determine the value of the swap to Busti 75 days after inception. Show your calculations.

USD 564,432,631




Answer Question 1-C on This Page Determine whether Busti will pay or receive the settlement on the swap.

(Circle one)

Pay

Receive

Calculate the settlement amount for Busti. Show your calculations.

USD 323,253,275




Answer Question 2-A on This Page Explain why the empirical duration of the BML bonds is different from the modified duration of the bonds, based solely on the information given. (Note: no calculations required)

• Change of yield for the bond is less than benchmark yield change (115bp < 130bp) Smaller yield change means smaller price change

Smaller price change means shorter empirical duration

Answer Question 2-B on This Page Determine whether Sutherland should choose a bullet structure,

a barbell structure, or a ladder structure for the AUD bond portfolio. (Circle one)

Bullet

Barbell

Ladder

Justify your response.

• Small yield change at 15-year maturity Bullet portfolio will lose little to no value

• Barbell and ladder hold long-duration bonds and short-duration bonds Long-duration bonds will lose more value than short-duration bonds will gain

Barbell and ladder portfolios will lose value

Answer Question 2-C on This Page Using the data in Exhibit 3, calculate the G-spread on the corporate bond (in basis points). Show your calculations.

181bp




Answer Question 2-D on This Page Calculate the expected 6-month holding period return on Sutherland’s proposed investment in XKX bonds. Show your calculations.

3.8879%

Note: two decimal places (3.89%) are sufficient to earn full marks.




Answer Question 3-A on This Page Determine the

most appropriate portfolio structure

for Milenković given his beliefs and objectives.

(Circle one)

For each structure not selected, state one reason why it is not appropriate.

Note: restating case facts without additional

support will not receive credit.

(Note: the space next to the chosen structure should be left blank.)

Long only

• Believes short run equity risk premium might be negative Requires short positions to capture

– or –

• Milenković does not want his active position in any stock to be

limited by that stock’s weighting in his benchmark. In a long-only strategy, the minimum position weight is zero, so the maximum underweighting (active position) is limited to the stock’s weighting in the benchmark.

130/30 long

extension

Low risk market neutral

Milenković wants to maintain some beta exposure. The beta exposure in a market-neutral strategy is zero, which doesn’t achieve this objective.




Answer Question 3-B on This Page

Judge whether each of Toàn’s statements is accurate or inaccurate.

(Circle one each)

Support each judgment.

Statement 1

Accurate

Inaccurate

• Market-neutral means money-beta is zero

Not necessarily zero net investment

Statement 2

Accurate

Inaccurate

• Market-neutral portfolio: β ≈ 0

Low σ of returns or low correlation with market returns

Likely low covariance with long-only returns

Diversification benefit




Answer Question 4-A on This Page Determine which strategy

is most appropriate for Frías’ portfolio.

(Circle one)

Calculate the cost of the chosen strategy (in PAB) per EUR 1,000.

Show your calculations.

Protective put

Collar

Long seagull spread

PAB 15.31−

Short seagull spread

Answer Question 4-B on This Page Determine which options(s) Canouse should buy, if any, and which option(s)

Canouse should write, if any, to implement Samms’ suggested strategy.

Buy

Write

Type (Call/Put)

Strike

Type (Call/Put)

Strike

Call

PAB 0.8933

Put

PAB 0.7297

Calculate the total cost to implement the strategy (in PAB). Show your calculations.

PAB 52,800−




Answer Question 4-C on This Page Determine whether Abu Layla should accept or reject the carry trade.

(Circle one)

Accept

Reject

Justify your choice. Show your calculations.

• Arbitrage-free 6-month forward rate = BRL/PAB 5.4651 Less than expected spot rate

Negative expected holding period return

– or –

• Expected holding period return: −0.49%




Answer Question 5-A on This Page Determine, based on her observed bias, whether Boudiaf will

most likely accept or reject Hasan’s recommendation. (Circle one)

Accept

Reject


• Believes her employer’s stock is a good investment • Confirmation: will stick with her belief

Answer Question 5-B on This Page Determine which bias Hyon-Jin most likely displays.

(Circle one)

Illusion of control

Hindsight

Framing

Support your choice.

• Rewriting history “Knew” a bad result would be bad Thinks she agreed with a good decision when she hadn’t




Answer Question 5-C on This Page Determine whether Hasan should most likely accommodate or mitigate Rogic’s bias.

(Circle one)

Accommodate

Mitigate

Justify your determination.

• Representativeness is a cognitive error Easier to mitigate than emotional biases

• Mitigation generally better than accommodation

Answer Question 5-D on This Page

Identify the most likely emotional bias that Ryan’s actions reveal.

Emotional bias:

Endowment

Support your response.

• Target price is well above the market price • Attributed to “owing it to his parents’ legacy”

Emotional attachment to stock




Answer Question 5-E on This Page

Identify the most likely cognitive bias from which Bean suffers.

Cognitive bias:

Conservatism


• Retains original assessment: good investment • Ignores contrary evidence: recent bad performance




Answer Question 6 on This Page Determine the

most appropriate equity investment

for the RIA. (Circle one)

For each investment not selected, state one reason why it is not the most appropriate. Show your calculations.

Note: restating case facts without additional

support will not receive credit.

(Note: the space next to the selected investment should be left blank.)

DKN

• Budget stabilization funds need high liquidity

Cash needs are unpredictable • DNK has moderate liquidity

ZPX

GRY

• Return objective is at least inflation: 2% • Expected portfolio return is 1.985% < 2%

LSQ

• Investments should have low price correlation with budget

revenue source • Price correlation with petroleum is +0.80





Determine whether each comment is accurate or inaccurate.

(Circle one each)

For each inaccurate comment, identify all inaccurate part(s) of the comment.

(Note: do not consider omissions to be inaccuracies.)

(Leave the space next to any accurate comment blank.)

Comment 1

Accurate

Inaccurate

• It also includes ex post calculations such as VaR, CVaR

Comment 2

Accurate

Inaccurate

• Absolute return of our portfolio is explained by performance measurement

Comment 3

Accurate

Inaccurate

• Calculating relative ratios, such as information ratio and capture ratios, is part of appraisal




Answer Question 7-B on This Page Calculate the geometric excess return for the Plan’s portfolio compared to its benchmark portfolio. Show your calculations.

0.53%

Answer Question 7-C on This Page Compare the return attributable to the asset owner

to the return attributable to the investment managers. (Circle one)

Less than

Equal to

Greater than

Justify your conclusion. Show your calculations.

• Return attributable to owner: 0.69% • Return attributable to managers: −0.13% • 0.69% > −0.13%




Answer Question 8-A on This Page Based on Abdujalilov’s categorization, determine the most likely

time period for the Plan to achieve the target allocation to KH. (Circle one)

Short-term

Intermediate-term

Long-term

Support your determination.

• KH has a 5-year investment period


Identify the most appropriate proxy for the Plan’s private real assets investment. (Circle one)

Public REITs

High-yield bonds

Commodity futures

Support your identification.

• Private real assets: timber, commodities, farmland, energy, infrastructure assets o Not real estate, bonds




Answer Question 8-C on This Page Evaluate the appropriateness of Abdujalilov’s approach for investing in private real assets and private credit, given his investment goals for those asset classes. Inappropriate

• Investment value will fluctuate from 0% to ~15% to 0% of portfolio value o Will not maintain 15% investment

Answer Question 8-D on This Page

Considering the Plan’s liquidity requirements, for each asset

class Abdujalilov is considering, determine whether

he should most likely increase or decrease the allocation to that

asset class. (Circle one for each asset class)

Justify each determination with one reason.

Show your calculations.

Bonds

Increase

Decrease

• Liquidity need: 5.6% • Available liquidity: 4.365% • Liquidity increase must come

from cash, bond coupons

Public Equity

Increase

Decrease

• Must reduce allocation to existing

assets • Cash, bonds should increase • Real estate, private equity are

hard to decrease





Identify two factors of the Plan that will most likely contribute to:

i. an increase in the Plan’s ability to take risk

1.

• Plan is overfunded 2.

• High ratio of active employees to retired employees

– or –

• High percentage of active employees

– or –

• Low percentage of retired employees

ii. a decrease in the Plan’s ability to take risk

1.

• Limited time horizon

– or –

• Closed to new employees 2.

• Lump-sum payout option 3.

• Payments adjusted for inflation

(Note: any two of the above identified factors for a decrease are sufficient.)




Answer Question 9-B on This Page Formulate the time horizon section of the Plan’s IPS. Two-stage, long-term

• Stage 1: today until the last eligible worker retires • Stage 2: after stage 1 until final pension payment

Answer Question 9-C on This Page

Discuss two factors that will most likely contribute to an increase in the Plan’s liquidity needs.

1.

• Payments adjusted for inflation Higher inflation than assumed

Higher payments 2.

• Lump-sum payout option Possible higher immediate payments than assumed




Answer Question 10-A on This Page Calculate the after-tax value of the Millers’ portfolio upon liquidation, assuming that their expectations hold. Show your calculations.

PAB 4,442,273

Answer Question 10-B on This Page Calculate the after-tax value of the Andrades’ portfolio upon their retirement, assuming that their expectations hold. Show your calculations.

PAB 4,138,949





Based on Saaif’s analysis, for three of the

components of implementation shortfall, determine which broker

is preferable. (Circle one for

each component)

Explain each choice.

Delay cost

Strain

MT

Cannot be determined

• Strain: 0.88% • MT: 1.24%

Trading cost

Strain

MT


• Purchases

o MT: −0.51% o Strain is 1.89%

• Sales o MT: 0.87% o Strain: 1.32%

Opportunity cost

Strain

MT


• Opportunity cost is zero or positive. • Fully executed trades

o Strain: 76% o MT: 70%

• Partially executed trades o Strain: 13% unfilled o MT: 18% unfilled





For each manager, determine which

algorithmic trading approach is most

appropriate. (Circle one for each manager)

Justify each selection.

Molina

Scheduled

Opportunistic

Arrival price

Dark

SOR

• Opportunistic handles large trades, market orders

o Generally ensures entire trade is filled • Scheduled, arrival-price, SORs best for small trades • Dark pools may not fill entire trade

Takano

Scheduled

Opportunistic

Arrival price

Dark

SOR

• SOR handles small trades, limit orders, multiple

volatile venues • Scheduled, opportunistic, arrival price, dark pools

can’t handle multiple volatile venues





Based on Kin’s observations and

projections, estimate the most likely level of real

interest rates and of inflation in Oacam

one year’s time. (Circle one each)

Explain each estimate.

Real interest rates

High

Low

• Expected fiscal policy is loose

Inflation

High

Low

• Expected monetary policy is loose





For each building block, determine what change Kin is likely to make for

this year’s estimated value compared to last year’s estimated value.

(Circle one each)

For each value that is expected to change, justify your indicated change.

(Leave the space next to any “No change” or

“Cannot be determined” answer blank.)

Risk-free rate

Increase

Decrease

No change


• Steepening interest rate futures curve

Term premium

Increase

Decrease

No change


• 5-year / 1-year yield spread widened

Credit premium

Increase

Decrease

No change


• IG bond price decline less than explained by

benchmark yield changes Spreads narrowed

Liquidity premium

Increase

Decrease

No change





Answer Question 13-A on This Page Based on the data in Exhibit 1 and Miller’s criterion, determine which

account Granitto should choose to hold the new investment. (Circle one)

Taxable

Tax-deferred

Does not matter

Justify your determination. Show your calculations.

( ) ( )Taxable Sharpe ratio 0.68 Tax-deferred Sharpe ratio 0.67>

Answer Question 13-B on This Page Determine how Relucio’s economic net worth

compares to her accounting net worth in Exhibit 2. (Circle one)

Less than

Equal to

Greater than

Support your determination. Show your calculations.

( ) ( )Economic net worth XCD 9,900,000 Accounting net worth XCD 10,000,000<




Answer Question 13-C on This Page i. Identify one bias exhibited by Relucio that Miller’s suggested benchmark would most likely

help to highlight.

Home-country bias ii. Identify one of

Relucio’s investment goals that Miller’s suggested benchmark would most likely reflect more accurately than Relucio’s suggested benchmark.

Explain why Miller’s benchmark would likely be more accurate than Relucio’s benchmark for that goal.

Minimizing

diversifiable risk

• Global market-value weighted index will minimize

diversifiable risk • Domestic stock/bond index will not do so

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2020/2021 Level III Mock Exam