L3 mock sample exam CFA level III mock exam itemset answers 2009

2009 Level III Mock Exam
ANSWERS AND REFERENCES
Questions 1 through 6 relate to Ethical and Professional Standards.

Weiying Shao Scenario
Weiying Shao, CFA, is an investment officer employed by Zhang Financial Services.
Zhang provides wealth management services solely to high net worth individuals and has
adopted the CFA Institute Standards and Asset Manager Code of Conduct.
Shao receives a request from a client asking for an itemized accounting of the actual fees
and other costs charged to them for the year. Shao sends the client a document itemizing
management fees paid by the client along with an explanation as to how the fees were
derived.
Zhang has expanded its services recently to include proprietary mutual funds. Two
experienced and respected research analysts were promoted to manage the new mutual
funds.
Shao meets with Guohua Xu, a client who holds a diversified portfolio of funds.
Traditionally, Shao has invested client assets in long-established funds with strong
performance and management continuity. Because he has great respect for Zhang’s new
products and their portfolio managers, Shao suggests investing a portion of Xu’s portfolio
in one of the new Zhang funds. He recommends a fund with investment objectives
similar to those of Xu. Shao provides performance data based on a simulated application
of the fund’s approach over the past 18 months. He adds, “The new fund’s simulated
performance is comparable to the performance of your current holdings over that period.”
Several clients ask Shao about hedge funds. After carefully screening for risk and return
characteristics, Shao recommends selected hedge funds he finds appropriate for even
conservative clients. The funds have had excellent performance so Shao believes they
are appropriate despite their three year lock out prevision. He discusses his research and
recommendations with a colleague who responds “I don’t believe hedge funds are
appropriate for any of our conservative clients, especially those with short-term liquidity
needs.”
Periodically Shao reviews Zhang’s confidential proxy voting policy that is disclosed to

clients only upon request. The policy directs investment officers to be selective when
reviewing proxies, and to avoid spending time reviewing and voting routine proxies. In
such cases, Zhang considers the cost involved for the client to be greater than the benefit
that the client would receive.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Zhang has strict trade allocation procedures developed in accordance with the CFA
Institute Standards and Asset Manager Code of Conduct. The firm distributes copies of
the procedures to clients annually. Occasionally, Shao receives notice from the trading
desk at the close of the day informing him that his block trades were only partially filled.
Recently, when the trading desk could not execute the full $750,000 in stock that he had
requested for two accounts, he allocated $100,000 of the stock to the $5 million dollar
private account and the remaining $500,000 of stock to a $25 million dollar institutional
account.
During the next month, Zhang’s founder is accused by regulatory authorities of a number
of violations including misappropriation of client funds. The same day, a team of senior
portfolio managers leave Zhang to start their own firm. Zhang instructs its personnel not
to discuss either of these developments with current or prospective clients.

1. Are the fee disclosures made by Shao to his client consistent with the CFA
Institute Asset Manager Code of Professional Conduct?
A. No.
B. Yes, because Shao disclosed how fees are derived.
C. Yes, because Shao itemized the management fees paid on the client’s behalf.

Answer: A
Asset Manager Code of Professional Conduct, CFA Institute
2009 Modular Level III, Volume 1, p. 215
Study Session 2-6-b
Interpret the Asset Manager Code in situations presenting issues of compliance,
disclosure, or professional conduct.
The Asset Manager Code of Conduct requires that managers disclose to each
client the actual fees and other costs charged to them, together with itemizations
of such charges, when requested by clients. The disclosure should include the
specific management fee, incentive fee, and the amount of commissions the
manager has paid on the client’s behalf during the period plus any other costs
such as custodian fees. The Asset Manager Code of Conduct also requires
managers to use plain language in presenting information to clients. Shao did not
disclose all fees as commissions were left out and a description using plain
language was also not used.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


2. By recommending that Xu switch a portion of his portfolio to a new Zhang fund,
does Shao violate any CFA Institute Standards of Professional Conduct?
A. No.
B. Yes, because he has a conflict of interest as the new funds are proprietary.
C. Yes, because the fund data used in the performance comparison was
simulated.
Answer: A

“Guidance for Standards I-VII,” CFA Institute
2009 Modular Level III, Volume 1, pp. 64-66, example 4
Study Session 1-2-a
Demonstrate a thorough knowledge of the Code of Ethics and Standards of
Professional Conduct by interpreting the Code and Standards in various situations
involving issues of professional integrity.
Shao does not violate the Standards. He recommends a fund with similar
investment objectives and discloses the use of simulated data in accordance with
Standard III (D). The Standard requires members and candidates to avoid
misstating performance or misleading clients. The Code does not prohibit the use
of proprietary funds for clients.

3. By recommending hedge funds, does Shao violate any CFA Institute Standards?
A. No.
B. Yes, because hedge funds have risk characteristics that are not suitable for
conservative investors.
C. Yes, because the hedge funds recommended are not suitable for conservative
investors with short-term liquidity requirements.
Answer: C
“Guidance for Standards I-VII,” CFA Institute
2009 Modular Level III, Volume 1, pp. 60-64
Study Session 1-2-a
Demonstrate a thorough knowledge of the Code of Ethics and Standards of
Professional Conduct by interpreting the Code and Standards in various situations
involving issues of professional integrity.
A member or candidate’s duty under Standard III(C) is satisfied with respect to a
particular investment if they have thoroughly considered the investment’s place in
the overall portfolio. Although Shao has performed appropriate due diligence
prior to making his recommendation in regards to the return/risk characteristics he
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to

currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


has not taken into consideration the particular short-term liquidity restrictions
posed by the three-year lock up.

4. Is Zhang’s proxy voting policy consistent with the requirements and
recommendations of CFA Institute Standards and the Asset Manager Code of
Conduct?
A. Yes.
B. No, because the proxy voting policy should be disclosed to all clients.
C. No, because voting of all proxies is a part of the management of client
investments.
Answer: B
“Guidance for Standards I-VII,” CFA Institute
Asset Manager Code of Professional Conduct, CFA Institute
2009 Modular Level III, Volume 1, pp. 51, 203-204, 216.
Study Session 1-2-a and 1-6-b
Demonstrate a thorough knowledge of the Code of Ethics and Standards of
Professional Conduct by interpreting the Code and Standards in various situations
involving issues of professional integrity.
Interpret the Asset Manager Code in situations presenting issues of compliance,
disclosure, or professional conduct.
Zhang’s policy should be disclosed to all clients. Standard III (A) and the Asset
Manager Code of Conduct (Section F.4.h) require members to disclose proxyvoting policies to all clients.

5. When allocating the shares on the partially filled block order does Shao violate

any CFA Institute Standards?
A. No.
B. Yes, because he fails to disclose the firm’s trade allocation policies.
C. Yes, because he should allocate shares to client accounts only after the order
is completely filled.
Answer: A
“Guidance for Standards I-VII,” CFA Institute
2009 Modular Level III, Volume 1, p. 57.
Study Session 1-2-a

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Demonstrate a thorough knowledge of the Code of Ethics and Standards of
Professional Conduct by interpreting the Code and Standards in various situations
involving issues of professional integrity.
Shao allocates the shares on a pro rata basis such that each account receives a 2%
allocation to the portfolio. To meet the fair dealing requirements of Standard III
(B) shares must be allocated among participating client accounts pro rata on the
basis of order size.

6. According to the CFA Institute Asset Manager Code of Conduct, Zhang must
disclose the information regarding its:
A. founder only.
B. team of senior portfolio managers only.
C. both the founder and the team of senior portfolio managers.

Answer: C
Asset Manager Code of Professional Conduct, CFA Institute
2009 Modular Level III, Volume 1, pp. 214-217.
Study Session 2-6-a, b
Summarize the ethical responsibilities required by the six components of the
Asset Manager Code.
Interpret the Asset Manager Code in situations presenting issues of compliance,
disclosure, or professional conduct.
Zhang must disclose both the information concerning the regulatory authorities
and the information regarding the team of senior portfolio managers. The Asset
Manager Code of Conduct requires that managers disclose material information
that reasonable investors would want to know relative to whether or not they
would choose to use or continue to use the Manager. In this regard, possible
regulatory or disciplinary action taken against the manager or its personnel related
to professional conduct would be considered “material”. The Code also requires
that managers disclose significant personnel or organizational changes that have
occurred.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Questions 7 through 12 relate to Ethical and Professional Standards.

Anne Zawadi Case Scenario
A group of fund management professionals recently formed a self-regulating professional
association, the Fund Managers’ Association (FMA), whose main objective is to increase

the level of integrity of fund management in the country. Membership in the FMA is
restricted to fund management firms.
The FMA wants to create a Code of Conduct to be used by all the firm members of the
FMA. To help in the creation of the Code, the FMA has hired Anne Zawadi, a CFA
charterholder.
In the first meeting between the Board of the FMA and Zawadi, the Chairman of the
FMA Board states, “Our initial thoughts are to require all of our members to adopt the
CFA Code of Ethics and Standards of Professional Conduct rather than create our own
code. If they fail to abide by the CFA Code, their membership will be revoked.”
Zawadi responds, “Perhaps it would be better to adopt the CFA Institute Asset Manager
Code of Professional Conduct, as it is specific to asset management firms, not
individuals. The Code lays out principles of conduct, including acting in a professional
and ethical manner, acting for the benefit of clients at all times and with independence
and objectivity, in addition to acting with skill, competence and diligence. It also covers
communication with clients. It is so comprehensive there is no need to allow any
flexibility amongst your members. However, it only covers some aspects of our capital
markets regulations but it should be adopted without any further provisions.”
After Zawadi’s comments, the FMA Board agreed to adopt the CFA Asset Manager Code
without any changes or additions, requiring all its members to strictly abide by it. It also
required its members to state in their marketing material that their clients could submit
complaints regarding any member to the FMA’s Compliance Committee.
One year later, the Compliance Committee of the FMA asks to meet with Zawadi to
discuss a complaint against one of its members, Amani Asset Management. The
complaint comes from a client who gave Amani full discretion and believes Amani
violated the Asset Managers Code. His opinion is based on the fact that he lost one third
of his portfolio value over the last year. The client claims he was told by one of Amani’s
managers that recently all of their clients’ asset allocations were heavily weighted to
more speculative equity investments in order to enhance returns. The manager is also
alleged to have told the client his performance is really quite good as the market lost 50
percent.

Along with his complaint, the client submitted his investment policy statement, prepared
by Amani. Zawadi noted that the client’s risk tolerance in the statement was described as
“moderate” due to his conservative nature and poor investment experiences in the past.
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Amani’s client also indicates he heard that Amani had been fined a substantial amount of
money by regulators for not complying with regulations regarding the handling of client
funds. The client also indicates that as a result of the disciplinary action, several top
management personnel left the company. The client enclosed Amani’s last bi-weekly
newsletter in which Amani disclosed recent staff additions, new management fee
structures, and changes in handling client account procedures.
As part of the FMA’s objective of improving standards in their industry, the FMA Board
asks Zawadi to review the procedures they require of their members in regards to
Compliance and Support, Trading and Disclosure. Zawadi finds the following existing
procedures in place:
Compliance Members are required to ensure all their employees sign a statement
and Support: acknowledging the firm’s mandatory compliance with the CFA Asset
Managers Code; appoint a Compliance Officer reporting to the CEO and
Board of Directors; maintain records regarding investment decisions for a
minimum of six years; and portfolio information must be checked by
another department within the Member firm.
Trading:
Members are required to enforce procedures to ensure: clients’ interests
are first and foremost; trade allocations are distributed equally amongst all
clients and best trade execution.

Disclosure: Members are required to ensure all Members disclose: basis for valuation
methodology; potential conflicts of interest; and use of derivatives.
After the review of the procedures she makes two recommendations as to how the FMA
can further enhance integrity amongst its members:
Recommendation:

Recommendation:

Each member firm should require all of its employees to
declare on a quarterly basis, any investment actions taken
by themselves or anyone else living in their household to
ensure the firms’ clients’ interests are being put before the
employees of the firm.
Member firms should restrict the use of performance fees
but solely charge clients on the basis of a percentage of
assets under management so to ensure managers do not
take excessive risk.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


7. Are Zawadi’s comments regarding the implementation and the ethical
responsibilities of the CFA Asset Manager Code of Professional Conduct most
likely accurate?
A. No.
B. Yes, because she covers all aspects of the ethical responsibilities.

C. Yes, because she covers all aspects of the ethical responsibilities and mentions
that the Code must be adopted without any changes.
Answer: A
“Asset Manager Code of Professional Conduct,” CFA Institute
2009 Modular Level III, Volume 1, pp. 199-201.
Study Session 2-6-a, b
Summarize the ethical responsibilities required by the six components of the
Asset Manager Code.
Interpret the Asset Manager Code in situations presenting issues of compliance,
disclosure, or professional conduct.
Zawadi does not include as part of the responsibilities the need to uphold the rules
governing capital markets and also states that the Code must be adopted without
any further provisions. The Code sets forth minimum ethical standards for
providing asset management services. It is meant to be general in nature and
allow flexibility for asset managers of various sizes and structures to develop the
particular policies and procedures necessary to implement the Code.

8. Did Amani’s client have a basis for making a complaint with regard to the Asset
Manager Code against Amani?
A. Yes.
B. No, Amani treated all the clients equally and did not favor one client over
another.
C. No, the client gave Amani full discretion and his portfolio outperformed the
market.
Answer: A
“Asset Manager Code of Professional Conduct,” CFA Institute
2009 Modular Level III, Volume 1, pp. 202, 205-208.
Study Session 2-6-b
Interpret the Asset Manager Code in situations presenting issues of compliance,
disclosure, or professional conduct.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Amani failed to abide by B(6) of Investment Process and Actions. Amani
managers did not take into account the client’s moderate risk tolerance when he
changed the asset allocation to emphasize speculative equity investments.

9. Which of the FMA’s existing procedures regarding Compliance and Support least
likely meets the minimum Standards of the Asset Managers Code?
A. Maintaining records.
B. Department confirmation.
C. Independent Compliance Officer.
Answer: B
“Asset Manager Code of Professional Conduct,” CFA Institute
2009 Modular Level III, Volume 1, pp. 210-211.
Study Session 2-6-b
Interpret the Asset Manager Code in situations presenting issues of compliance,
disclosure, or professional conduct.
While confirmation is required to ensure that portfolio information is accurate,
and complete, an independent third party, not within a department of the firm,
should undertake the confirmation.

10. Which of the following disclosures would the FMA least likely require of their
members to meet the minimum Standards of the Asset Managers Code?
A. Use of leverage.

B. Fund audit results.
C. Remuneration of Professional Staff.
Answer: C
“Asset Manager Code of Professional Conduct,” CFA Institute
2009 Modular Level III, Volume 1, pp. 214-217.
Study Session 2-6-c
Recommend practices and procedures designed to prevent violations of the Asset
Manager Code.
The remuneration of professional staff would most likely not be considered
material when a client is determining whether to hire or stay with a fund manager.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


11. Could Zawadi’s first recommendation be improved further to better meet the
Standards of the Asset Manager Code and the CFA Standards of Professional
Conduct?
A. No, it already meets the requirements of both Codes.
B. Yes, disallow all employees to trade in investment securities.
C. Yes, require all employees to obtain permission prior to making a trade.
Answer: C
“Asset Manager Code of Professional Conduct,” CFA Institute
2009 Modular Level III, Volume 1, pp. 94-97, 202.
Study Session 2-6-c, 1-2-b
Recommend practices and procedures designed to prevent violations of the Asset
Manager Code.

Recommend practices and procedures designed to prevent violations of the Code
of Ethics and Standards of Professional Conduct.
The Code and Standards require Managers to give priority to investments made
on behalf of the client over those that benefit their own interests and must develop
and maintain policies and procedures to ensure that their activities comply with
the provisions of the Code and all applicable legal and regulatory requirements.
By requiring employees to seek permission prior to a trade, it would better protect
the interests of the clients being served prior to the Managers. Standard VI(B)Priority of Transactions of the CFA Standards of Professional Conduct requires
pre-clearance procedures to identify possible conflicts of interest prior to the
execution of personal trades.

12. Does Zawadi’s recommendation conform to the Asset Manager Code of
Standards?
A. Yes.
B. No, Code does not forbid performance fees as long as the fee calculation is
clearly disclosed.
C. No, Code does not forbid performance fees as long as each client’s
performance fee is calculated identically.
Answer: B
“Asset Manager Code of Professional Conduct,” CFA Institute
2009 Modular Level III, Volume 1, p. 215.
Study Session 2-6-c
Recommend practices and procedures designed to prevent violations of the Asset
Manager Code.
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.

The Code does not disallow the use of a performance fee. The Code however
states that Managers must disclose to all clients and potential client’s management
fees and other investment costs charged to investors, including what costs are
included in the fees and the methodologies for determining fees and costs.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Questions 13 through 18 relate to Risk Management.

Lara Fraser Case Scenario
Lara Fraser is the risk manager for Galaxy & Co., a large investment firm located in
Scotland. She recently hired a new employee, Stuart Wallace, to assist her with
enhancing the firm’s risk management process. Fraser asks Wallace to document the
exposures to risk that have been identified through Galaxy & Co.’s current risk
management process. As Wallace begins the project, Fraser responds to client questions
and requests.
Client A states:
“I am a new client and received my first investment portfolio statement. The statement
specifies, “With 95 percent confidence, the VAR of the portfolio is $1 million for one
month.” My portfolio holds long stock positions along with some option positions on
those stocks and I am concerned about the impact that low probability events may have
on my portfolio performance. Can the VAR measure be adjusted to address this concern?
In addition, please explain the primary limitation of VAR.”
Fraser responds with the following statements:

Statement 1: VAR quantifies potential losses in simple terms.
Statement 2: VAR often underestimates the magnitude and frequency of the worst
returns.
Statement 3: VAR is a forward-looking measure that cannot be backtested against
historical data.
Client B asks:
“I am preparing to make a VAR presentation to my Board of Directors. I am familiar
with the analytical method of measuring VAR that Galaxy & Co. uses. Please describe
other methods for estimating VAR and indicate a disadvantage of each.”
Galaxy & Co.’s senior management wants to be confident that the firm is managing and
measuring credit risk in an appropriate manner. They ask Fraser to provide a specific
example of an investment instrument within the portfolio that may create credit risk.
Fraser chooses to illustrate the concept of credit risk with a swap example. A portion of
the firm’s portfolio is invested in floating rate notes. Galaxy uses interest rate swaps to
manage the interest rate risk exposure of this investment. Specifically, the firm has
entered into a one year pay variable receive fixed interest rate swap. The swap has a
notional value of £1,000,000. The current market value of the swap to Galaxy is
-£47,000.
Fraser is confident that the techniques she employs to mitigate credit risk are
comprehensive and follow industry best practice standards. She drafts a description of
the techniques used at Galaxy and includes the following statement:
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


“In keeping with industry standards, our primary means of managing credit risk is
requiring that our counterparties post collateral.”

Meanwhile, Wallace drafts a memo to Fraser with some of his initial thoughts:
“As an investment firm that manages international and domestic fixed income and equity
portfolios, Galaxy & Co. is exposed to both financial and non-financial risks. Each of
these broad topics will be addressed in turn.”
Wallace decides to initially add depth to the financial risks that the firm faces.

13. Fraser’s most appropriate response to Client A’s question regarding the possibility
of adjusting the VAR measure is:
A. an increase in the confidence interval will increase the magnitude of the VAR
measure.
B. the VAR measure will decrease if the time frame of measurement is
increased.
C. for your portfolio, any confidence interval will provide essentially identical
VAR information.
Answer: A
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland
2009 Modular Level III, Volume 5, pp. 211-213
Study Session 14-40-e
Interpret and compute value at risk (VAR) and explain its role in measuring
overall and individual position market risk.
Increasing the confidence interval will increase VAR, which provides the client
more information about less likely (low probability) events.

14. Fraser correctly identifies a limitation of VAR in:
A. Statement 1.
B. Statement 2.
C. Statement 3.
Answer: B
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland
2009 Modular Level III, Volume 5, pp. 225-226

Study Session 14-40-g
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Discuss the advantages and limitations of VAR and its extensions, including cash
flow at risk, earnings at risk, and tail value at risk.
VAR may be derived from erroneous assumptions and models leading to poor
estimates of the size and frequency of bad outcomes.

15. Fraser drafts a number of possible responses to Client B. An appropriate
response would include:
A. The Monte Carlo simulation method requires an assumption of normally
distributed returns.
B. The historical method is nonparametric and does not allow the user to make
assumptions about the probability distribution of returns.
C. The historical method relies completely on events of the past, and the
probability distribution of the past may not hold in the future.
Answer: C
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland
2009 Modular Level III, Volume 5, pp. 218-223
Study Session 14-40-g
Compare and contrast the analytical (variance-covariance), historical, and Monte
Carlo methods for estimating VAR and discuss the advantages and disadvantages
of each.
The historical method relies completely on events of the past, and whatever
distribution prevailed in the past might not hold in the future. This is a

disadvantage of the measure.

16. With respect to the plain vanilla interest rate swap, which of the following most
accurately describes Galaxy’s exposure to credit risk?
A. No current credit risk
B. £47,000 at risk of loss
C. £953,000 at risk of loss
Answer: A
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland
2009 Modular Level III, Volume 5, pp. 229-236
Study Session 14-40-i
Evaluate the credit risk of an investment position, including forward contract,
swap, and option positions.
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


The market value is negative, therefore Galaxy would lose nothing if the
counterparty defaulted immediately.

17. Fraser’s statement regarding the management of credit risk is most likely:
A. correct.
B. incorrect, because the primary means of managing credit risk is periodic
marking to market.
C. incorrect, because the primary means of managing credit risk is limiting the
total exposure to a given counterparty.
Answer: C

“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland
2009 Modular Level III, Volume 5, pp. 243-247
Study Session 14-40-k
Demonstrate the use of exposure limits, marking to market, collateral, netting
arrangements, credit standards, and credit derivatives to manage credit risk.
A party will not engage in too many derivative transactions with one
counterparty. The risk manager makes extensive use of quantitative credit
exposure measures to guide them in the process to determine where and when to
limit exposure.

18. As Wallace begins to add depth to the description of the initial source of risks
present at Galaxy & Co., which of the following will he least likely include:
A. taxes.
B. liquidity.
C. interest rates.
Answer: A
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland
2009 Modular Level III, Volume 5, pp. 199-202
Study Session 14-40-b
Recommend and justify the risk exposures an analyst should report as part of an
enterprise risk management system.
Taxes are a non-financial risk.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.

Questions 19 through 24 relate to Equity Portfolio Management.

William Pugh Case Scenario
William Pugh is a portfolio manager for the pension plan of the FMJ Corporation. Pugh
is evaluating portfolio managers for the pension plan.
PMA Asset Management follows a passive investment strategy that is implemented using
ETF’s rather than conventional mutual funds. PMA proposes to offer a new index
portfolio that reflects the Russell 2000 small-cap value index. PMA indicates that the
technique used to construct the new index portfolio assumes that the factors used to
explain stock returns are uncorrelated.
ASM Partners is an active manager. A common strategy that ASM implements is a pairs
trade where they take equal long and short positions in two common stocks in a single
industry. These positions are constructed so that they have no correlation with equity
market returns.
CKI Financial Advisors also follows an active portfolio strategy. A portfolio analysis for
CKI is provided below in Exhibit 1.
Exhibit 1
Portfolio Analysis for CKI
Portfolio Benchmark
Number of Stocks
25
700
Weighted Average Market Cap $25 billion $50 billion
Dividend Yield
3.7%
1.8%
P/E
12
22
P/B

1.2
2.5
Projected EPS growth
8%
13%
Pugh is also evaluating another active manager, the DCM Group. Selected information
for all three active managers as well as their normal and investor benchmarks are
presented in Exhibit 2
Exhibit 2
Active Portfolio Managers’ Characteristics
and Benchmark Information
Normal
Investor
Total Misfit
Portfolio Manager Benchmark Benchmark Active Active
Manager Return
Return
Return
Risk
Risk
ASM
15.00%
11.25%
8.50%
6.05% 4.40%
CKI
13.20%
14.25%
7.50%
4.68% 3.40%

DCM
12.75%
15.00%
10.00%
5.50% 4.00%
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Pugh proposes to construct a core-satellite portfolio with the following allocations: 45
percent in PMA, 15 percent in ASM, 20 percent in CKI and 20 percent in DCM. The
investment management committee for the pension plan has stated that it expects the
core-satellite portfolio to achieve a total active return of at least 2.1 percent and have total
active risk of no more than 1.8 percent. Pugh assumes that the managers’ active returns
are uncorrelated. Furthermore, since PMA follows a passive strategy, he assumes that
active return and active risk for PMA are 0 percent.

19. A characteristic of PMA Asset Management’s investment strategy is that it:
A. is more tax efficient.
B. has lower license fees.
C. has higher expenses due to fund level accounting.
Answer: A
“Equity Portfolio Management,” Gary L. Gastineau, Andrew R. Olma, and Robert
G. Zielinski
2009 Modular Level III, Volume 4, pp. 192-194
Study Session 11-33- e
Compare and contrast alternative methods for establishing passive exposure to an

equity market, including indexed separate or pooled accounts, index mutual
funds, exchange-traded funds, equity index futures, and equity total return swaps.
When a shareholder in a conventional mutual fund redeems shares, the fund sells
shares in the portfolio and pays cash to the shareholder. This transaction generates
a taxable event. In contrast, the redemption mechanism for ETF’s involves
payment “in kind”, i.e. redemption in the form of a basket of stocks. This
transaction is not taxable from the fund’s perspective.

20. The most appropriate technique for constructing PMA’s new portfolio is:
A. optimization.
B. full-replication.
C. stratified sampling.
Answer: C
“Equity Portfolio Management,” Gary L. Gastineau, Andrew R. Olma, and Robert
G. Zielinski
2009 Modular Level III, Volume 4, pp. 195-197
Study Session 11-33-f
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Compare and contrast full replication, stratified sampling, and optimization as
approaches to constructing an indexed portfolio and recommend an approach
when given a description of the investment vehicle and the index to be tracked.
The Russell 2000 small-cap value index contains a large proportion of illiquid
stocks. PMA also indicates that they assume that the factors used to explain stock
returns are uncorrelated. In such cases the best index construction method is

stratified sampling.

21. Relative to a long-only strategy, the expected alpha of ASM Partners’ investment
strategy is most likely:
A. half.
B. twice.
C. similar.
Answer: B
“Equity Portfolio Management,” Gary L. Gastineau, Andrew R. Olma, and Robert
G. Zielinski
2009 Modular Level III, Volume 4, pp. 222-223
Study Session 11-33-m
Compare and contrast long-short versus long-only investment strategies,
including their risks and potential alphas, and explain why greater pricing
inefficiency may exist on the short side of the market.
ASM Partners’ strategy is a market neutral long-short strategy. This strategy
generates two alphas, one from the long position and one from the short position.

22. Based on the information presented in Exhibit 1, CKI Financial Advisors most
likely follows a:
A. value strategy.
B. growth strategy.
C. market-oriented strategy.
Answer: A
“Equity Portfolio Management,” Gary L. Gastineau, Andrew R. Olma, and Robert
G. Zielinski
2009 Modular Level III, Volume 4, pp. 206-215
Study Session 11-33-i
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam

preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Compare and contrast techniques for identifying investment styles and
characterize the style of an investor when given a description of the investor’s
security selection method, details on the investor’s security holdings, or the
results of a returns-based style analysis.
The CKI portfolio has a dividend yield that exceeds the benchmark dividend
yield. The P/E and P/B for the portfolio are less than the benchmark P/E and P/B.
In addition, the forecast growth of the portfolio is under the forecast growth of the
benchmark. These factors indicate that CKI manages a value portfolio.

23. Based on the information in Exhibit 2, does the portfolio proposed by Pugh meet
the investment management committee’s stated thresholds of risk and return?
A. Yes.
B. No, portfolio active risk is above the threshold.
C. No, portfolio active return is below the threshold.
Answer: A
“Equity Portfolio Management,” Gary L. Gastineau, Andrew R. Olma, and Robert
G. Zielinski
2009 Modular Level III, Volume 4, pp. 231-235
Study Session 11-33-q
Discuss and justify, in a risk-return framework, the optimal portfolio allocations
to a group of investment managers.
Portfolio total active return = 2.67% = (0%×0.45) + (6.5%×0.15) + (5.7%×0.2) +
(2.75%×0.2)
Portfolio total active risk = 1.6% =[(0%2×0.) + (6.05%2×0.) + (4.68%2×0.) +
(5.5%2×0.)]1/2

24. Based on the information presented in Exhibit 2, the “true” active risk for ASM
Partners is closest to:
A. 1.65%.
B. 4.15%.
C. 6.05%.
Answer: B
“Equity Portfolio Management,” Gary L. Gastineau, Andrew R. Olma, and Robert
G. Zielinski
2009 Modular Level III, Volume 4, pp. 235-238
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Study Session 11-33-s
Distinguish among the components of total active return (“true” active return and
“misfit” active return) and their associated risk measures and explain their
relevance for evaluating a portfolio of managers.
True active risk = [6.05%2 – 4.4%2] 1/2 = 4.15%

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.

Questions 25 through 30 relate to Performance Attribution.

Malcolm O’Kelly Case Scenario
Malcolm O’Kelly is a performance evaluation consultant working for the Board of
Trustees of the Rutherford University (RU) Pension Fund. The Board has asked O’Kelly
to conduct a macro attribution analysis for the pension fund. O’Kelly gathered the data
shown in Exhibit 1 and Exhibit 2. The one-month return on a U.S. Treasury bill is 0.41
percent.
Exhibit 1
RU Pension Fund Investment Policy Allocations and Benchmark Assignments
Asset Category
Policy Allocations
Benchmark
Domestic equities
70%
S&P 500
Equity Manager A
60%
Large-cap Growth Index
Equity Manager B
40%
Large-cap Value Index
Domestic fixed income
30%
Lehman Govt./Credit Index
Fixed-income Manager C
65%
Lehman Int’l. Govt./Credit Index
Fixed-income Manager D
35%

Lehman Treasury Index
Exhibit 2
RU Pension Fund One-month Actual and Benchmark Returns
Asset Category
Actual Return Benchmark Return
Domestic equities
4.55%
4.46%
Equity Manager A
4.84%
4.61%
Equity Manager B
4.10%
4.31%
Domestic fixed income
2.32%
2.56%
Fixed-income Manager C
1.72%
1.99%
Fixed-income Manager D
3.43%
2.55%
Total Fund
3.90%
3.94%
The Board is considering adding Cottonwood Equity Advisors as their third domestic
equity manager. In their proposal to the Board, Cottonwood claims to generate positive
alpha by overweighting sectors that they expect will outperform the overall benchmark
portfolio. Cottonwood also attempts to enhance overall return by overweighting

securities their analysts have identified as undervalued. The Board asked O’Kelly to
perform a micro attribution analysis of Cottonwood’s equity portfolio. O’Kelly’s
analysis is shown in Exhibit 3.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


Exhibit 3
Micro Attribution Analysis for Cottonwood Equity Advisors Portfolio
Sector
Sector
Performance Attribution
Portfol Benchma Portfol Benchma
Pure
Allocatio Within
io
rk
io
rk Return Sector
n/
Sector
Economic
Weight
Weight
Return
(%)

Selecti Selection Selecti
Sectors
(%)
(%)
(%)
on
Interacti
on
on
Capital goods
8.7
9.3
–3.60
–3.95
0.030
–0.002
0.033
Consumer
nondurables
36.2
40.6
1.92
1.77
–0.029
–0.007
0.061
Energy
9.5
7.3
0.37

0.14
–0.021
0.005
0.017
Financial
23.8
24.3
2.92
2.05
–0.005
–0.004
0.211
Technology
20.5
18.5
2.00
1.30
0.004
0.014
0.130
Cash/equivale
1.3
0.0
0.14
–0.014
0.002
0.000
nts
Buy/hold +
100.0

100.0
1.52
1.10
–0.035
0.008
0.451
cash
–0.15
Trading &
other
Total
1.37
1.10
portfolio
The discussion then turns to fixed-income attribution analysis. Board member Carolyn
Tripp asks O’Kelly about the determinants of fixed-income portfolio returns. O’Kelly
responds that fixed-income portfolio returns can be attributed to an external interest rate
effect and the management effect. Then Tripp asks O’Kelly about analyzing the
management effect. O’Kelly responds that the management effect can be decomposed
into the following components:
• Interest rate management effect: indicates how well the manager predicts interest
rate changes. Each security must be priced as a default-free security. Then the
Treasury bill rate is added to the returns on the repriced securities to obtain the
interest rate management effect.
• Sector/quality effect: measures the manager’s ability to select outperforming
sectors and quality groups. The sector/quality return is estimated by repricing
each security in the portfolio using the average yield premium in its respective
category. A gross return can be then calculated based on this price. The return
from the sector/quality effect is calculated by subtracting the external effect and
the interest rate management effect from this gross return.

• Security selection effect: measures how the return on specific securities within a
sector relates to the average performance of the sector. The security selection
effect for each security is the total return for that security less all the other
components. The portfolio’s security selection effect is the arithmetic average of
all the individual security selection effects.
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.

Total
Valu
eAdde
d
0.061
0.025
0.001
0.202
0.147
–
0.012
0.424
–0.15

0.27


•

Trading activity: measures the effect of sales and purchases of securities and is
calculated as the total portfolio return less all the other components.

25. Based on a macro attribution analysis of the information given in Exhibits 1 and
2, the incremental return contribution attributed to the Asset Category investment
strategy is closest to:
A. –0.09%.
B. 3.48%.
C. 3.89%.
Answer: B
“Evaluating Portfolio Performance,” Jeffrey V. Bailey, CFA, Thomas M.
Richards, CFA, and David E. Tierney
2009 Modular Level III, Volume 6, pp. 144-146
Study Session 17-47-l
Demonstrate, justify, and contrast the use of macro and micro performance
attribution methodologies to evaluate the drivers of investment performance.
The incremental return attributed to the asset category investment strategy is
calculated as follows:
A

r

AC

= ∑ wi × (r Ci − r f )
i =1

Where is the incremental return contribution of the asset category investment
strategy, is the return on the ith asset category, is the risk-free return, is the
policy weight assigned to the ith asset category, and A is the number of asset

categories. In this case, the incremental return attributed to the asset category
investment strategy is:
= 0.7 × (4.46 – 0.41) + 0.3 × (2.56 – 0.41) = 3.48%
where 0.41% is the monthly risk-free rate. See Equation 47-10 (p.145)

26. Based on a macro attribution analysis of the information given in Exhibits 1 and
2, the incremental return contribution attributed to misfit return (i.e., style bias) is
closest to:
A. –0.09%.
B. 0.08%.
C. 0.32%.
Answer: A
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


“Evaluating Portfolio Performance,” Jeffrey V. Bailey, CFA, Thomas M.
Richards, CFA, and David E. Tierney
2009 Modular Level III, Volume 6, pp. 146-147
Study Session 17-47-l
Demonstrate, justify, and contrast the use of macro and micro performance
attribution methodologies to evaluate the drivers of investment performance.
The aggregate manager benchmark or misfit return is calculated as follows:
A

r

IS

=∑
i =1

M

∑w ×w
j =1

i

ij

× (r Bij − r Ci )

Where is the incremental return contribution of the Benchmarks strategy, is the
return of the jth manager’s benchmark in asset category i, is the return on the ith
asset category, is the policy weight assigned to the ith asset category, is the
policy weight assigned to the jth manager in asset category i, and A and M are the
number of asset categories and managers, respectively. The misfit return is –
0.09% calculated as follows:
= 0.7 × 0.6 × (4.61 – 4.46) + 0.7 × 0.4 × (4.31 – 4.46) + 0.3 × 0.65 ×
(1.99 – 2.56) + 0.3 × 0.35 × (2.55 – 2.56) = –0.09%
See Equation 47-11 (p.146)

27. Based on a macro attribution analysis of the information given in Exhibits 1 and
2, the incremental return contribution attributed to the investment managers is
closest to:
A. –0.09%.

B. 0.08%.
C. 0.49%.
Answer: B
“Evaluating Portfolio Performance,” Jeffrey V. Bailey, CFA, Thomas M.
Richards, CFA, and David E. Tierney
2009 Modular Level III, Volume 6, pp. 147-148
Study Session 17-47-l
Demonstrate, justify, and contrast the use of macro and micro performance
attribution methodologies to evaluate the drivers of investment performance.
The incremental return contribution of the investment manager is calculated as
follows:
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.


A

r

IM

=∑
i =1

M

∑ w × w × (r

j =1

i

ij

Aij

− r Bij )

Where is the incremental return contribution of the investment managers, is the
return on the jth manager’s portfolio within asset category i, is the return of the
jth manager’s benchmark in asset category i, is the policy weight assigned to the
ith asset category, is the policy weight assigned to the jth manager in asset
category i, and A and M are the number of asset categories and managers,
respectively. In this case, return attributable to the investment managers is 0.08%
calculated as follows:
= 0.7 × 0.6 × (4.84 – 4.61) + 0.7 × 0.4 × (4.10 – 4.31) + 0.3 × 0.65 ×
(1.72 – 1.99) + 0.3 × 0.35 × (3.43 – 2.55) = 0.0775% ≈ 0.08%
See Equation 47-12 (p.147)

28. Based on the micro attribution analysis presented in Exhibit 3, which part or parts
of Cottonwood’s strategy most likely succeeded?
A. Sector selection.
B. Securities selection.
C. Neither securities nor sector selection.
Answer: B
“Evaluating Portfolio Performance,” Jeffrey V. Bailey, CFA, Thomas M.
Richards, CFA, and David E. Tierney
2009 Modular Level III, Volume 6, pp. 150-154

Study Session 17-47-l
Demonstrate, justify, and contrast the use of macro and micro performance
attribution methodologies to evaluate the drivers of investment performance.
The Pure Sector Allocation column total of –0.035 indicates that Cottonwood was
not successful during the period in regard to its sector selection strategy. If that
strategy were successful, the column total would have been positive and large
relative to the portfolio’s Total Value Added. However, Cottonwood was
successful in selecting securities within sectors as evidenced by the Within Sector
Allocation total of 0.451. This was the driver of the portfolio’s Total Value
Added before expenses of 0.424.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to
currently-registered CFA candidates. Candidates may view and print the exam for personal exam
preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal
action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying,
posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose.