CFA 2018 level 3 schweser practice exam CFA 2018 level 3 question bank 28 a

CFA LEVELIII, PRACTICE SOLUTIONS (LOS # 27)
Question 1 - #91779
Your answer: A was correct!
Since the asset manager cannot know the future value of the equity position, it is impossible to perfectly
hedge the position with only currency contracts.
This question tested from Session 15, Reading 27, LOS g.
Question 2 - #91447
Your answer: B was correct!
The manager would want to short the forward contracts to hedge depreciation of the foreign currency.
To prevent hedging too much, over-hedging, the manager would hedge an amount less than the equity
position because that position may decline in value from the equity risk.
This question tested from Session 15, Reading 27, LOS g.
Question 3 - #92301
Your answer: B was correct!
Number of contracts = -16 = (0 − beta) × (16 × futures price) / (beta × futures price)
This question tested from Session 15, Reading 27, LOS a.
Question 4 - #91799
Your answer: B was incorrect. The correct answer was A) “long” the currency and should short the
forward contract on the foreign currency.
In hedging foreign exchange risk, anticipating a receipt (payment) of a currency is like being long (short)
the currency. To hedge the associated risk, a manager should take the opposite position in the forward
contract.
This question tested from Session 15, Reading 27, LOS f.
Question 5 - #91565
Your answer: B was correct!
NOTE – on the exam, it is very likely for material on tactical asset allocation to be tested in conjunction
with material from derivatives as tactical asset allocation can be accomplished by selling assets, or with
a derivative overlay. Stuart should disagree with both of Swemba’s statements. Although Stuart’s goal of
reducing the duration could be accomplished by selling bonds in the portfolio, doing so would likely
incur significant transaction costs. Also, since the duration of each bond in the portfolio is likely
different, specific bonds would have to be selected in order to accomplish Stuart’s goal, making the

process more difficult. A derivative overlay, accomplished by using futures contracts, would be much
easier and cost effective. Swemba is also incorrect with respect to the number of futures contracts that
would need to be sold. The correct number of futures contracts to be sold is: (1.0)[(2.2 – 4.4) /
8.2]($12,000,000 / $102,000) = -31.56 ≈ -32 futures contracts. The minus sign means that 32 contracts
should be sold to achieve the desired duration in the portfolio.
This question tested from Session 15, Reading 27, LOS d.
Question 6 - #91570
Your answer: B was incorrect. The correct answer was A) the risk free rate is not zero.
The risk free rate does not enter into the formulas for determining the strategy for synthetically adjusting
a stock/bond portfolio. Although the risk free rate may play a role in some futures strategies to
synthetically adjust a portfolio, the effectiveness of the strategy would not depend upon its value.
This question tested from Session 15, Reading 27, LOS d.
Question 7 - #92351
Your answer: B was incorrect. The correct answer was C) Short 69 contracts.
Number of contracts = -69.26 = (0.5 − 0.9) × ($20,000,000) / (1.1 × $105,000), and this rounds down to
69 (absolute value). Since the goal is to decrease beta, the manager should go short which is also
indicated by the negative sign.
This question tested from Session 15, Reading 27, LOS a.
Question 8 - #92304
Your answer: B was incorrect. The correct answer was A) 564.

The negative sign indicates the need to take a short position.


This question tested from Session 15, Reading 27, LOS c.
Question 9 - #92225
Your answer: B was incorrect. The correct answer was C) called pre-investing.
This is the definition of pre-investing using futures contracts, and it is not illegal.
This question tested from Session 15, Reading 27, LOS e.
Question 10 - #92404

Your answer: B was correct!
Futures + Cash = Security, therefore, buy the corresponding futures contract and invest in a T-bill.
This question tested from Session 15, Reading 27, LOS b.
Question 11 - #91569
Your answer: B was correct!
This should be obvious because a decline in the equity position is bad and the short position in a forward
currency contract hurts when the foreign currency appreciates. If the equity position falls short of the
contracted amount, in addition to the loss from the decline in asset prices, then the manager will suffer a
loss equal to the difference in the hedged amount and the actual equity value times the difference in the
spot and contracted forward rate.
This question tested from Session 15, Reading 27, LOS g.
Question 12 - #91762
Your answer: B was correct!
The exchange-rate dimension generally adds risk. The two hedging strategies utilized by global portfolio
managers to manage the risk of a foreign-denominated portfolio involve selling forward contracts on the
foreign market index (to manage market risk) and selling forward contracts on the foreign currency (to
manage the currency risk). They can choose to hedge one or the other, both, or neither.
This question tested from Session 15, Reading 27, LOS g.
Question 13 - #91571
Your answer: B was incorrect. The correct answer was C) both equity risk and foreign exchange risk.
The position will have both equity and foreign exchange risk. This makes the position, in isolation, more
risky than a domestic equity portfolio.
This question tested from Session 15, Reading 27, LOS g.
Question 14 - #93166
Your answer: C was incorrect. The correct answer was B) Sell 176.
First determine the new target beta by multiplying the current beta of the portfolio which is 1.23 by .7 to
achieve a new target beta that is 30% less than the current portfolio beta:
(1.23)(.7) = 0.861
Then use the equation: [(BetaT - Betap)/Betaf][Vp/(Pf x multiplier)]
[(0.861-1.23)/1](150,000,000)/(1260)(250) = (-.369)(476.19) = -175.71, rounded to -176.

This question tested from Session 15, Reading 27, LOS a.
Question 15 - #91672
Your answer: B was incorrect. The correct answer was C) Buy 804 contracts.
The number of futures contracts required to double the portfolio beta is computed as follows:
Number of contracts = [(target beta - portfolio beta)/futures beta] x (Portfolio value / Futures contract
value) = [(2.4 - 1.2) / 1] x [$100 million / (596.90 × $250)] = 804 contracts
To double the portfolio beta we buy 804 contracts.
This question tested from Session 15, Reading 27, LOS a.
Question 16 - #91573
Your answer: B was correct!
This move will accomplish the goal by reducing the exposure to equity and increasing the exposure to
bonds.
This question tested from Session 15, Reading 27, LOS d.
Question 17 - #92002
Your answer: B was incorrect. The correct answer was A) Transaction exposure.
The three types of exchange-rate risk are transaction exposure, economic exposure, and translation
exposure. Futures are most often used to hedge transaction exposure, which is the risk that exchange
rates will change the real value (in the domestic currency) of the contracted price.


This question tested from Session 15, Reading 27, LOS f.
Question 18 - #92054
Your answer: B was correct!
Expecting to make a payment is like being short the currency. The firm would want to take a long
forward position. If the currency appreciates and there is no hedge, the firm would pay more. With the
hedge, the overall cost in domestic currency is locked in (cost increases will be offset by gains on the
forward contract). Of course, the forward contract will result in a loss if the foreign currency actually
depreciates, but this will be offset by a decrease in the cost of the underlying transaction.
This question tested from Session 15, Reading 27, LOS f.
Question 19 - #92286

Your answer: B was correct!
The number of futures contracts required for the 100% risk-minimizing hedge (or to reduce the beta to
zero) is computed as follows:
Number of contracts = Portfolio value / Futures contract value × beta
$80 million / (596.70 × $250) × 1.1 = 590 contracts
Therefore, to reduce the by 50% we simply use half this number of contracts or 295 contracts.
This question tested from Session 15, Reading 27, LOS a.
Question 20 - #92801
Your answer: B was incorrect. The correct answer was A) 673 contracts.
Number of contracts = 673.3 = $175,000,000 × (1.02)0.5/(1050 × 250)
This question tested from Session 15, Reading 27, LOS b.
Question 21 - #92428
Your answer: C was incorrect. The correct answer was B) To synthetically create the risk/return profile
of an underlying common equity security, buy the corresponding futures contract, sell the common short,
and invest in a T-bill.
To synthetically create the risk/return profile of an underlying common equity security, buy the
corresponding futures contract and invest in a T-bill.
This question tested from Session 15, Reading 27, LOS b.
Question 22 - #92525
Your answer: B was incorrect. The correct answer was C) Long 7 contracts.
Number of contracts = 6.80 = (1.1 − 0.9) × ($10,000,000) / (1.2 × $245,000), and this rounds up to
seven. Since the goal is to increase beta, the manager should go long.
This question tested from Session 15, Reading 27, LOS a.
Question 23 - #91572
Your answer: B was incorrect. The correct answer was C) both currency forwards and equity futures.
Forwards are most often used for currency risk and futures are most often used for equity risk. The
manager would have to use both contracts to completely hedge all the risk.
This question tested from Session 15, Reading 27, LOS g.
Question 24 - #91999
Your answer: B was correct!

Economic exposure is the loss of sales that a domestic exporter might experience if the domestic
currency appreciates relative to a foreign currency. That is, if the euro/dollar exchange rate increases, a
U.S. exporter to Europe would see a fall in revenue as the European buyers purchase fewer U.S. exports
that have effectively increased in price from the dollar appreciation.
This question tested from Session 15, Reading 27, LOS f.
Question 25 - #92172
Your answer: B was incorrect. The correct answer was A) long position in 22 of the stock futures and 25
of the bond futures.
The goal is to create a $7 million equity position with a beta of 0.8 and a $3 million bond position with a
duration of 5:
number of stock futures = 21.8 = (0.8 − 0) × ($7,000,000) / (1.1 × $233,450)
number of bond futures = 25.13 = (5 − 0) × ($3,000,000) / (6 × $99,500)
The manager should take a long position in 22 of the stock index futures and 25 of the bond index
futures.


This question tested from Session 15, Reading 27, LOS e.
Question 26 - #91683
Your answer: B was incorrect. The correct answer was A) Short 85 bond futures and go long 33 stock
index futures.
Since the manager wishes to increase the equity position and decrease the bond position by $10 million
(10% of $100 million), the correct strategy is to take a short position in the bond futures and a long
position in the stock index futures:
number of bond futures = -85.03 = [(0 − 5) / 6]($10,000,000 / $98,000)
number of stock futures = 32.82 = [(1 − 0) / 1.1]($10,000,000 / $277,000)
This question tested from Session 15, Reading 27, LOS d.
Question 27 - #92463
Your answer: B was correct!
The position created by risk-minimizing hedging is essentially the creation of a synthetic T-Bill. The
number of futures contracts required for the risk-minimizing hedge is computed as follows:

Number of contracts = Portfolio value / Futures contract value × beta
$100 million / (596.70 × $250) × 1.1 = 737 contracts
Therefore, the investor has to sell 737 S&P 500 futures contracts short.
This question tested from Session 15, Reading 27, LOS b.
Question 28 - #92057
Your answer: B was incorrect. The correct answer was A) $10,800,000.
On the day the order comes in, the firm effectively has a long position in pounds; therefore, it should
take a short position in a forward contract. This contract would obligate the firm to deliver the pounds
that it will receive for dollars. The contract would be to exchange ₤8 million for:
$10,800,000 = (₤8,000,000) × $1.35/₤.
This question tested from Session 15, Reading 27, LOS f.
Question 29 - #92033
Your answer: B was correct!
Translation exposure refers to the fact that multinational corporations might see a decline in the value of
their assets that are denominated in foreign currencies when those foreign currencies depreciate. When
the consolidated balance sheet is composed, changing exchange rates will introduce variation in account
values from year to year.
This question tested from Session 15, Reading 27, LOS f.
Question 30 - #92440
Your answer: B was correct!
Payoff of futures plus T-bill = 886 × $250 × (1,120 − 1,100) + $240,000,000 × 1.03 0.25
Payoff of futures plus T-bill = $246,210,097
This question tested from Session 15, Reading 27, LOS b.
Question 31 - #91845
Your answer: B was incorrect. The correct answer was A) Buy 218 contracts.
In order to be hedged against stock price increases, S&P 500 futures contracts have to be purchased. The
quantity of contracts to buy is computed as follows:
# contracts = (beta)(Portfolio value) ÷ (futures price)(contract multiplier)
= (1)(60,000,000) ÷ (1100)(250) @ 218.18 = 218 contracts
This question tested from Session 15, Reading 27, LOS d.

Question 32 - #92361
Your answer: B was incorrect. The correct answer was C) take a short position in 152 contracts.

The negative sign indicates the need to take a short position.
This question tested from Session 15, Reading 27, LOS c.
Question 33 - #92382
Your answer: B was correct!
The trader can buy stock index futures and hold them in conjunction with T-Bills to mimic a stock
portfolio. So we have:


Synthetic stock portfolio = T-Bills + stock index futures.
This question tested from Session 15, Reading 27, LOS b.
Question 34 - #91834
Part 1)
Your answer: B was correct!
The loss of sales that a domestic exporter might experience if the domestic currency appreciates relative
to the foreign currency is economic exposure. The risk that contracted future cash flows become less
valuable in terms of the domestic currency or that planned purchases become more expensive is known
as transaction exposure. Derivatives are primarily used to hedge transaction exposure. (Study Session
15, LOS 36.f)
This question tested from Session 15, Reading 27, LOS f.
Part 2)
Your answer: B was incorrect. The correct answer was A) sell 15 million in exchange for $18.75 million.
The day the freight cars are sold, Jackson is effectively long Euros so the optimal solution is to sell the
Euro forward contract in exchange for $18,750,000 (15,000,000 / $0.80). If the company did not hedge,
two months from now the sale would net only $16,666,667 (15,000,000 / $0.90). (Study Session 15,
LOS 36.f)
This question tested from Session 15, Reading 27, LOS f.
Part 3)

Your answer: B was correct!
Jackson wants to “lock in” the price of $6,390,977 (8,500,000 / $1.33) for the Canadian steel now by
buying Canadian dollars with a forward contract. (Study Session 15, LOS 36.f)
This question tested from Session 15, Reading 27, LOS f.
Part 4)
Your answer: B was correct!
Being long the currency means holding or expecting to receive a foreign currency, therefore to hedge
this foreign currency exposure you must sell forward contracts (deliver foreign currency and receive
domestic currency at the expiration of the contract).
Being short the currency indicates either an expectation to pay the foreign currency or the future
obligation to deliver foreign currency which has already been sold. To hedge this foreign currency
exposure it is necessary to buy forward contracts (deliver home currency and receive foreign currency at
the expiration of the contract). (Study Session 15, LOS 36.g)
This question tested from Session 15, Reading 27, LOS f.
Part 5)
Your answer: B was incorrect. The correct answer was C) Statement 2.
Futures contracts trade on an exchange so they are required to be more regulated than forward contracts,
and thus have lower default risk. (Study Session 15, 36.a)
This question tested from Session 15, Reading 27, LOS f.
Part 6)
Your answer: B was incorrect. The correct answer was A) the manager gets a leverage effect with
futures because the only required “investment” is the margin deposit.
The point of a hedge is not to leverage a position. If the investor is speculating, or even if they are preinvesting or turning cash into synthetic equity or debt, there may be a leverage advantage to futures
rather than buying the underlying. However, with respect to hedging, leverage is not the desired
outcome. The main advantages to using futures and forwards rather than adjusting the underlying
security positions are cost, less disruption, and greater liquidity. (Study Session 15, LOS 36.g)
This question tested from Session 15, Reading 27, LOS f.
Question 35 - #91936
Your answer: B was correct!
We should recall our formula for altering beta,

number of contracts = ({target beta − Bportfolio} × V) / (Bfutures × futures price)
In this case, for the first step where we convert the mid-cap position to cash, V=$15 million, and the
target beta is 0. The current beta is 1.0, and the futures beta is 1.05:
-54.95 = (0 − 1) × ($15,000,000) / (1.05 × $260,000)
The manager should short 55 of the futures on the mid-cap index. Then the manager should take a long
position in the following number of contracts on the small-cap index:
72.00 = (1.6 − 0) × ($15,000,000) / (1.5 × $222,222)


Thus, the manager should take a long position in 72 of the contracts on the small-cap index.
This question tested from Session 15, Reading 27, LOS e.
Question 36 - #92159
Your answer: B was incorrect. The correct answer was A) go long both stock and bond futures.
Since the original portfolio is long in both stocks and bonds, the manager will go long both stock and
bond futures contracts.
This question tested from Session 15, Reading 27, LOS e.
Question 37 - #92559
Your answer: B was correct!
First determine the new target beta by multiplying the current beta of the portfolio which is .95 by 1.4 to
achieve a new target beta that is 40% greater than the current portfolio beta:
(.95)(1.4) = 1.33
Then use the equation: [(BetaT - Betap)/Betaf][Vp/(Pf x multiplier)]
[(1.33-.95)/1](78,000,000)/(856)(250) = (.38)(364.49) = 138.50, rounded to 139.
This question tested from Session 15, Reading 27, LOS a.
Question 38 - #93144
Part 1)
Your answer: B was incorrect. The correct answer was C) $21,710, with Kaufman paying the bank the
settlement.
= 20,000,000 × [(0.0485 – 0.05) × (270 / 360)] / [1 + ((0.0485)(270 /
Settlement payment

360)]
= 20,000,000 × (-0.001125 / 1.036375) = $21,710.29
Since the realized rate at the time of the loan, 4.85%, is lower than the contract rate of 5%, Kaufman
would want to pay to get out of the FRA so that he can borrow at the prevailing lower rate. (Study
Session 14, LOS 34.i)
This question tested from Session 15, Reading 27, LOS a.
Part 2)
Your answer: B was correct!
In this case use the modified duration of the bond portfolio, 6.3 to find the value of the portfolio given a
25 basis point increase in rates:
New value = $40,000,000 × (1 - (6.3 × 0.0025)) = $39,370,000 (Study Session 9, LOS 23.g)
This question tested from Session 15, Reading 27, LOS a.
Part 3)
Your answer: B was correct!
Contracts = (Yield Beta) [(MDTarget – MDP) / MDF][VP / (Pf(Multiplier))]
Contracts = 1.1 × [(5 – 6.3) / 4.2] × ($40,000,000 / $245,000) = -55.59
To reduce the duration of the portfolio, take a short position in the futures contract. Note that we must
round the number of contracts up to 56 since partial contracts cannot be traded. (Study Session 15, LOS
36.d)
This question tested from Session 15, Reading 27, LOS a.
Part 4)
Your answer: B was correct!
Number of Contracts = (Target Beta – Portfolio Beta / Beta on Futures) × (Value of the portfolio / Price
of the futures × the multiplier).
Number of Contracts = [(1.4 – 1.25) / 0.90] × ($60,000,000 / $335,000) = 29.85 contracts.
The positive sign indicates that we should take a long position in the futures to “leverage up” the
position. If that is Kaufman’s goal, he must be expecting an increase in the market. (Study Session 15,
LOS 36.a)
This question tested from Session 15, Reading 27, LOS a.
Part 5)

Your answer: B was incorrect. The correct answer was C) Sell approximately 121 contracts.
[$60,000,000 × (1.02)0.50] / (2000 × $250) = 121.19 contracts
Kaufman would need to sell the contracts to create the synthetic cash (zero equity) position. If he were
converting cash to a synthetic equity position, he would of course buy contracts. (Study Session 15, LOS
36.c)
This question tested from Session 15, Reading 27, LOS a.


Part 6)
Your answer: B was incorrect. The correct answer was C) buy 22 bond futures contracts and buy 13
stock futures contracts.
Take the existing portfolio weights, 40% debt and 60% equity and apply them to the new money that is
coming in. Also, “mirror” the duration and beta of the original portfolios.
Number of bond futures = 1.05 × [(6.3 - 0) / 6.2] × [(6,000,000 × 0.40) / 115,460] = 22.18 contracts
Number of stock futures = [(1.25 – 0) / 1.10] × [(6,000,000 × 0.60) / 315,650] = 12.96
Kaufman Co. would take a long position in both the stock index and bond futures contracts because it is
synthetically creating an existing portfolio until the actual $6 million is received and can be invested.
(Study Session 15, LOS 36.e)
This question tested from Session 15, Reading 27, LOS a.
Question 39 - #92256
Your answer: B was incorrect. The correct answer was C) 69.

The negative sign indicates the need to take a short position.
This question tested from Session 15, Reading 27, LOS c.
Question 40 - #92389
Your answer: B was incorrect. The correct answer was A) the fewer the number of needed contracts.
The formula is:
Number of contractsUnrounded = (V × (1 + risk free rate)T) / (futures price × multiplier)
As the multiplier increases, the number of needed contracts declines.
This question tested from Session 15, Reading 27, LOS b.

Question 41 - #92423
Your answer: B was correct!
Security – Futures = Cash, therefore, buy the common equity and sell short the corresponding futures
contract.
This question tested from Session 15, Reading 27, LOS b.
Question 42 - #91460
Your answer: B was incorrect. The correct answer was C) long position in 5 contracts.
We should recall our formula for altering beta,
number of contracts = ({target beta − Bportfolio} × V) / (Bfutures × futures price)
the provided information gives:
number of contracts = 5 = 0.5 × 10 × (futures price) / (1 × futures price).
This question tested from Session 15, Reading 27, LOS e.
Question 43 - #93174
Your answer: B was incorrect. The correct answer was C) Buy 175 equity futures contracts.
NOTE – on the exam, it is very likely for material on tactical asset allocation to be tested in conjunction
with material from derivatives as tactical asset allocation can be accomplished by selling assets, or with
a derivative overlay. Because Corser wants to increase the beta of his portfolio, he should buy futures
contracts. The appropriate number of contracts to buy is calculated as:
[(1.25 − 0.85) / 1.03] × ($140,000,000 / $310,000) = 175.38 ≈ 175 contracts.
This question tested from Session 15, Reading 27, LOS a.