Level III 2018 IFT mock exams sample

2018 Level III Mocks

2018 CFA® Exam Prep
IFT Mock Exams
Level III

Document Version: 1.5
Publish Date: May 13, 2018
Errata information can be found at: />This document should be used in conjunction with the corresponding reading in the 2018
Level III CFA® Program curriculum. Some of the graphs, charts, tables, examples, and figures
are copyright 2017, CFA Institute. Reproduced and republished with permission from CFA
Institute. All rights reserved.
Required disclaimer: CFA Institute does not endorse, promote, or warrant the accuracy or
quality of the products or services offered by IFT. CFA Institute, CFA®, and Chartered
Financial Analyst® are trademarks owned by CFA Institute.

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2018 Level III Mocks

Table of Contents
Exam 1 Morning Session .................................................................................................................................... 3
Exam 1 Afternoon Session .............................................................................................................................. 60
Exam 2 Morning Session .................................................................................................................................. 88
Exam 2 Afternoon Session ........................................................................................................................... 140
Exam 3 Morning Session ............................................................................................................................... 165
Exam 3 Afternoon Session ........................................................................................................................... 205
Exam 1 Morning Session Solutions ........................................................................................................... 228

Exam 1 Afternoon Session Solutions ....................................................................................................... 262
Exam 2 Morning Session Solutions ........................................................................................................... 276
Exam 2 Afternoon Session Solutions ....................................................................................................... 302
Exam 3 Morning Session Solutions ........................................................................................................... 314
Exam 3 Afternoon Session Solutions ....................................................................................................... 336

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2018 Level III Mocks

Exam 1 Morning Session

Exam 1 Morning Session
Questions

Topic

Minutes

1

Portfolio Management – Behavioral

10

2

Portfolio Management – Individual

25

3

Portfolio Management – Individual

15

4

Portfolio Management – Institutional

17

5

Portfolio Management – Institutional

18

6

Portfolio Management – Individual

18

7

Portfolio Management – Economics

15

8

Portfolio Management – Fixed Income

14

9

Portfolio Management – Equity

17

10

Portfolio Management – Risk Management

12

11

Portfolio Management – Trading, Monitoring, and
Rebalancing

19
Total: 180

Start time: 9:00 AM
End time:

12:00 PM

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2018 Level III Mocks

Exam 1 Morning Session

QUESTION 1 HAS THREE PARTS (A, B, & C) FOR A TOTAL OF 10 MINUTES.
An advisor for Freans Capital Management is working with a new client, Tom Braidwood.
Prior to meeting with him, the advisor asks Braidwood a series of diagnostic questions to
determine whether he may have any of the following investment behavioral biases:
• Loss aversion
• Endowment
• Regret aversion
• Illusion of control
• Overconfidence
• Framing
Sample diagnostic questions are shown in Exhibit 1.
Exhibit 1
Freans Capital Management
Sample Diagnostic Questions
1. If you are offered two free lottery tickets, would you select your own numbers or
have a machine do it?

2. At what price are you willing to sell off your investment holdings that you received as
inheritance?
3. How do you generally attribute the success of your decisions?

A. Identify the behavioral bias that each diagnostic question in Exhibit 1 is most likely to
reveal.
Note: Each diagnostic question is designed to reveal a different bias.
ANSWER QUESTION 1-A IN THE TEMPLATE PROVIDED.
(3 Minutes)
Tom Braidwood informs his advisor that he has always been willing to take a small chance of
losing up to 7 percent of the portfolio annually. He says that he can accept any asset classes
to meet his financial goals if the following constraint is considered.
“Expected return – 1.645 × Expected standard deviation ≥ –7%.”
After listening to him, the advisor concludes that he is actually striving for a mean- variance
efficient portfolio.

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2018 Level III Mocks

Exam 1 Morning Session

Braidwood tells the advisor that his previous Wealth Advisor, Andy, made following
statements to him.
Statement 1: It is always recommended to know the historical performance of the CEO of
the company before investing in a company. Based on this belief, you should own shares of
Frio Industries as Frio’s CEO used to run APCO’s operations and he did a wonderful job

there.
Statement 2: Global Equity Funds have increased 1.5 – 2.0 times the historical average over
the past two years. Based on this information, I expect global equity funds to face a reversal
in near future. As a result, it is preferred to reallocate funds from equities to fixed-rate
portfolio assets.
B. Comment on the conclusion made by the Advisor regarding Braidwood’s portfolio
preference.
(2 Minutes)

C. Select the behavioral finance concept (availability, confirmation, framing, gambler’s
fallacy, representativeness, overconfidence, hot hand fallacy) best exhibited in each of
Andy’s two statements. Justify your response with one reason.
ANSWER QUESTION 1-C IN THE TEMPLATE PROVIDED.
(5 Minutes)

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2018 Level III Mocks

Exam 1 Morning Session

Answer Question 1 on This Page
1-A. Identify the behavioral bias that each diagnostic question in Exhibit 1 is most likely to
reveal.
Note: Each diagnostic question is designed to reveal a different bias.
Diagnostic Question

Identify the behavioral bias that each
diagnostic question in Exhibit 1 is most
likely to reveal.
(circle one)

1. If you are offered two free lottery
tickets. You may either select your own
numbers or have a machine do it. What
would you do?

2. How would you describe your
emotional attachment to possessions or
investment holdings?

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ã

Loss aversion

ã

Endowment

ã

Regret aversion

ã

Illusion of control

•

Overconfidence

•

Framing

•

Loss aversion

•

Endowment

•

Regret aversion

•

Illusion of control

•

Overconfidence

•

Framing


2018 Level III Mocks

Exam 1 Morning Session

3. How do you generally attribute the
success of your decisions?

•

Loss aversion

•

Endowment

•

Regret aversion

•

Illusion of control

•

Overconfidence

•

Framing

1-B. Comment on the conclusion made by the Advisor regarding Braidwood’s portfolio
preference.

1-C. Select the behavioral finance concept (availability, confirmation, framing, gambler’s
fallacy, representativeness, overconfidence, hot hand fallacy) best exhibited in each of Andy’s
two statements. Justify your response with one reason.
Andy’s statement

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Select the behavioral
finance concept best
exhibited in each of
Advisor’s two
statements.
Note: No behavioral finance
concept can be used more than
once.
(circle one)
7

Justification

2018 Level III Mocks

Exam 1 Morning Session

1. It is always recommended
to know the historical
track record of the CEO of
the company before
investing in a company.
Based on this belief, you
should own shares of Frio
Industries as Frio’s CEO
was previously in charge
of APCO’s operations
where he did a wonderful
job.

2. Global Equity Funds have
increased 1.5 – 2.0 times
the historical average
over the past two years.
Based on this
information, I expect
global equity funds to face
a reversal in near future.
As a result, it is preferred
to reallocate funds from
equities to fixed-rate

portfolio assets.

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ã

Availability

ã

Confirmation

ã

Framing

ã

Gamblers fallacy

ã

Representativeness

ã

Overconfidence

ã

Hot hand fallacy

ã

Availability

ã

Confirmation

ã

Framing

ã

Gamblers fallacy

ã

Representativeness

ã

Overconfidence

ã

Hot hand fallacy

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2018 Level III Mocks

Exam 1 Morning Session

QUESTION 2 HAS FOUR PARTS (A, B, C, & D) FOR A TOTAL OF 25 MINUTES.
Robert and Mary Puentes are meeting with John Mesa, CFA, their long-time advisor, to
discuss financial planning issues. Robert and Mary Puentes, both age 50, live in U.S. Robert is
retired. He ran an advertising company which he recently sold off. The Puentes will rely on
their investment portfolio to meet future expenses in excess of Robert’s retirement income.
Mary is not employed. Puentes will receive retirement payments of USD 110,000 per year for
his lifetime from the business he sold. The retirement payments are not indexed for future
inflation and are fully taxable as ordinary income.
The Puentes’ total living expenses last year were USD 200,000, and they are expected to
grow each year at the inflation rate. The tax rate on ordinary income and all investment
returns is 30%. The inflation rate is expected to be 3% per year.
The Puentes live in a house with a market value of USD 1,250,000, mortgage-free. They have
a taxable investment portfolio with a current market value of USD 5,500,000. The Puentes’
plan to purchase a second home worth approximately USD 1,150,000 to be used for holidays,
in around five years’ time.
Their goals are to grow the asset base of the portfolio over time to maintain its after-tax
purchasing power and to establish and maintain a cash reserve of USD 200,000. Upon his
death, Robert wishes to provide for his wife, but intends to donate the majority of his assets
to charity.
John has gathered following information about the Puentes to determine their personality
types i.e. cautious, methodical, spontaneous, or individualist.
A summary of this information is presented below.
• Robert often reads the CEO’s statement about the company in annual reports while

analyzing stocks rather than doing a detailed analysis.
• Robert prefers riskier stocks, and sometimes trades excessively so as not to miss an
investment trend.
• Mary is less concerned with market sentiment or analysts’ recommendations of stocks.
• Mary’s investment decisions are made based on detailed analysis and investment
research.
• Mary follows a very disciplined approach to stock selection and she is always on the
quest for new information.
The Puentes live in a community property regime. The community property regime entitles
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2018 Level III Mocks

Exam 1 Morning Session

a surviving spouse to receive one-half of the community property after the first spouse’s
death. Only 15% of Robert’s assets are community property. Exhibit 1 summarizes gift and
inheritance tax rates applicable to the Puentes Family.
Exhibit 1
Gift and Inheritance Tax Rates
Tax Type

Tax Rate

Spousal inheritance tax

25%

Spousal gift tax

30%

Non-spousal inheritance tax

50%

Non-spousal gift tax

30%

Note: All taxes are due immediately at the time of the transfer and are paid for by the
recipient.
Robert feels that Mary’s legal entitlement under the community property rules will not be
sufficient to meet her financial needs. John estimates that if Robert were to die today, Mary
would need to inherit USD 750,000 net of any taxes to meet her needs.
A. Determine the Puentes’ nominal after-tax required rate of return for the coming year.
Show your calculations.
(10 minutes)
B. Characterize the Puentes’ as below-average, average, or above-average in their ability to
take risk. Justify your response with two reasons based on the Puentes’ specific
circumstances.
ANSWER QUESTION 2-B IN THE TEMPLATE PROVIDED.
(6 minutes)
C. Select the investor personality type for:
i. Robert
ii. Mary
Justify each selection with one fact from the information about the Puentes’ provided in

vignette.
ANSWER QUESTION 2-C IN THE TEMPLATE PROVIDED.
(4 minutes)

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2018 Level III Mocks

Exam 1 Morning Session

D. Calculate the minimum bequest (in USD) from Robert’s estate to Mary in order to meet
her spending needs and taxes. Show your calculations.
(5 minutes)

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2018 Level III Mocks

Exam 1 Morning Session

Answer Question 2 on This Page
2-A. Determine the Puentes’ nominal after-tax required rate of return for the coming year.
Show your calculations.

2-B. Characterize the Puentes’ as below-average, average, or above-average in their ability
to take risk. Justify your response with two reasons based on the Puentes’ specific
circumstances.
Characterize the
Puentes as below average,
average, or
above-average in
their ability to take
risk.
(circle one)

Justify your response with two reasons
based on the Puentes’ specific
circumstances.

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2018 Level III Mocks

Exam 1 Morning Session

Below-average

Average

Above-average
2-C. Select the investor personality type for:

i. Robert
ii. Mary
Justify each selection with one fact from the information about the Puentes’ provided in
vignette.
Justify each selection with
one fact from the
Select the investor
information
personality type for i. Robert and ii. Mary.
about the Puentes’
(circle one for each)
presented in vignette.
Cautious
i. Robert

Methodical
Spontaneous
Individualist

Cautious
Methodical
ii. Mary
Spontaneous
Individualist

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2018 Level III Mocks

Exam 1 Morning Session

2-D. Calculate the minimum bequest (in USD) from Robert’s estate to Mary in order to meet
her spending needs and taxes. Show your calculations.

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2018 Level III Mocks

Exam 1 Morning Session

QUESTION 3 HAS FOUR PARTS (A, B, C, & D) FOR A TOTAL OF 15 MINUTES.
Gus Weaver is the owner of a privately traded manufacturing concern which is currently
worth $25 million and was established twenty-five years ago. Weaver is 65 years of age and
has approached his financial advisor, Kyle Lucas, to discuss his goals and investment
portfolio. Weaver’s is concerned about minimizing the downside risk and wants to maintain
a minimum net worth of $5 million at all times. Exhibit 1 shows Weaver other assets details.
Exhibit 1
“Aspirational” Risk
Bucket

“Personal” Risk Bucket

“Market” Risk Bucket

Home

$2,000,000

Equities

$3,000,000

Family
Business

$25,000,000

Mortgage on
Primary
Residence

$0

Intermediateand LongTerm Fixed
Income

$2,500,000

Private
Equity

$5,000,000

Cash/ShortTerm

Treasury
Bonds and
Notes

$1,500,000

Total

$3,500,000

Total

$5,500,000

Total

$30,000,000

Lucas thinks that current asset allocation seems very aggressive for someone his age. Lucas
suggests Weaver to consider diversifying his current portfolio by selling a portion of his
family business. Weaver agrees to Lucas’ suggestion but requests him to consider following
near term objectives while deciding for monetization strategies.
• Maximize the amount of cash up front at the time of sale;
• Remain actively involved in the company for near future;
• Retain some upside exposure to the value of the business;
Weaver presents the following three potential monetization strategies:
i. Full sale to the senior management team in a management buyout;
ii. Full sale to the Family or Next Generation;
iii. Partial sale through an initial public offering;

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2018 Level III Mocks

Exam 1 Morning Session

A. Using a goal-based planning framework (i.e., personal, market, and aspirational risk
buckets), identify the significant risk(s) that Weaver is currently facing.
(3 minutes)
B. Select the monetization strategy that will most likely achieve all of Weaver’s objectives.
Identify, for each strategy not selected, one objective it fails to achieve.
ANSWER QUESTION 3-B IN THE TEMPLATE PROVIDED.
(4 minutes)
Weaver’s brother, Mattios, is also Kyle Lucas’ client. Mattios recently retired from
DigitalTime, Inc., a technology company where he experienced a long and successful tenure
as a senior executive. During his 30-year career with DigitalTime. Mattios received a
considerable portion of his compensation in the form of employee stock options. Lucas
recommended Mattios to hedge the risk of his employee stock options using an option-based
cash less collar. The underlying stock increases by $5 million above the strike price of the
call options while the hedge is in place.
During his career, Mattios accumulated one million shares of a company named Lakson Inc.
These shares are currently valued at USD 30 million and represent the majority of his
wealth. These shares do not pay a dividend. Lucas notes that Mattios’ Lakson shares have a
very low cost basis. The jurisdiction in which Mattios resides levies capital gains taxes only
on the sale or disposal of a security. Therefore, any outright sales of shares would result in
significant long-term capital gains which would be taxed at 30%.
Lucas suggests to Mattios to consider tax-free stock swap to diversify his concentrated

position in Lakson’s stocks. Tax–free swap would involve $35 million in Maple shares in
exchange for all of Lakson’s shares, with no cash consideration. The tax cost basis that
Mattios has in Lakson shares, essentially zero, would become his tax cost basis in Maple
shares transferred to the Maple shares. If Mattios accepts a tax-free stock swap, he is able to
sell the Maple shares short against the box. He would realize 95% of the value of the Maple
shares with no limitations on the use of proceeds. The after-tax cost to access the proceeds
would be locked in at 15 bps per year. Mattios would be able to keep the position in place
indefinitely.
Mattios asks Lucas about cashless collar strategy as it sounds easier to implement. Lucas
determines that the pairs of options shown in Exhibit 2 are available, all with the same
expiration dates. Lakson’s share price is currently USD 30.00.

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2018 Level III Mocks

Exam 1 Morning Session

Exhibit 2
Strike Prices of Available Lakson Options (in USD)
Option Pair
Put
Call
A
32.50
32.50
B

27.50
33.50
C
33.50
27.50
C. Describe the mismatch in character that potentially affects Mattios with regard to use of
option-based collar for hedging his employee stock options.
(2 minutes)
D. Determine the value of the tax-free stock swap offer with a short sale against the box
and with immediate sale of the Maple shares. Show your calculations.
(3 minutes)
E. Identify which option pair is most likely to create a cashless collar position for Mattios.
Justify your response.
Note: No calculations are required.
(3 minutes)

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2018 Level III Mocks

Exam 1 Morning Session

Answer Question 3 on This Page
3-A. Using a goal-based planning framework (i.e., personal, market, and aspirational risk
buckets), identify the significant risk(s) that Weaver is currently facing.

3-B. Select the monetization strategy that will most likely achieve all of Weaver’s objectives.

Identify, for each strategy not selected, one objective it fails to achieve.
Select the monetization strategy that
will most likely achieve all of Weaver’s
objectives.
(circle one)
i. Full sale to the senior management
team in a management buyout;

Identify, for each strategy not selected,
one objective it fails to achieve.

ii. Full sale to the Family or Next
Generation;

iii. Partial sale through an initial public
offering;

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2018 Level III Mocks

Exam 1 Morning Session

3-C. Describe the mismatch in character that potentially affects Mattios with regard to use
of option-based collar for hedging his employee stock options.

3-D. Determine the value of the tax-free stock swap offer with a short sale against the box

and with immediate sale of the Maple shares. Show your calculations.

3-E. Identify which option pair is most likely to create a cashless collar position for Mattios.
Justify your response.
Note: No calculations are required.

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2018 Level III Mocks

Exam 1 Morning Session

QUESTION 4 HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 17 MINUTES
Link Bank is a commercial bank operating in the U.S. The Bank’s Board of Directors (the
“Board”) is responsible for formulating and implementing investment policies. The Board
delegates authority for making specific investments to the Bank’s officers (“Management”)
that are consistent with this IPS. The Board has appointed an Investment Committee (the
“Committee”) who is responsible for monitoring and reviewing all investment decisions for
compliance with the IPS and with federal and state regulations. The Committee also
recommends changes to IPS to the Board when appropriate.
The Committee, in its last meeting, discussed the following different scenarios with respect
to its loan portfolio and requested the Management to apprise the Committee in next
meeting the effect of each of the suggested changes on the bank’s investment objectives,
constraints, or risk-taking ability.
I.
The Bank has decided to restrict lending to customers with a credit rating of A or
higher although the Bank’s overall risk tolerance is unchanged.

II.
The Bank decides to increase the holdings of long-term mortgage-backed securities.
III.
The target average maturity of loans is decreased, with overall risk tolerance
unchanged.
IV.
Fewer opportunities exist for expanding net interest margins with low risk in Link
Bank’s loan portfolio than in its securities portfolio.
The Chairman of the Bank’s ALCO Committee, Mr. Samuel Miller, is analyzing the
implications of the recent unexpected fall in interest rates on the bank’s market value of
equity.
The current structure of the bank’s balance sheet is as follows:
• Market value of Assets: $ 150 MN
• Market Value of Liabilities: $ 170 MN
• Duration of Assets: 7.5
• Duration of Liabilities: 4.5
Mr. Miller states to other member that besides earning a positive return on invested capital,
we should maximize the duration of Bank’s Equity.
A. Explain the impact of each of the scenarios on the bank’s objectives and constraints, or
risk-taking ability. Your response should consider each policy in isolation.
ANSWER QUESTION 4-A IN THE TEMPLATE PROVIDED
(4 minutes)

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2018 Level III Mocks

Exam 1 Morning Session

B. Discuss one implication of a negative interest rate shock on the bank’s balance sheet.
(3 minutes)
C. Determine the course of action that should most likely be taken if the duration of Bank’s
Equity is lower than desired.
(2 minutes)
D. Determine whether Link Bank has below-average, average, or above average ability to
take risk regarding their securities portfolio. Justify your response.
ANSWER QUESTION 4-D IN THE TEMPLATE PROVIDED.
(2 minutes)
E. Formulate each of the following constraints for Link Bank’s IPS:
i. time horizon
ii. liquidity
iii. tax concerns
(6 minutes)

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2018 Level III Mocks

Exam 1 Morning Session

Answer Question 4 on This Page
4-A. Explain the impact of each of the scenarios on the bank’s objectives and constraints, or
risk-taking ability. Your response should consider each policy in isolation.
Scenario

Evaluate the Impact of the scenario on the
Bank’s Objectives and Constraints, or
risk-taking ability. Consider each Policy
in Isolation

I. The Bank has decided to restrict lending
to customers with a credit rating of A or
higher although the Bank’s overall risk
tolerance is unchanged

II. The Bank decides to increase the
holdings of long-term mortgage-backed
securities

III. The target average maturity of loans is
decreased, with overall risk tolerance
unchanged.

IV. Fewer opportunities exist for expanding
net interest margins with low risk in
Link Bank’s loan portfolio than in its
securities portfolio.

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2018 Level III Mocks

Exam 1 Morning Session

4-B. Discuss one implication of a negative interest rate shock on the bank’s balance sheet.

4-C. Determine the course of action that should most likely be taken if the duration of Bank’s
Equity is lower than desired.

4-D. Determine whether Link Bank has below-average, average, or above average ability to
take risk regarding their securities portfolio. Justify your response.
Ability to take risk: Circle one.
Below-average

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Average

23

Above-average


2018 Level III Mocks

Exam 1 Morning Session

4-E. Formulate each of the following constraints for Link Bank’s IPS:
I. time horizon
II. liquidity
III. tax concerns

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2018 Level III Mocks

Exam 1 Morning Session

QUESTION 5 HAS FOUR PARTS (A, B, C, D, E) FOR A TOTAL OF 18 MINUTES.
Theo Radcliff is Head of Finance at Network Solutions (NS). NS is solely responsible for
funding its Defined Benefit (DB) plan by making annual contributions. Management of NS
asks Radcliff to compare NS’s DB plan against the DB plan of its two main competitors, Tyler
Technologies (TT) and Munis Support (MS). He summarizes financial data and plan
characteristics for the three companies.
NS

TT

MS

Sales

21,000,000

38,000,000

29,500,000

Profit margin

29%

35%

35%

Projected benefit obligations

23,500,000

34,000,000

27,600,000

Long term debt-to-capital ratio

47%

43%

53%

Provision allowing lump-sum
distribution

YES

YES

NO

Provision allowing early retirement

NO

YES

NO

Proportion of active lives

43%

28%

64%

Plan funded status

Deficit

Surplus

Surplus

A. Determine which company’s pension plan has the highest risk tolerance based on:
i.
Financial position.

ii.
Plan features.
(4 minutes)
Magnus Capital Management provides asset management services to a diverse pool of
clients. Among its clientele is the endowment associated with University of Brussels (UB).
• Endowment currently has a planned time horizon till 2035.
• All returns on the investments made by endowment are tax exempt.
• UB currently receives enough funds from the endowment to meet its spending needs
and in recent years it has actually had a budget surplus.
• UB’s board is confident that it could raise funds through donor contributions, if
necessary.
Magnus Capital Management also manages a large fund for Hassler Insurance Corp (HIC), a

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