2019 CFA level 3 qbank reading 23 liability driven and index based strategies questions

Question #1 of 12
Since the great recession of 2007-2008, rms have had a di cult time achieving actuarial
estimated targeted returns in their xed income portfolios for their de ned bene t plans. As a
result, many de ned bene t plans have turned to investing in more risky investments, like
stocks and longer maturity bonds, Reliant Manufacturing is no di erent. Reliant has hired a
well-respected actuarial rm to close the duration gap between their assets and liabilities by
using Treasury bond futures contracts.

12.25. The BPV of the liability is estimated at $612,500.

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Assume Reliant's DB pension plan has a PBO of $500 million, with an e ective duration of

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The plan assets of $600 million are invested 70% equities and 30% xed income. The manager
currently holds a laddered bond portfolio of 2 and 3 year Treasuries and longer term
investment grade corporate bonds. The duration of the bond portfolio is approximately 5.0 and
the BPV of the plan assets are approximately $250,000. The actuarial rm estimates that Reliant

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has a duration gap of $362,500 and the Treasury Bond Futures contract is based on $100,000
par. The CTD bond has a BPV of 125, duration of 13 and a conversion factor of .98. The BPV of
each futures contract is 127.55 BPV.

Assuming the actuarial rm's PM has no view on interest rates and decides to construct a 100%

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hedge to eliminate the duration gap, the number of futures contracts that the PM will purchase

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A) 2,678.

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to increase the asset duration is closest to:

B) 2,900.

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C) 2,842.

Question #2 of 12
Smart Beta in xed income investing has evolved from equity investing and uses simple,
transparent, rules-based strategies to help make investment decisions. Basically, smart beta
attempts to identify strategies that can generate excess returns. Many xed-income investors
use smart beta to address systematic biases such as the "Bums problem".
The Bums problem in regard to Fixed Income Investing is:


A) often a positive correlation between the amount of bonds issued and credit worthiness
of the issuer.

B) a less credit worthy issuer that gets increasing weightings in a value weighted index as
they issue more bonds.
C) a more creditworthy issuer that tends to become an increasing percentage of a bond
index.

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Question #3 of 12
Hans Wilsdarf specializes in risk management strategies with Bezel Limited and has been hired

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to defease $5 million of xed income liabilities for a local municipality. The bonds under
consideration are putable in May of 2021, pay interest semi-annually of 4.25%, and mature in
2030. Based on the bond's underlying structure, the amount of cash outlay is known but the

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timing of cash outlay is unknown.
These liabilities would be classi ed as:

A) Type II.

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C) Type IV.

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B) Type I.

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Question #4 of 12

Kirsten Smith is a fund manager with Balco Fixed Income Consulting and specializes in sector
and quality enhanced indexing. Smith is expecting signi cant spread widening and is altering
her allocation between Treasuries and corporates.
Smith would execute the following trading strategy:

A) Smith would decrease her allocation to Treasuries over corporates.
B) Smith would increase her allocation to Treasuries over corporates.
C) Smith would increase her allocation to AAA corporate bonds.


Question #5 of 12
In using Treasury futures for immunization, a possible source of underperformance with this
hedging strategy is likely because:

A) a less accurate estimate of futures BPV could adjust for accrued interest discounted at
short-term rates.
B) futures BPV is calculated using an estimated CTD allowable security divided by its
conversion factor. The estimated CTD security values can change the futures duration

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C) actuarial assumptions are frequently very unreliable.

Question #6 of 12

Randolph David is the lead Fixed Income portfolio manager at a rm that specializes in

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Environmental, Social and Governance (ESG) investing. His rm has just recently launched a
bond fund that seeks to provide as high a level of current income as is consistent with
preservation of capital through investment in bonds and other debt securities. The fund also
focuses on issuers that meet the rm's comprehensive Responsible Investing (RI) and nancial
valuation analysis. The Bond fund is benchmarked to the Bloomberg Barclays U.S. Aggregate

18.43

AA

4.19

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A

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AAA

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Bond Index, current credit quality breakdown of the benchmark is shown below.

15.34

42.62

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BBB
BB

7.11

B

1.89

NOT RATED 10.42
Randolph and his analyst team nd that the benchmark has a large percentage of bonds that
are rated BB that do not meet the rm's comprehensive Responsible Investing (RI) analysis
because they are primarily composed of high carbon emission Industries.

Randolph is worried about reducing tracking error for his portfolio while also meeting the rm's
stringent ESG investing parameters. Randolph should recommend what investment strategy:


A) Active Management.
B) Pure Indexing.
C) Cell matching.

Question #7 of 12
Caitlin Randolph is a xed income consultant for a large endowment that has a $15 million
single liability that is due in 8 years. The Board of Directors for the endowment has requested

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that Caitlin immunize the payment and it is not possible to use zero-coupon bonds in this
situation. The Board is requesting Caitlin to consider two portfolios of government securities

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for consideration that were selected by the endowment's investment committee.

The consultant is instructed to initially select the portfolio that will minimize the risk of the
portfolio over the 8 year period.

Yield of Portfolio 4.0%
7.99

Convexity

94.16

4.2%
8.02

123.57

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Macaulay
duration

Portfolio 2

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Portfolio 1

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Indicate the portfolio that Caitlin should recommend:

A) Portfolio 1.

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B) Neither Portfolio 1 or 2.
C) Portfolio 2.

Question #8 of 12
Randolph Lyndsey is a de ned bene t plan consultant and is advising pension managers to be
cautious of interest rate risk in their portfolios from expected increases in rates by the Fed.
To lower the duration of their portfolios because of Randolph's rising interest rate forecast:


A) A receive- xed swap has negative duration so this will decrease the overall portfolio’s
duration.
B) A portfolio manager can enter into a receive- oating swap to lower the portfolio’s
duration.
C) A portfolio manager can enter into a receive- xed swap to lower the portfolio’s
duration.

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Question #9 of 12
A wealth manager purchases equal positions in the 2018 through 2020 xed maturity corporate

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bond ETFs to create a laddered portfolio that approximately replicates holding the individual
bonds.

The advantages of purchasing the ETFs over the purchase of the individual bonds include

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increased:

A) ability for tax-loss harvesting strategies in taxable accounts.
B) liquidity, price stability in earlier maturing ETF’s, and increased convexity.

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C) liquidity and decreased convexity compared to holding a bullet structure portfolio.

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Question #10 of 12

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Noah Randolph, Chief Risk O cer for TREND Corp, has determined that the most e cient way
to immunize against interest-rate risk on a known single liability is to purchase a government
issued zero-coupon bond that matches the term of the liability. However, Noah decides not to
follow this method when he has to immunize TREND's upcoming liability. The most likely
reason that Noah did not immunize the single liability with a government zero is:

A) Noah was worried about reinvestment risk because rates were expected to decrease
over the next year.

B) Noah wanted to use a more complex strategy to achieve superior returns.
C) Noah could not nd a zero-coupon bond available to match the liability.


Question #11 of 12
Liz Ruzzboy is a De ned Bene ts Pension fund manager for a large multinational in Australia.
Her rm was recently acquired by a U.S. based corporation and the pension will now be
operating under U.S. tax code. Under the U.S. tax code, Liz is concerned about interest rate risk
because:

A) Changes in the funding status ow through the balance sheet and can lower rm assets
thus decreasing asset based nancial ratios.
B) Changes in the funding status ow through the income statement and can a ect EPS.
C) Liz is not worried about interest rate risk because it can be hedged away with

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derivatives.

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Question #12 of 12

Randy Kosso , CFO of Johnson Systems, has decided to implement an immunization strategy
for multiple upcoming liabilities. Kosso reaches out to the rm's lead xed income trader to

create the portfolio.

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What information must the trader have to create a successful immunized portfolio?

A) The trader would need both the money duration and the convexity of the underlying

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assets and liabilities.

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B) The trader would need to have the cash ow yield and Macaulay duration of the
underlying liabilities.

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C) The trader would need the money duration and the Macaulay duration of the
underlying liabilities and the assets.