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Free CFA Institute CFA-Level-III Exam Questions

Absolute Free CFA-Level-III Exam Practice for Comprehensive Preparation 

  • CFA Institute CFA-Level-III Exam Questions
  • Provided By: CFA Institute
  • Exam: CFA Level III Chartered Financial Analyst
  • Certification: CFA Level III
  • Total Questions: 365
  • Updated On: Jan 13, 2026
  • Rated: 4.9 |
  • Online Users: 730
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  • Question 1
    • Milson Investment Advisors (MIA) specializes in managing fixed income portfolios for institutional clients. Many
      of MIA's clients are able to take on substantial portfolio risk and therefore the firm's funds invest in all credit
      qualities and in international markets. Among its investments, MIA currently holds positions in the debt of Worth
      inc., Enertech Company, and SBK Company.
      Worth Inc. is a heavy equipment manufacturer in Germany. The company finances a significant amount of its
      fixed assets using bonds. Worth's current debt outstanding is in the form of non-callable bonds issued two
      years ago at a coupon rate of 7.2% and a maturity of 15 years. Worth expects German interest rates to decline
      by as much as 200 basis points (bps) over the next year and would like to take advantage of the decline. The
      company has decided to enter into a 2-year interest rate swap with semiannual payments, a swap rate of 5.8%,
      and a floating rate based on 6-month EURIBOR. The duration of the fixed side of the swap is 1.2. Analysts at
      MIA have made the following comments regarding Worth's swap plan:
      • "The duration of the swap from the perspective of Worth is 0.95."
      • "By entering into the swap, the duration of Worth's long-term liabilities will become smaller, causing the value
      of the firm's equity to become more sensitive to changes in interest rates."
      Enertech Company is a U.S.-based provider of electricity and natural gas. The company uses a large proportion
      of floating rate notes to finance its operations. The current interest rate on Enertech's floating rate notes, based
      on 6-month LIBOR plus 150bp, is 5.5%. To hedge its interest rate risk, Enertech has decided to enter into a
      long interest rate collar. The cap and the floor of the collar have maturities of two years, with settlement dates
      (in arrears) every six months. The strike rate for the cap is 5.5% and for the floor is 4.5%, based on 6-month
      LIBOR, which is forecast to be 5.2%, 6.1%, 4.1%, and 3.8%, in 6,12, 18, and 24 months, respectively. Each
      settlement period consists of 180 days. Analysts at MIA are interested in assessing the attributes of the collar.
      SBK Company builds oil tankers and other large ships in Norway. The firm has several long-term bond issues
      outstanding with fixed interest rates ranging from 5.0% to 7.5% and maturities ranging from 5 to 12 years.
      Several years ago, SBK took the pay floating side of a semi-annual settlement swap with a rate of 6.0%, a
      floating rate based on LIBOR, and a tenor of eight years. The firm now believes interest rates may increase in 6
      months, but is not 100% confident in this assumption. To hedge the risk of an interest rate increase, given its
      interest rate uncertainty, the firm has sold a payer interest rate swaption with a maturity of 6 months, an
      underlying swap rate of 6.0%, and a floating rate based on LIBOR.
      MIA is considering investing in the debt of Rio Corp, a Brazilian energy company. The investment would be in
      Rio's floating rate notes, currently paying a coupon of 8.0%. MIA's economists are forecasting an interest rate
      decline in Brazil over the short term.
      Determine whether the MIA analysts' comments regarding the duration of the Worth Inc. swap and the effects
      of the swap on the company's balance sheet are correct or incorrect.

      Answer: C
  • Question 2
    • William Bliss, CFA, runs a hedge fund that uses both managed futures strategies and positions in physical
      commodities. He is reviewing his operations and strategies to increase the return of the fund. Bliss has just
      hired Joseph Kanter, CFA, to help him manage the fund because he realizes that he needs to increase his
      trading activity in futures and to engage in futures strategies other than fully hedged, passively managed
      positions. Bliss also hired Kanter because of Kantcr's experience with swaps, which Bliss hopes to add to his
      choice of investment tools.
      Bliss explains to Kanter that his clients pay 2% on assets under management and a 20% incentive fee. The
      incentive fee is based on profits after having subtracted the risk-free rate, which is the fund's basic hurdle rate,
      and there is a high water mark provision. Bliss is hoping that Kanter can help his business because his firm did
      not earn an incentive fee this past year. This was the case despite the fact that, after two years of losses, the
      value of the fund increased 14% during the previous year. That increase occurred without any new capital
      contributed from clients. Bliss is optimistic about the near future because the term structure of futures prices is
      particularly favorable for earning higher returns from long futures positions.
      Kanter says he has seen research that indicates inflation may increase in the next few years. He states this
      should increase the opportunity to earn a higher return in commodities and suggests taking a large, margined
      position in a broad commodity index. This would offer an enhanced return that would attract investors holding
      only stocks and bonds. Bliss mentions that not all commodity prices are positively correlated with inflation so it
      may be better to choose particular types of commodities in which to invest. Furthermore, Bliss adds that
      commodities traditionally have not outperformed stocks and bonds either on a risk-adjusted or absolute basis.
      Kanter says he will research companies who do business in commodities, because buying the stock of those
      companies to gain commodity exposure is an efficient and effective method for gaining indirect exposure to
      commodities.
      Bliss agrees that his fund should increase its exposure to commodities and wants Kanter's help in using swaps
      to gain such exposure. Bliss asks Kanter to enter into a swap with a relatively short horizon to demonstrate how
      a commodity swap works. Bliss notes that the futures prices of oil for six months, one year, eighteen months,
      and two years are $55, S54, $52, and $5 1 per barrel, respectively, and the risk-free rate is less than 2%.
      Bliss asks how a seasonal component could be added to such a swap. Specifically, he asks if either the
      notional principal or the swap price can be higher during the reset closest to the winter season and lower for the
      reset period closest to the summer season. This would allow the swap to more effectively hedge a commodity
      like oil, which would have a higher demand in the winter than the summer. Kanter says that a swap can only
      have seasonal swap prices, and the notional principal must stay constanl. Thus, the solution in such a case
      would be to enter into two swaps, one that has an annual reset in the winter and one that has an annual reset in
      the summer.
      Given the information, the most likely reason that Bliss's firm did not earn an incentive fee in the past year was
      because:

      Answer: C
  • Question 3
    • Harold Chang, CFA, has been the lead portfolio manager for the Woodlock Management Group (WMG) for the last five years. WMG runs several equity and fixed income portfolios, all of which are authorized to use derivatives as long as such positions are consistent with the portfolio's strategy. The WMG Equity Opportunities Fund takes advantage of long and short profit opportunities in equity securities. The fund's positions are often a relatively large percentage of the issuer's outstanding shares and fund trades frequently move securities prices. Chang runs the Equity Opportunities Fund and is concerned that his performance for the last three quarters has put his position as lead manager in jeopardy. Over the last three quarters, Chang has been underperforming his benchmark by an increasing margin and is determined to reduce the degree of underperformance before the end of the next quarter. Accordingly, Chang makes the following transactions for the fund: Transaction 1: Chang discovers that the implied volatility of call options on GreenCo is too high. As a result, Chang shorts a large position in the stock options while simultaneously taking a long position in GreenCo stock, using the funds from the short position to partially pay for the long stock. The GreenCo purchase caused the share price to move up slightly. After several months, the GreenCo stock position has accumulated a large unrealized gain. Chang sells a portion of the GreenCo position to rebalance the portfolio. Richard Stirr, CFA, who is also a portfolio manager for WMG, runs the firm's Fixed Income Fund. Stirr is known for his ability to generate excess returns above his benchmark, even in declining markets. Stirr is convinced that even though he has only been with WMG for two and a half years, he will be named lead portfolio manager if he can keep his performance figures strong through the next quarter. To achieve this positive performance, Stirr enters into the following transactions for the fund: Transaction 2: Stirr decides to take a short forward position on the senior bonds of ONB Corporation, which Stirr currently owns in his Fixed Income Fund. Stirr made his decision after overhearing two of his firm's investment bankers discussing an unannounced bond offering for ONB that will subordinate all of its outstanding debt. As expected, the price of the ONB bonds falls when the upcoming offering is announced. Stirr delivers the bonds to settle the forward contract, preventing large losses for his investors. Transaction 3: Sitrr has noticed that in a foreign bond market, participants are slow to react to new information relevant to the value of their country's sovereign debt securities. Stirr, along with other investors, knows that an announcement from his firm regarding the sovereign bonds will be made the following day. Stirr doesn't know for sure, but expects the news to be positive, and prepares to enter a purchase order. When the positive news is released, Stirr is the first to act, making a large purchase before other investors and selling the position after other market participants react and move the sovereign bond price higher. Because of their experience with derivatives instruments, Chang and Stirr are asked to provide investment advice for Cherry Creek, LLC, a commodities trading advisor. Cherry Creek uses managed futures strategies that incorporate long and short positions in commodity futures to generate returns uncorrelated with securities markets. The firm has asked Chang and Stirr to help extend their reach to include equity and fixed income derivatives strategies. Chang has been investing with Cherry Creek since its inception and has accepted increased shares in his Cherry Creek account as compensation for his advice. Chang has not disclosed his arrangement with Cherry Creek since he meets with the firm only during his personal time. Stirr declines any formal compensation but instead requests that Cherry Creek refer their clients requesting traditional investment services to WMG. Cherry Creek agrees to the arrangement. Three months have passed since the transactions made by Chang and Stirr occurred. Both managers met their performance goals and are preparing to present their results to clients via an electronic newsletter published every quarter. The managers want to ensure their newsletters are in compliance with CFA Institute Standards of Professional Conduct. Chang states, "in order to comply with the Standards, we are required to disclose the process used to analyze and select portfolio holdings, the method used to construct our portfolios, and any changes that have been made to the overall investment process. In addition, we must include in the newsletter all factors used to make each portfolio decision over the last quarter and an assessment of the portfolio's risks." Stirr responds by claiming, "we must also clearly indicate that projections included in our report are not factual evidence but rather conjecture based on our own statistical analysis. However, I believe we can reduce the amount of information included in the report from what you have suggested and instead issue more of a summary report as long as we maintain a full report in our internal records." Determine whether Chang's comments regarding the disclosure of investment processes used to manage WMG's portfolios and the disclosure of factors used to make portfolio decisions over the last quarter are correct.

      Answer: C
  • Question 4
    • Dakota Watson and Anthony Smith are bond portfolio managers for Northern Capital Investment Advisors,
      which is based in the U.S. Northern Capital has $2,000 million under management, with S950 million of that in
      the bond market. Northern Capital's clients are primarily institutional investors such as insurance companies,
      foundations, and endowments. Because most clients insist on a margin over the relevant bond benchmark,
      Watson and Smith actively manage their bond portfolios, while at the same time trying to minimize tracking
      error.
      One of the funds that Northern Capital offers invests in emerging market bonds. An excerpt from its prospectus
      reveals the following fund objectives and strategies:
      “The fund generates a return by constructing a portfolio using all major fixed-income sectors within the Asian
      region (except Japan) with a bias towards non-government bonds. The fund makes opportunistic investments
      in both investment grade and high yield bonds. Northern Capital analysts seek those bond issues that are
      expected to outperform U.S. bonds with similar credit risk, interest rate risk, and liquidity risk-Value is added by
      finding those bonds that have been overlooked by other developed world bond funds. The fund favors nondollar, local currency denominated securities to avoid the default risk associated with a lack of hard currency on
      the part of issuer."
      Although Northern Capital does examine the availability of excess returns in foreign markets by investing
      outside the index in these markets, most of its strategies focus on U.S. bonds and spread analysis of them.
      Discussing the analysis of spreads in the U.S. bond market, Watson comments on the usefulness of the option
      adjusted spread and the swap spread and makes the following statements:
      Statement 1: Due to changes in the structure of the primary bond market in the U.S., the option adjusted
      spread is increasingly valuable for analyzing the attractiveness of bond investments.
      Statement 2: The advantage of the swap spread framework is that investors can compare the relative
      attractiveness of fixed-rate and floating-rate bond markets.
      Watson's view of the U.S. economy is decidedly bearish. She is concerned that the recent withdrawal of liquidity
      from the U.S. financial system will result in a U.S. recession, possibly even a depression. She forecasts that
      interest rates in the U.S. will continue to fall as the demand for loanable funds declines with the lack of business
      investment. Meanwhile, she believes that the Federal Reserve will continue to keep short-term rates low in
      order to stimulate the economy. Although she sees the level of yields declining, she believes that the spread on
      risky securities will increase due to the decline in business prospects. She therefore has reallocated her bond
      portfolio away from high-yield bonds and towards investment grade bonds.
      Smith is less decided about the economy. However, his trading strategy has been quite successful in the past.
      As an example of his strategy, he recently sold a 20-year AA-rated $50,000 Mahan Corporation bond with a
      7.75% coupon that he had purchased at par. With the proceeds, he then bought a newly issued A-rated Quincy
      Corporation bond that offered an 8.25% coupon. By swapping the first bond for the second bond, he enhanced
      his annual income, which he considers quite favorable given the declining yields in the market.
      Watson has become quite interested in the mortgage market. With the anticipated decline in interest rates, she
      expects that the yields on mortgages will decline. As a result, she has reallocated the portion of Northern
      Capital's bond portfolio dedicated to mortgages. She has shifted the holdings from 8.50% coupon mortgages to
      7.75% coupon mortgages, reasoning that if interest rates do drop, the lower coupon mortgages will rise in price
      more than the higher coupon mortgages. She identifies this trade as a structure trade.
      Smith is examining the liquidity of three bonds. Their characteristics are listed in the table below:
      CFA-Level-III-page476-image280
      Which of the following best describes the relative value analysis used in the Northern Capita! Emerging market
      bond fund? It is a:

      Answer: B
  • Question 5
    • Dan Draper, CFA is a portfolio manager at Madison Securities. Draper is analyzing several portfolios which
      have just been assigned to him. In each case, there is a clear statement of portfolio objectives and constraints,
      as welt as an initial strategic asset allocation. However, Draper has found that all of the portfolios have
      experienced changes in asset values. As a result, the current allocations have drifted away from the initial
      allocation. Draper is considering various rebalancing strategies that would keep the portfolios in line with their
      proposed asset allocation targets.
      Draper spoke to Peter Sterling, a colleague at Madison, about calendar rebalancing. During their conversation,
      Sterling made the following comments:
      Comment 1: Calendar rebalancing will be most efficient when the rebalancing frequency considers the volatility
      of the asset classes in the portfolio.
      Comment 2: Calendar rebalancing on an annual basis will typically minimize market impact relative to more
      frequent rebalancing.
      Draper believes that a percentage-of-portfolio rebalancing strategy will be preferable to calendar rebalancing,
      but he is uncertain as to how to set the corridor widths to trigger rebalancing for each asset class. As an
      example, Draper is evaluating the Rogers Corp. pension plan, whose portfolio is described in Figure 1.
      CFA-Level-III-page476-image124
      Draper has been reviewing Madison files on four high net worth individuals, each of whom has a $1 million
      portfolio. He hopes to gain insight as to appropriate rebalancing strategies for these clients. His research so far
      shows:
      Client A is 60 years old, and wants to be sure of having at least $800,000 upon his retirement. His risk tolerance
      drops dramatically whenever his portfolio declines in value. He agrees with the Madison stock market outlook,
      which is for a long-term bull market with few reversals.
      Client B is 35 years old and wants to hold stocks regardless of the value of her portfolio. She also agrees with
      the Madison stock market outlook.
      Client C is 40 years old, and her absolute risk tolerance varies proportionately with the value of her portfolio.
      She does not agree with the Madison stock market outlook, but expects a choppy stock market, marked by
      numerous reversals, over the coming months.
      In selecting a rebalancing strategy for his clients, Draper would most likely select a constant mix strategy for:

      Answer: C
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