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: Jul 25, 2026
Rated: 4.9 |
Online Users: 730

Page No. 1 of 73

Add To Cart

Question 1
- Gabrielle Reneau, CFA, and Jack Belanger specialize in options strategies at the brokerage firm of Damon and
  Damon. They employ fairly sophisticated strategies to construct positions with limited risk, to profit from future
  volatility estimates, and to exploit arbitrage opportunities. Damon and Damon also provide advice to outside
  portfolio managers on the appropriate use of options strategies. Damon and Damon prefer to use, and
  recommend, options written on widely traded indices such as the S&P 500 due to their higher liquidity.
  However, they also use options written on individual stocks when the investor has a position in the underlying
  stock or when mispricing and/or trading depth exists.
  In order to trade in the one-year maturity puts and calls for the S&P 500 stock index, Reneau and Belanger
  contact the chief economists at Damon and Damon, Mark Blair and Fran Robinson. Blair recently joined Damon
  and Damon after a successful stint at a London investment bank. Robinson has been with Damon and Damon
  for the past ten years and has a considerable record of success in forecasting macroeconomic activity. In his
  forecasts for the U.S. economy over the next year, Blair is quite bullish, for both the U.S. economy and the S&P
  500 stock index. Blair believes that the U.S. economy will grow at 2% more than expected over the next year.
  He also states that labor productivity will be higher than expected, given increased productivity through the use
  of technological advances. He expects that these technological advances will result in higher earnings for U.S.
  firms over the next year and over the long run.
  Reneau believes that the best S&P 500 option strategy to exploit Blair's forecast involves two options of the
  same maturity, one with a low exercise price, and the other with a high exercise price. The beginning stock
  price is usually below the two option strike prices. She states that the benefit of this strategy is that the
  maximum loss is limited to the difference between the two option prices.
  Belanger is unsure that Blair's forecast is correct. He states that his own reading of the economy is for a
  continued holding pattern of low growth, with a similar projection for the stock market as a whole. He states that
  Damon and Damon may want to pursue an options strategy where a put and call of the same maturity and
  same exercise price are purchased. He asserts that such a strategy would have losses limited to the total cost
  of the two options.
  Reneau and Belanger are also currently examining various positions in the options of Brendan Industries.
  Brendan Industries is a large-cap manufacturing firm with headquarters in the midwestern United States. The
  firm has both puts and calls sold on the Chicago Board Options Exchange. Their options have good liquidity for
  the near money puts and calls and for those puts and calls with maturities less than four months. Reneau
  believes that Brendan Industries will benefit from the economic expansion forecasted by Mark Blair, the Damon
  and Damon economist. She decides that the best option strategy to exploit these expectations is for her to
  pursue the same strategy she has delineated for the market as a whole.
  Shares of Brendan Industries are currently trading at $38. The following are the prices for their exchangetraded options.
  
  As a mature firm in a mature industry, Brendan Industries stock has historically had low volatility. However,
  Belanger's analysis indicates that with a lawsuit pending against Brendan Industries, the volatility of the stock
  price over the next 60 days is greater by several orders of magnitude than the implied volatility of the options.
  He believes that Damon and Damon should attempt to exploit this projected increase in Brendan Industries1
  volatility by using an options strategy where a put and call of the same maturity and same exercise price are
  utilized. He advocates using the least expensive strategy possible.
  During their discussions, Reneau cites a counter example to Brendan Industries from last year. She recalls that
  Nano Networks, a technology firm, had a stock price that stayed fairly stable despite expectations to the
  contrary. In this case, she utilized an options strategy where three different calls were used. Profits were earned
  on the strategy because Nano Networks' stock price stayed fairly stable. Even if the stock price had become
  volatile, losses would have been limited.
  Later that week, Reneau and Belanger discuss various credit option strategies during a lunch time presentation
  to Damon and Damon client portfolio managers. During their discussion, Reneau describes a credit option
  strategy that pays the holder a fixed sum, which is agreed upon when the option is written, and occurs in the
  event that an issue or issuer goes into default. Reneau declares that this strategy can take the form of either
  puts or calls. Belanger states that this strategy is known as either a credit spread call option strategy or a credit
  spread put option strategy.
  Reneau and Belanger continue by discussing the benefits of using credit options. Reneau mentions that credit
  options written on an underlying asset will protect against declines in asset valuation. Belanger says that credit
  spread options protect against adverse movements of the credit spread over a referenced benchmark.
  Assume Reneau applies the options strategy used earlier for Nano Networks. Assuming there is a 3-month 45
  call on Brendan Industries trading at $1.00, calculate the maximum gain and maximum loss on this position.
  Max gain Max loss
  
  A : $2.50 -$2.50
  
  B : $5.00 -$5.00
  
  C : $3.00 -$2.00
  
  Answer: A
Question 2
- Carl Cramer is a recent hire at Derivatives Specialists Inc. (DSI), a small consulting firm that advises a variety
  of institutions on the management of credit risk. Some of DSI's clients are very familiar with risk management
  techniques whereas others are not. Cramer has been assigned the task of creating a handbook on credit risk,
  its possible impact, and its management. His immediate supervisor, Christine McNally, will assist Cramer in the
  creation of the handbook and will review it. Before she took a position at DSI, McNally advised banks and other
  institutions on the use of value-at-risk (VAR) as well as credit-at-risk (CAR).
  Cramer's first task is to address the basic dimensions of credit risk. He states that the first dimension of credit
  risk is the probability of an event that will cause a loss. The second dimension of credit risk is the amount lost,
  which is a function of the dollar amount recovered when a loss event occurs. Cramer recalls the considerable
  difficulty he faced when transacting with Johnson Associates, a firm which defaulted on a contract with the
  Grich Company. Grich forced Johnson Associates into bankruptcy and Johnson Associates was declared in
  default of all its agreements. Unfortunately, DSI then had to wait until the bankruptcy court decided on all claims
  before it could settle the agreement with Johnson Associates.
  McNally mentions that Cramer should include a statement about the time dimension of credit risk. She states
  that the two primary time dimensions of credit risk are current and future. Current credit risk relates to the
  possibility of default on current obligations, while future credit risk relates to potential default on future
  obligations. If a borrower defaults and claims bankruptcy, a creditor can file claims representing the face value
  of current obligations and the present value of future obligations. Cramer adds that combining current and
  potential credit risk analysis provides the firm's total credit risk exposure and that current credit risk is usually a
  reliable predictor of a borrower's potential credit risk.
  As DSI has clients with a variety of forward contracts, Cramer then addresses the credit risks associated with
  forward agreements. Cramer states that long forward contracts gain in value when the market price of the
  underlying increases above the contract price. McNally encourages Cramer to include an example of credit risk
  and forward contracts in the handbook. She offers the following:
  A forward contract sold by Palmer Securities has six months until the delivery date and a contract price of 50.
  The underlying asset has no cash flows or storage costs and is currently priced at 50. In the contract, no funds
  were exchanged upfront.
  Cramer also describes how a client firm of DSI can control the credit risks in their derivatives transactions. He
  writes that firms can make use of netting arrangements, create a special purpose vehicle, require collateral
  from counterparties, and require a mark-to-market provision. McNally adds that Cramer should include a
  discussion of some newer forms of credit protection in his handbook. McNally thinks credit derivatives
  represent an opportunity for DSL She believes that one type of credit derivative that should figure prominently in
  their handbook is total return swaps. She asserts that to purchase protection through a total return swap, the
  holder of a credit asset will agree to pass the total return on the asset to the protection seller (e.g., a swap
  dealer) in exchange for a single, fixed payment representing the discounted present value of expected cash
  flows from the asset.
  A DSI client, Weaver Trading, has a bond that they are concerned will increase in credit risk. Weaver would like
  protection against this event in the form of a payment if the bond's yield spread increases beyond LIBOR plus
  3%. Weaver Trading prefers a cash settlement.
  Later that week, Cramer and McNally visit a client's headquarters and discuss the potential hedge of a bond
  issued by Cuellar Motors. Cuellar manufactures and markets specialty luxury motorcycles. The client is
  considering hedging the bond using a credit spread forward, because he is concerned that a downturn in the
  economy could result in a default on the Cuellar bond. The client holds $2,000,000 in par of the Cuellar bond
  and the bond's coupons are paid annually. The bond's current spread over the U.S. Treasury rate is 2.5%. The
  characteristics of the forward contract are shown below.
  Information on the Credit Spread Forward
  
  Determine whether the forward contracts sold by Palmer Securities have current and/or potential credit risk.
  
  A :
  The contract has current credit risk only.
  
  B : The contract has potential credit risk only
  
  C : The contract has neither potential credit risk nor current credit risk.
  
  Answer: B
Question 3
- 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.
  
  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:
  
  A : Client A.
  
  B : Client B.
  
  C : Client C.
  
  Answer: C
Question 4
- Rowan Brothers is a full service investment firm offering portfolio management and investment banking services. For the last ten years, Aaron King, CFA, has managed individual client portfolios for Rowan Brothers, most of which are trust accounts over which King has full discretion. One of King's clients, Shelby Pavlica, is a widow in her late 50s whose husband died and left assets of over $7 million in a trust, for which she is the only beneficiary. Pavlica's three children are appalled at their mother's spending habits and have called a meeting with King to discuss their concerns. They inform King that their mother is living too lavishly to leave much for them or Pavlica's grandchildren upon her death. King acknowledges their concerns and informs them that, on top of her ever-increasing spending, Pavlica has recently been diagnosed with a chronic illness. Since the diagnosis could indicate a considerable increase in medical spending, he will need to increase the risk of the portfolio to generate sufficient return to cover the medical bills and spending and still maintain the principal. King restructures the portfolio accordingly and then meets with Pavlica a week later to discuss how he has altered the investment strategy, which was previously revised only three months earlier in their annual meeting. During the meeting with Pavlica, Kang explains his reasoning tor altering the portfolio allocation but does not mention the meeting with Pavlica's children. Pavlica agrees that it is probably the wisest decision and accepts the new portfolio allocation adding that she will need to tell her children about her illness, so they will understand why her medical spending requirements will increase in the near future. She admits to King that her children have been concerned about her spending. King assures her that the new investments will definitely allow her to maintain her lifestyle and meet her higher medical spending needs. One of the investments selected by King is a small allocation in a private placement offered to him by a brokerage firm that often makes trades for King's portfolios. The private placement is an equity investment in ShaleCo, a small oil exploration company. In order to make the investment, King sold shares of a publicly traded biotech firm, VNC Technologies. King also held shares of VNC, a fact that he has always disclosed to clients before purchasing VNC for their accounts. An hour before submitting the sell order for the VNC shares in Pavlica's trust account. King placed an order to sell a portion of his position in VNC stock. By the time Pavlica's order was sent to the trading floor, the price of VNC had risen, allowing Pavlica to sell her shares at a better price than received by King. Although King elected not to take any shares in the private placement, he purchased positions for several of his clients, for whom the investment was deemed appropriate in terms of the clients* objectives and constraints as well as the existing composition of the portfolios. In response to the investment support, ShaleCo appointed King to their board of directors. Seeing an opportunity to advance his career while also protecting the value of his clients' investments in the company, King gladly accepted the offer. King decided that since serving on the board of ShaleCo is in his clients' best interest, it is not necessary to disclose the directorship to his clients or his employer. For his portfolio management services, King charges a fixed percentage fee based on the value of assets under management. All fees charged and other terms of service are disclosed to clients as well as prospects. In the past month, however. Rowan Brothers has instituted an incentive program for its portfolio managers. Under the program, the firm will award an all-expense-paid vacation to the Cayman islands for any portfolio manager who generates two consecutive quarterly returns for his clients in excess of 10%. King updates his marketing literature to ensure that his prospective clients are fully aware of his compensation arrangements, but he does not contact current clients to make them aware of the newly created performance incentive. According to the CFA Institute Standards of Professional Conduct, which of the following statements is correct concerning King's directorship with ShaleCo?
  A : King may not accept the directorship since it creates a conflict of interest
  
  B : King may accept the directorship as long as it is disclosed to clients and prospects
  
  C : King may accept the directorship as long as it is disclosed to his employer, clients, and prospects
  
  Answer: C
Question 5
- Walter Skinner, CFA, manages a bond portfolio for Director Securities. The bond portfolio is part of a pension
  plan trust set up to benefit retirees of Thomas Steel Inc. As part of the investment policy governing the plan and
  the bond portfolio, no foreign securities are to be held in the portfolio at any time and no bonds with a credit
  rating below investment grade are allowable for the bond portfolio. In addition, the bond portfolio must remain
  unleveraged. The bond portfolio is currently valued at $800 million and has a duration of 6.50. Skinner believes
  that interest rates are going to increase, so he wants to lower his portfolio's duration to 4.50. He has decided to
  achieve the reduction in duration by using swap contracts. He has two possible swaps to choose from:
  1. Swap A: 4-year swap with quarterly payments.
  2. Swap B: 5-year swap with semiannual payments.
  Skinner plans to be the fixed-rate payer in the swap, receiving a floating-rate payment in exchange. For
  analysis, Skinner always assumes the duration of a fixed rate bond is 75% of its term to maturity.
  Several years ago, Skinner decided to circumvent the policy restrictions on foreign securities by purchasing a
  dual currency bond issued by an American holding company with significant operations in Japan. The bond
  makes semiannual fixed interest payments in Japanese yen but will make the final principal payment in U.S.
  dollars five years from now. Skinner originally purchased the bond to take advantage of the strengthening
  relative position of the yen. The result was an above average return for the bond portfolio for several years.
  Now, however, he is concerned that the yen is going to begin a weakening trend, as he expects inflation in the
  Japanese economy to accelerate over the next few years. Knowing Skinner's situation, one of his colleagues,
  Bill Michaels, suggests the following strategy:
  "You need to offset your exposure to the Japanese yen by establishing a short position in a synthetic dual
  currency bond that matches the terms of the dual currency bond you purchased for the Thomas Steel bond
  portfolio. As part of the strategy, you will have to enter into a currency swap as the fixed-rate yen payer. The
  swap will neutralize the dual-currency bond position but will unfortunately increase the credit risk exposure of
  the portfolio."
  Skinner has also spoken to Orval Mann, the senior economist with Director Securities, about his expectations
  for the bond portfolio. Mann has also provided some advice to Skinner in the following comment:
  "1 know you expect a general increase in interest rates, but I disagree with your assessment of the interest rate
  shift. I believe interest rates are going to decrease. Therefore, you will want to synthetically remove the call
  features of any callable bonds in your portfolio by purchasing a payer interest rate swaption."
  After his lung conversation with Director Securities' senior economist, Orval Mann, Skinner has completely
  changed his outlook on interest rates and has decided to extend the duration of his portfolio. The most
  appropriate strategy to accomplish this objective using swaps would be to enter into a swap to pay:
  
  A :
  fixed and receive floating.
  
  B : floating and receive fixed.
  
  C : floating and receive floating.
  
  Answer: B

PAGE: 1 - 73

Add To Cart

Free CFA Institute CFA-Level-III Exam Questions

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