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

CFA Institute CFA-Level-III Exam Questions
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Exam: CFA Level III Chartered Financial Analyst
Certification: CFA Level III

Total Questions: 365
Updated On: Sep 04, 2026
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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
- Joan Weaver, CFA and Kim McNally, CFA are analysts for Cardinal Fixed Income Management. Cardinal
  provides investment advisory services to pension funds, endowments, and other institutions in the U.S. and
  Canada. Cardinal recommends positions in investment-grade corporate and government bonds.
  Cardinal has largely advocated the use of passive approaches to bond investments, where the predominant
  holding consists of an indexed or enhanced indexed bond portfolio. They are exploring, however, the possibility
  of using a greater degree of active management to increase excess returns. The analysts have made the
  following statements.
  • Weaver: "An advantage of both enhanced indexing by matching primary risk factors and enhanced indexing
  by minor risk factor mismatching is that there is the potential for excess returns, but the duration of the portfolio
  is matched with that of the index, thereby limiting the portion of tracking error resulting from interest rate risk."
  • McNally: "The use of active management by larger risk factor mismatches typically involves large duration
  mismatches from the index, in an effort to capitalize on interest rate forecasts."
  As part of their increased emphasis on active bond management, Cardinal has retained the services of an
  economic consultant to provide expectations input on factors such as interest rate levels, interest rate volatility,
  and credit spreads. During his presentation, the economist states that he believes long-term interest rates
  should fall over the next year, but that short-term rates should gradually increase. Weaver and McNally are
  currently advising an institutional client that wishes to maintain the duration of its bond portfolio at 6.7. In light of
  the economic forecast, they are considering three portfolios that combine the following three bonds in varying
  amounts.
  
  Weaver and McNally next examine an investment in a semiannual coupon bond newly issued by the Manix
  Corporation, a firm with a credit rating of AA by Moody's. The specifics of the bond purchase are provided
  below given Weaver's projections. It is Cardinal's policy that bonds be evaluated for purchase on a total return
  basis.
  
  One of Cardinal's clients, the Johnson Investment Fund (JIF), has instructed Weaver and McNally to
  recommend the appropriate debt investment for $125,000,000 in funds. JIF is willing to invest an additional
  15% of the portfolio using leverage. JIF requires that the portfolio duration not exceed 5.5. Weaver
  recommends that JIF invest in bonds with a duration of 5.2. The maximum allowable leverage will be used and
  the borrowed funds will have a duration of 0.8. JIF is considering investing in bonds with options and has asked
  McNally to provide insight into these investments. McNally makes the following comments:
  "Due to the increasing sophistication of bond issuers, the amount of bonds with put options is increasing, and
  these bonds sell at a discount relative to comparable bullets. Putables are quite attractive when interest rates
  rise, but, we should be careful if with them, because valuation models often fail to account for the credit risk of
  the issuer."
  Another client, Blair Portfolio Managers, has asked Cardinal to provide advice on duration management. One
  year ago, their portfolio had a market value of $3,010,444 and a dollar duration of $108,000; current figures are
  provided below:
  
  The expected bond equivalent yield for the Manix Bond, using total return analysis, is closest to:
  
  A : 5.92%.
  
  B : 11.86%.
  
  C : 12.12%.
  
  Answer: B
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.
  A : Both of Chang-s comments are correct.
  
  B : Neither of Chang-s comments is correct.
  
  C : Only Chang-s comments regarding disclosure of investment processes are correct.
  
  Answer: C
Question 4
- John Green, CFA, is a sell-side technology analyst at Federal Securities, a large global investment banking and
  advisory firm. In many of his recent conversations with executives at the firms he researches, Green has heard
  disturbing news. Most of these firms are lowering sales estimates for the coming year. However, the stock
  prices have been stable despite management's widely disseminated sales warnings. Green is preparing his
  quarterly industry analysis and decides to seek further input. He calls Alan Volk, CFA, a close friend who runs
  the Initial Public Offering section of the investment banking department of Federal Securities.
  Volk tells Green he has seen no slowing of demand for technology IPOs. "We've got three new issues due out
  next week, and two of them are well oversubscribed." Green knows that Volk's department handled over 200
  IPOs last year, so he is confident that Volk's opinion is reliable. Green prepares his industry report, which is
  favorable. Among other conclusions, the report states that "the future is still bright, based on the fact that 67%
  of technology IPOs are oversubscribed." Privately, Green recommends to Federal portfolio managers that they
  begin selling all existing technology issues, which have "stagnated," and buy the IPOs in their place.
  After carefully evaluating Federal's largest institutional client's portfolio, Green contacts the client and
  recommends selling all of his existing technology stocks and buying two of the upcoming IPOs, similar to the
  recommendation given to Federal's portfolio managers. Green's research has allowed him to conclude that only
  these two IPOs would be appropriate for this particular client's portfolio. Investing in these IPOs and selling the
  current technology holdings would, according to Green, "double the returns that your portfolio experienced last
  year."
  Federal Securities has recently hired Dirks Bentley, a CFA candidate who has passed Level 2 and is currently
  preparing to take the Level 3 CFA® exam, to reorganize Federal's compliance department. Bentley tells Green
  that he may be subject to CFA Institute sanctions due to inappropriate contact between analysts and
  investment bankers within Federal Securities. Bentley has recommended that Green implement a firewall to
  rectify the situation and has outlined the key characteristics for such a system. Bentley's suggestions are as
  follows:
  1. Any communication between the departments of Federal Securities must be channeled through the
  compliance department for review and eventual delivery. The firm must create and maintain watch, restricted,
  and rumor lists to be used in the review of employee trading.
  2. All beneficial ownership, whether direct or indirect, of recommended securities must be disclosed in writing.
  3. The firm must increase the level of review or restriction of proprietary trading activities during periods in
  which the firm has knowledge of information that is both material and nonpublic.
  Bentley has identified two of Green's analysts, neither of whom have non-compete contracts, who are preparing
  to leave Federal Securities and go into competition. The first employee, James Ybarra, CFA, has agreed to
  take a position with one of Federal's direct competitors. Ybarra has contacted existing Federal clients using a
  client list he created with public records. None of the contacted clients have agreed to move their accounts as
  Ybarra has requested. The second employee, Martha Cliff, CFA, has registered the name Cliff Investment
  Consulting (CIC), which she plans to use for her independent consulting business. For the new business
  venture, Cliff has developed and professionally printed marketing literature that compares the new firm's
  services to that of Federal Securities and highlights the significant cost savings that will be realized by switching
  to CIC. After she leaves Federal, Cliff plans to target many of the same prospects that Federal Securities is
  targeting, using an address list she purchased from a third-party vendor. Bentley decides to call a meeting with
  Green to discuss his findings.
  After discussing the departing analysts. Green asks Bentley how to best handle the disclosure of the following
  items: (1) although not currently a board member. Green has served in the past on the board of directors of a
  company he researches and expects that he will do so again in the near future; and (2) Green recently inherited
  put options on a company for which he has an outstanding buy recommendation. Bentley is contemplating his
  response to Green.
  According to Standard 11(A) Material Nonpublic Information, when Green contacted Volk, he:
  
  A : violated CFA Institute Standards
  
  B : violated of CFA Institute Standards unless the contact was disclosed to his clients
  
  C : did not violate CFA Institute Standards since he was conducting a legitimate research activity.
  
  Answer: C
Question 5
- 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:
  
  Which of the following best describes the relative value analysis used in the Northern Capita! Emerging market
  bond fund? It is a:
  
  A : top-down approach.
  
  B : bottom-up approach.
  
  C : combination of a top-down approach and a bottom-up approach.
  
  Answer: B

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Free CFA Institute CFA-Level-III Exam Questions

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