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
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  • Question 1
    • Pace Insurance is a large, multi-line insurance company that also owns several proprietary mutual funds. The
      funds are managed individually, but Pace has an investment committee that oversees all of the funds. This
      committee is responsible for evaluating the performance of the funds relative to appropriate benchmarks and
      relative to the stated investment objectives of each individual fund. During a recent investment committee
      meeting, the poor performance of Pace's equity mutual funds was discussed. In particular, the inability of the
      portfolio managers to outperform their benchmarks was highlighted. The net conclusion of the committee was
      to review the performance of the manager responsible for each fund and dismiss those managers whose
      performance had lagged substantially behind the appropriate benchmark.
      The fund with the worst relative performance is the Pace Mid-Cap Fund, which invests in stocks with a
      capitalization between S40 billion and $80 billion. A review of the operations of the fund found the following:
      • The turnover of the fund was almost double that of other similar style mutual funds.
      • The fund's portfolio manager solicited input from her entire staff prior to making any decision to sell an existing
      holding.
      • The beta of the Pace Mid-Cap Fund's portfolio was 60% higher than the beta of other similar style mutual
      funds.
      • No stock is considered for purchase in the Mid-Cap Fund unless the portfolio manager has 15 years of
      financial information on that company, plus independent research reports from at least three different analysts.
      • The portfolio manager refuses to increase her technology sector weighting because of past losses the fund
      incurred in the sector.
      • The portfolio manager sold all the fund's energy stocks as the price per barrel of oil rose above $80. She
      expects oil prices to fall back to the $40 to S50 per barrel range.
      A committee member made the following two comments:
      Comment 1: "One reason for the poor recent performance of the Mid-Cap Mutual Fund is that the portfolio
      lacks recognizable companies. I believe that good companies make good investments."
      Comment 2: "The portfolio manager of the Mid-Cap Mutual Fund refuses to acknowledge her mistakes. She
      seems to sell stocks that appreciate, but hold stocks that have declined in value."
      The supervisor of the Mid-Cap Mutual Fund portfolio manager made the following statements:
      Statement 1: "The portfolio manager of the Mid-Cap Mutual Fund has engaged in quarter-end window dressing
      to make her portfolio look better to investors. The portfolio manager's action is a behavioral trait known as overreaction."
      Statement 2: "Each time the portfolio manager of the Mid-Cap Mutual fund trades a stock, she executes the
      trade by buying or selling one-third of the position at a time, with the trades spread over three months. The
      portfolio manager's action is a behavioral trait known as anchoring."
      Indicate whether Statement 1 and Statement 2 made by the supervisor are correct.

      Answer: C
  • Question 2
    • Jack Mercer and June Seagram are investment advisors for Northern Advisors. Mercer graduated from a
      prestigious university in London eight years ago, whereas Seagram is newly graduated from a mid-western
      university in the United States. Northern provides investment advice for pension funds, foundations,
      endowments, and trusts. As part of their services, they evaluate the performance of outside portfolio managers.
      They are currently scrutinizing the performance of several portfolio managers who work for the Thompson
      University endowment.
      Over the most recent month, the record of the largest manager. Bison Management, is as follows. On March 1,
      the endowment account with Bison stood at $ 11,200,000. On March 16, the university contributed $4,000,000
      that they received from a wealthy alumnus. After receiving that contribution, the account was valued at $
      17,800,000. On March 31, the account was valued at $16,100,000. Using this information, Mercer and
      Seagram calculated the time-weighted and money-weighted returns for Bison during March. Mercer states that
      the advantage of the time-weighted return is that it is easy to calculate and administer. Seagram states that the
      money-weighted return is, however, a better measure of the manager's performance.
      Mercer and Seagram are also evaluating the performance of Lunar Management. Risk and return data for the
      most recent fiscal year are shown below for both Bison and Lunar. The minimum acceptable return (MAR) for
      Thompson is the 4.5% spending rate on the endowment, which the endowment has determined using a
      geometric spending rule. The T-bill return over the same fiscal year was 3.5%. The return on the MSCI World
      Index was used as the market index. The World index had a return of 9% in dollar terms with a standard
      deviation of 23% and a beta of 1.0.
      CFA-Level-III-page476-image50
      The next day at lunch, Mercer and Seagram discuss alternatives for benchmarks in assessing the performance
      of managers. The alternatives discussed that day are manager universes, broad market indices, style indices,
      factor models, and custom benchmarks. Mercer states that manager universes have the advantage of being
      measurable but they are subject to survivor bias. Seagram states that manager universes possess only one
      quality of a valid benchmark.
      Mercer and Seagram also provide investment advice for a hedge fund, Jaguar Investors. Jaguar specializes in
      exploiting mispricing in equities and over-the-counter derivatives in emerging markets. They periodically engage
      in providing foreign currency hedges to small firms in emerging markets when deemed profitable. This most
      commonly occurs when no other provider of these contracts is available to these firms. Jaguar is selling a large
      position in Mexican pesos in the spot market. Furthermore, they have just provided a forward contract to a firm
      in Russia that allows that firm to sell Swiss francs for Russian rubles in 90 days. Jaguar has also entered into a
      currency swap that allows a firm to receive Japanese yen in exchange for paying the Russian ruble.
      Regarding their statements about manager universes, determine whether Mercer and Seagram are correct or
      incorrect.

      Answer: C
  • Question 3
    • 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:

      Answer: B
  • Question 4
    • John Rawlins is a bond portfolio manager for Waimea Management, a U.S.-based portfolio management firm. Waimea specializes in the management of equity and fixed income portfolios for large institutional investors such as pension funds, insurance companies, and endowments. Rawlins uses bond futures contracts for both hedging and speculative positions. He frequently uses futures contracts for tactical asset allocation because, relative to cash instruments, futures have lower transactions costs and margin requirements. They also allow for short positions and longer duration positions not available with cash market instruments. Rawlins has a total of approximately $750 million of assets under management. In one of his client portfolios, Rawlins currently holds the following positions:
      CFA-Level-III-page476-image240
      The dollar duration of the cheapest to deliver bond (CTD) is $10,596.40 and the conversion factor is 1.3698.
      In a discussion of this bond hedge, Rawlins confers with John Tejada, his assistant. Tejada states that he has
      regressed the corporate bond's yield against the yield for the CTD and has found that the slope coefficient for
      this regression is 1.0. He states his results confirm the assumptions made by Rawlins for his hedging
      calculations. Rawlins states that had Tejada found a slope coefficient greater than one, the number of futures
      contracts needed to hedge a position would decrease (relative to the regression coefficient being equal to one).
      In addition to hedging specific bond positions, Rawlins tends to be quite active in individual bond management
      by moving in and out of specific issues to take advantage of temporary mispricing. Although the turnover in his
      portfolio is sometimes quite high, he believes that by using his gut instincts he can outperform a buy-and-hold
      strategy. Tejada on the other hand prefers using statistical software and simulation to help him find undervalued
      bond issues. Although Tejada has recently graduated from a prestigious university with a master's degree in
      finance, Rawlins has not given Tejada full rein in decision-making because he believes that Tejada's approach
      needs further evaluation over a period of both falling and rising interest rates, as well as in different credit
      environments.
      Rawlins and Tejada are evaluating two individual bonds for purchase. The first bond was issued by Dynacom, a
      U.S. telecommunications firm. This bond is denominated in dollars. The second bond was issued by Bergamo
      Metals, an Italian based mining and metal fabrication firm. The Bergamo bond is denominated in euros. The
      holding period for either bond is three months.
      The characteristics of the bonds are as follows:
      CFA-Level-III-page476-image239
      3-month cash interest rates are 1% in the United States and 2.5% in the European Union. Rawlins and Tejada
      will hedge the receipt of euro interest and principal from the Bergamo bond using a forward contract on euros.
      Rawlins evaluates these two bonds and decides that over the next three months, he will invest in the Dynacom
      bond. He notes that although (he Bergamo bond has a yield advantage of 1% over the next quarter, the euro is
      at a three month forward discount of approximately 1.5%. Therefore, he favors the Dynacom bond because the
      net return advantage for the Dynacom bond is 0.5% over the next three months.
      Tejada does his own analysis and states that, although he agrees with Rawlins that the Dynacom bond has a
      yield advantage, he is concerned about the credit quality of the Dynacom bond. Specifically, he has heard
      rumors that the chief executive and the chairman of the board at Dynacom are both being investigated by the
      U.S. Securities and Exchange Commission for possible manipulation of Dynacom's stock price, just prior to the
      exercise of their options in the firm's stock. He believes that the resulting fallout from this alleged incident could
      be damaging to Dynacom's bond price.
      Tejada analyzes the potential impact on Dynacom's bond price using breakeven analysis. He believes that
      news of the incident could increase the yield on Dynacom's bond by 0.75%. Under this scenario, he states that
      he would favor the Bergamo bond over the next three months, assuming that the yield on the Bergamo bond
      stays constant. Rawlins reviews Tejada's breakeven analysis and states that though he is appreciative of
      Tejada's efforts, the analysis relies on an approximation.
      Suppose that the original dollar duration for a 100 basis point change in interest rates was $4,901,106 and that
      the bond prices remain constant during the year. Based upon the durations one year from today, and assuming
      a proportionate investment in each of the three bonds, the amount of cash that will need to be invested to
      restore the average dollar duration to the original level is closest to:

      Answer: C
  • Question 5
    • Jacques Lepage, CFA, is a portfolio manager for MontBlanc Securities and holds 4 million shares of AirCon in
      client portfolios. Lepage issues periodic research reports on AirCon to both discretionary and nondiscretionary
      accounts. In his October investment report, Lepage stated, "In my opinion, AirCon is entering a phase, which
      could put it 'in play' as a takeover target. Nonetheless, this possibility appears to be fully reflected in the market
      value of the stock."
      One month has passed since Lepage's October report and AirCon has just announced the firm's executive
      compensation packages, which include stock options (50% of which expire in one year), personal use of
      corporate aircraft (which can be used in conjunction with paid vacation days), and a modest base salary that
      constitutes a small proportion of the overall package. While he has not asked, he believes that the directors of MontBlanc will find the compensation excessive and sells the entire position immediately after the news. Unbeknownst to Lepage, three days earlier an announcement was made via Reuters and other financial news services that AirCon had produced record results that were far beyond expectations. Moreover, the firm has established a dominant position in a promising new market that is expected to generate above-average firm growth for the next five years. A few weeks after selling the AirCon holdings, Lepage bought 2.5 million shares of Spectra Vision over a period of four days. The typical trading volume of this security is about 1.3 million shares per day, and his purchases drove the price up 9% over the 4-day period. These trades were designated as appropriate for 13 accounts of differing sizes, including performance-based accounts, charitable trusts, and private accounts. The shares were allocated to the accounts on a pro rata basis at the end of each day at the average price for the day. One of the investment criteria used in evaluating equity holdings is the corporate governance structure of the issuing company. Because Lepage has dealt with this topic extensively, he has been asked to present a talk of corporate governance issues to the firm's portfolio managers and analysts at the next monthly meeting. At the meeting, Lepage makes the following comments: "When evaluating the corporate governance policies of a company, you should begin by assessing the responsibilities of the company's board of directors. In general, the board should have the responsibility to set long-term objectives that are consistent with shareholders' interests. In addition, the board must be responsible for hiring the CEO and setting his or her compensation package such that the CEO's interests are aligned with those of the shareholders. In that way the board can spend its time on matters other than monitoring the CEO. A firm with good corporate governance policies should also have an audit committee made up of independent board members that are experienced in auditing and related legal matters. The audit committee should have full access to the firm's financial statements and the ability to question auditors hired by the committee." According to the CFA Institute Code and Standards, Lepage's ignorance of AirCon's press release to Reuters three days before he sold shares of the company:

      Answer: A
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