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

Joan Nicholson, CFA, and Kim Fluellen, CFA, sit on the risk management committee for Thomasville Asset

Management. Although Thomasville manages the majority of its investable assets, it also utilizes outside firms

for special situations such as market neutral and convertible arbitrage strategies. Thomasville has hired a

hedge fund, Boston Advisors, for both of these strategies. The managers for the Boston Advisors funds are

Frank Amato, CFA, and Joseph Garvin, CFA. Amato uses a market neutral strategy and has generated a return

of S20 million this year on the $100 million Thomasville has invested with him. Garvin uses a convertible

arbitrage strategy and has lost $15 million this year on the $200 million Thomasville has invested with him, with

most of the loss coming in the last quarter of the year. Thomasville pays each outside manager an incentive fee

of 20% on profits. During the risk management committee meeting Nicholson evaluates the characteristics of

the arrangement with Boston Advisors. Nicholson states that the asymmetric nature of Thomasville's contract

with Boston Advisors creates adverse consequences for Thomasville's net profits and that the compensation

contract resembles a put option owned by Boston Advisors.

Garrison Investments is a money management firm focusing on endowment management for small colleges

and universities. Over the past 20 years, the firm has primarily invested in U.S. securities with small allocations

to high quality long-term foreign government bonds. Garrison's largest account, Point University, has a market

value of $800 million and an asset allocation as detailed in Figure 1.

Figure 1: Point University Asset Allocation

*Bond coupon payments are all semiannual. Managers at Garrison are concerned that expectations for a strengthening U.S. dollar relative to the British pound could negatively impact returns to Point University's U.K. bond allocation. Therefore, managers have collected information on swap and exchange rates. Currently, the swap rates in the United States and the United Kingdom are 4.9% and 5.3%, respectively. The spot exchange rate is 0.45 GBP/USD. The U.K. bonds are currently trading at face value. Garrison recently convinced the board of trustees at Point University that the endowment should allocate a portion of the portfolio into international equities, specifically European equities. The board has agreed to the plan but wants the allocation to international equities to be a short-term tactical move. Managers at Garrison have put together the following proposal for the reallocation: To minimize trading costs while gaining exposure to international equities, the portfolio can use futures contracts on the domestic 12-month mid-cap equity index and on the 12-month European equity index. This strategy will temporarily exchange $80 million of U.S. mid-cap exposure for European equity index exposure. Relevant data on the futures contracts are provided in Figure 2. Figure 2: Mid-cap index and European Index Futures Data

better idea to just formally adopt both the Code and Standards and the Asset Manager Code of Conduct, which would make a detailed policy and procedure manual redundant. Keith wants to assure CMT's compliance with the requirements of the CFA Institute Code and Standards of Professional Conduct. Which of the following statements most accurately describes CMT's responsibilities in order to assure compliance?

Andre Hickock, CFA, is a newly hired fixed income portfolio manager for Deadwood Investments, LLC. Hickock

is reviewing the portfolios of several pension clients that have been assigned to him to manage. The first

portfolio, Montana Hardware, Inc., has the characteristics shown in Figure 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