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Level III CFA® Program Question of the Day

June 19 | Answer: B




No manager views were indicated in the question; lacking views, an active manager should take a neutral exposure to the currency. Being underweighted in the assets would produce an underweighting in the currency which is corrected by buying the currency forward. The other two answers are incorrect. Being overweighted would lead to selling the currency forward. A carry trade would buy the higher yield currency in the spot, not forward, market.

June 18 | Answer: B




Both violated Standard VII(A) Conduct as Participants in CFA Institute Programs because they compromised the validity of the examinations.

June 17 | Answer: C




The tax benefit for a tax-exempt account occurs when the funds are withdrawn.

June 16 | Answer: A




A checklist approach actually allows for changes in the model over time.

June 15 | Answer: C




Buy-and-hold investors have less need for liquidity as they have no plans to sell the bonds, therefore, they may prefer to select less liquid bonds in exchange for higher yield. In contrast, active investors will prefer more liquid bonds, reasoning their active management strategies will generate additional return and compensate for lower initial yield.
The YTM of recent trades of bonds with similar features is used to calculate the inferred market price of similar bonds. The presence of prepay features such as a call option makes finding appropriate YTM information more difficult, making inferred price less accurate.
Most bond trading is still done over the counter (in dealer markets) so it means that less liquid bonds trade at higher bid-ask spreads.

June 14 | Answer: A




Spreads do not involve a position in the underlying share. A bear call spread involves buying a higher strike price call and selling a lower strike price call. Because the lower strike price option is more expensive, the maximum gain from this trade is the credit received from the net premiums. In case of a share price decline, the options would become out-of-the-money and the investor keeps the net premium. In case of a share price increase, the investor's loss is limited to the difference between the two call option premiums, less the initial credit received from the net premiums.
A bull put spread is not appropriate as it benefits from a share price increase, not a decline. A collar is not appropriate since it, in addition to trading a call and a put, also involves a position in the underlying share.

June 13 | Answer: A




Inflation-linked bonds are linked to real interest rates, not nominal rates and real rates are generally not as volatile as conventional bonds or equities.

June 12 | Answer: B




By screening the universe and allocating naively for stocks with a low price-to-book ratio the manager will likely be investing in many securities that appear attractively valued, but are correctly priced or even overpriced due to seriously deteriorating business conditions. This is referred to as the value trap.

June 11 | Answer: C




Convertible bonds are typically smaller sized debt offerings from unrated companies. Frequently, shares of these companies are hard to borrow.

June 10 | Answer: C




Life annuities are designed to pay income to the owner as long as the owner is alive. Therefore, unless the insurance company issuing the annuity fails and is unable to make the payments as promised, the annuitant cannot outlive their income.

June 9 | Answer: B




Under source jurisdiction transfer taxes are levied on assets located within (e.g., real estate) or transferred within a country, whether by citizens or foreigners. Under residence jurisdiction citizens and residents pay transfer taxes, regardless of the world-wide location of the assets.

June 8 | Answer: C




Macaulay duration is a simple duration formula that measures the weighted period until an instrument's cash flows will be received. Macaulay duration is also the balancing point at which an instrument's price risk and reinvestment risk are equal. If an investor holds an instrument for less time than its Macaulay duration, then price risk dominates over reinvestment risk. If an investor holds an instrument for a longer time than its Macaulay duration, then reinvestment risk dominates over price risk.
An increase in interest rates will have two opposing effects on a coupon-paying bond. First, the bond's price will decline. Second, the reinvestment return will rise. Given that the investor holds the bond for one year only, less than its Macaulay duration of eight years, then price risk dominates and the investor will realize a loss since the decline in the bond's price will be greater than the additional income from the higher reinvestment return.

June 7 | Answer: C




Management fees and trading commissions are highest for active investing and lowest for market-cap weighted passive investing.

June 6 | Answer: B




Generally speaking, financial capital will be low when an individual enters the workforce and will increase during their working life. Human capital will decrease as retirement approaches. Net worth takes into account an individual's traditional assets and liabilities, whereas their net wealth also takes into account their human capital, pensions and the present value of their future lifestyle costs.

June 5 | Answer: B




A long straddle consists of a long call and put with the same exercise price and the same expiration, at a stock price of $125 the put will expire worthless and the call value will be $25.

June 4 | Answer: B




Idiosyncratic risk comes from large concentrated positions. Quantitative factor-based managers tend to hold many hundreds of position to generate their desired exposures and therefore will likely diversify away idiosyncratic risk. Similarly, an enhanced indexing manager will hold a broad portfolio very close to the benchmark index and therefore is likely to be diversified. Fundamental stock-picking managers are likely to hold fewer positions since they generate few high-conviction ideas through time consuming research, hence are likely to be the least diversified and have the highest contribution to active return from idiosyncratic risk factors.

June 3 | Answer: B




Choice B is correct. If the firm does not disclose the valuation hierarchy that they are employing and is following the GIPS valuation principles, then the firm is using the recommended GIPS valuation hierarchy. The GIPS valuation hierarchy is as follows:
Quoted prices from an active market for the same or similar security.
Quoted prices from an inactive market for the same or similar security.
Observable market-based inputs other than quoted prices.
Subjective, unobservable inputs.
Based on this hierarchy, if observed market prices from an active market are not available, the next best valuation basis is to use quoted prices from an inactive market.

June 2 | Answer: A




Loss aversion, self-control, regret-aversion, and overconfidence are all emotional biases. The other biases would fall under the category of cognitive errors.

June 1 | Answer: A




The Code and Standards do not focus on personal conduct as long as the conduct does not reflect poorly on one's professional reputation, integrity, or competence.

May 31 | Answer: B




Immunizing multiple liabilities requires that the asset portfolio's initial market value equal or exceed the liability market value.

The asset portfolio BPV and liability BPV should very closely match (as opposed to the asset BPV exceeding the liability BPV).

The asset's dispersion of cash flows and convexity should exceed (as opposed to being equal or slightly less than) those of the liabilities.

May 30 | Answer: A




Expected repricing return = change in P/E ratio = 0.5%

Expected income return = dividend yield − increase in shares outstanding = 3.5% − (
−1.0%) = 4.5%

Expected nominal earnings growth = real earnings growth + inflation = 2.1% + 1.9%
= 4.0%

May 29 | Answer: C




The investor should sell £2,000,000 worth of futures contracts for U.S. dollars. This will offset the existing long position in pound-denominated assets. In so doing, the investor has effectively fixed the exchange rate for pounds into dollars for the duration of the futures contract.

May 28 | Answer: B




The Z-spread uses the implied spot yield curve. The other two measures use a single YTM benchmark.

May 27 | Answer: A




Smith would increase her allocation to Treasuries over corporate bonds when significant spread widening is anticipated. Smith would increase her allocation to corporates over Treasuries if she expected significant spread narrowing.

May 26 | Answer: C




The strategy incorporates the time associated between merger announcement and transaction closing which is discounted at the risk free rate. M/A hedge funds also earn additional "premium" from equity holders which reflects the potential that the deal may not successfully close. Similarly, hedge funds are in effect, long a call if a higher bid were to surface. All cash flows are discounted at the risk free rate.

May 25 | Answer: C




The use of a few common factors greatly reduces the number of observations needed to produce a variance-covariance matrix and is a strength of the factor-based approach.

Disadvantages of the factor-based approach are that the matrix is not unbiased and is not consistent.

May 24 | Answer: A




If bonds are issued with negative coupon rates, the duration of the bonds will be longer than the maturity.

May 23 | Answer: B




Value-weighted indices' primary bias is toward large firms that may be mature and/or overvalued. This bias is a result of these large firms having a greater impact on the index than firms with lower market capitalization.

May 22 | Answer: A




A delta of 0.45 implies that for each $1 fall in the share price, the risk reversal would lose $1 × 0.45 × 500 shares = $225. Because the risk reversal delta is positive, the risk reversal strategy has a long exposure to the underlying shares. A delta hedge involving selling 225 shares (= 0.45 x 500) would remove the net exposure to the stock.

May 21 | Answer: A




The taxable account will have the lowest risk because the government essentially shares the risk of the investment with the investor when it is taxed annually. When taxed annually, the standard deviation of the investment returns is reduced by (1– TI).

May 20 | Answer: C




Any act involving lying, cheating, stealing, or other dishonest conduct that reflects adversely on the charterholder's professional activities is a violation of Standard I(D). Although the crime did not relate to the investment profession, it certainly reflected adversely on the charterholder professionally.

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