Overview for Questions #1-5 of 101 Question ID: 1436166

TOPIC: PRIVATE WEALTH MANAGEMENT

TOTAL POINT VALUE OF THIS QUESTION SET IS 15 POINTS

Jane Guthrie is a social media coach. For several years, she has been exclusively
retained by a financially stable public corporation to provide support to its executives
and advice in designing the company's social media message and presentation
strategy. She is 36 years old, believes her skills are highly marketable and, if needed,
she could find comparable employment elsewhere. However, her relationship with
the company is on a one-year renewable employment contract. Her goal is to retire at
age 58. When pressed for an answer, Guthrie believes that she is not much of a risk
taker.

Guthrie has never been married, but 10 years ago, she accepted sole responsibility for
her sister's two children when her sister and her sister's husband were killed in a car
accident. A relatively substantial trust was funded by her sister's life insurance
proceeds and has provided for the children's needs to date and will continue to do so
all the way through four years of college. It is quite certain that both children will start
their undergraduate college education in two years. Guthrie plans to establish an
additional trust to provide for postgraduate education needs and contribute USD
175,000 from one of her existing portfolios to the additional trust within the next year.
Additionally, Guthrie's mother, age 70, is widowed and her health is slowly declining.
Due to rising rents in the city and rising health care costs, her mother's modest
income will soon become insufficient to meet her living needs. Therefore, once the
children move out and begin college, Guthrie plans to have her mother move in with
her so that the elimination of the rent expense will allow her mother's income to meet
her living needs.

Guthrie has a moderately aggressive stock and bond portfolio held in a tax-exempt
account and worth USD 450,000. The funds were accumulated from after-tax
contributions, and any withdrawals made before age 60 would be subject to a very
high tax penalty. Guthrie lives in a tax jurisdiction that has favorable tax treatment for
capital gains. Dividend income is taxed at regular rates, and interest income above
USD 10,000 is subject to an additional tax above regular rates.

Guthrie also has USD 400,000 in a fully taxable portfolio. Included in the portfolio is
USD 200,000 of money market assets. Guthrie is in the 28% income tax bracket
(progressive tax structure).
Guthrie has annual after-tax employment income of USD 150,000 and current living
expenses of USD 100,000. She plans to contribute the difference to her tax-exempt
portfolio annually up to the limit allowed. The balance will go into her taxable
portfolio at the end of each year.

Question #1 of 101 Question ID: 1436167

State and discuss two factors that reduce Guthrie's ability to bear risk.

Question #2 of 101 Question ID: 1431120

Discuss Guthrie's time horizon.

Question #3 of 101 Question ID: 1431121

Discuss Guthrie's liquidity needs.

Question #4 of 101 Question ID: 1431122

Assume that capital gains make up most of stock returns, are taxed at a lower rate
than other investment income, and that Guthrie is a passive investor planning to hold
all securities for long periods. State where Guthrie would most likely be better off
holding her stocks and her bonds: in her taxable or tax-exempt portfolio. Then,
explain why. To answer the question, assume stocks must be held in one account and
bonds in the other.

Question #5 of 101 Question ID: 1431123

Assume that Guthrie plans to accumulate a USD 50,000 emergency cash reserve.
Explain whether the reserve should be held in her tax-exempt or taxable portfolio if
the goal is to minimize taxes on the cash withdrawal.

Overview for Questions #6-8 of 101 Question ID: 1436168

TOPIC: ASSET ALLOCATION AND PRIVATE WEALTH MANAGEMENT

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Jane Guthrie is now 42 years old. Due to a severe recession, she was underemployed
for a couple of years. While she was underemployed, she found a few part-time
opportunities and returned to university for an MBA degree. During that period, she
substantially reduced her investment portfolio.

Three years ago she took a position with a small, private startup company as Senior
Vice President for product marketing. Guthrie along with two other individuals
essentially control the company, and the company has been quite successful so far.
While her immediate compensation is moderate and she has been unable to add to
her portfolio from savings, she has received restricted stock grants in the company of
50,000 shares in lieu of direct monetary compensation. The employer stock currently
comprises over 40% of her total investment portfolio.

She consults Kate VonLee, CFA, to assist her in developing a financial plan. VonLee
suggests an investment strategy involving a personal bank loan to generate some
liquidity from her portfolio so that Guthrie may use those funds to pursue investment
diversification opportunities. If undertaken, Guthrie intends to fully repay the loan
and will make all interest payments during the term of the loan.

Fifteen years later, Guthrie is 57 years old and considering retirement. She again turns
to VonLee, seeking advice on whether she has the resources to retire now or if she
should continue to work for another three years. VonLee runs Monte Carlo
simulations to present to Guthrie.

Question #6 of 101 Question ID: 1431125

State how Guthrie's decision to pursue the MBA has affected her allocation between
financial and human capital over the last few years and justify with two reasons.
State how her decision could have increased her total wealth.

Question #7 of 101 Question ID: 1436169

State how VonLee's suggestion of the personal bank loan would operate. Identify
three benefits of the bank loan.

Question #8 of 101 Question ID: 1436170

Describe two benefits of using Monte Carlo analysis when considering Guthrie's
decision to retire now or in three years.

Overview for Questions #9-15 of

101 Question ID: 1436150

TOPIC: BEHAVIORAL FINANCE

TOTAL POINT VALUE OF THIS QUESTION SET IS 15 POINTS

Thomas Simms, CFA, is a client manager for Bueno Capital Management ("Bueno"), an
asset management firm located in Manhattan. For several months, Simms has
expressed his concern in adhering to the firm's strategy to adopt traditional capital
market theory for asset allocation purposes. He believes the theory should be
complemented with behavioral finance perspectives to help gain better insights into
market and client behavior.

Simms is currently reviewing the profiles of some of his individual clients. He has
compiled some notes describing their specific attributes and personality traits.

Shortly after receiving his quarterly investment reports, Client 1 generally calls
Simms to instruct him to reallocate his invested funds out of stocks that have
risen into stocks that have declined over the past quarter.
 Client 2 is a high-net-worth investor whose wealth has considerably increased
over the past decade. He attributes his financial success to his methodical
approach in running separate custodian accounts for each asset class category.
For instance, he holds four separate custodian accounts for his investments in
domestic small cap stocks, overseas growth stocks, domestic value stocks, and
domestic large cap stocks. He believes that his much disciplined approach of
separating funds this way has helped him to stay in control of his finances and
make the most appropriate financial decisions at all times.
Client 3 is a new client who has regularly expressed some objections against
Simms's recommendation to increase the equity exposure in his asset portfolio.
Client 3 had the tendency of favoring bond investment because of selectively
reading articles and journals that talk highly of fixed income investments.
Moreover, she is very confident about solid performance in the bond market
because many of her friends have built up substantial wealth by investing in the
bond market. However, in a recent meeting with Client 3, Simms has observed
the change in her attitude toward stocks when he took time to explain to her
the purpose of gradually increasing the exposure level to stocks. In short,
Simms explained that in an asset portfolio, bonds tend to provide an effective
solid investment base while public listed stocks could potentially improve her
long-term living standard without so much impacting her lifestyle. Client 3
showed a keen interest in Simms's explanation and was willing to learn more
about the long-term benefits of equity investing. More recently, Client 3 has
sent Simms an email requesting for an increase in her equity investment
exposure in her asset portfolio.

Three weeks ago, Simms met with a new client, Albert Jenkins, who is a middle-level
corporate finance executive working for a large Nasdaq-listed blue chip corporation
based in West Virginia. Jenkins, aged 55, and his wife, aged 52, are both in excellent
health and have combined wealth in excess of $50 million. At the meeting, Jenkins
spent most of the time talking about the significant role he played in developing all
the successful strategies that were employed by the company. He added that through
his involvement, the company had enjoyed a significant increase in value. This in turn
has led to a considerable increase in the value of his stock options. Jenkins further
explained that when the corporation later began to pursue broader diversification by
investing offshore, he decided to shift a large part of his investment into emerging
market pooled funds and high yield bonds. This strategy helped him triple his wealth.
He then further enhanced these gains by adopting call option strategies. Jenkins
suggested that ideally Simms should keep pursuing those strategies when managing
Jenkins's portfolio to help maintain these excellent returns.
Last week, Simms met with Jenkins for a second time to officially review his financial
situation and establish an investment mandate and policy statement. Upon discussing
risk-return objectives and constraints, Jenkins underscored the importance of
meeting, at a minimum, the return levels previously achieved. Jenkins added that he
believed the asset allocation and strategies, as discussed in their previous meeting,
were by far the best techniques that could help achieve those returns.

Question #9 of 101 Question ID: 1431042

Identify the psychological tendency most likely exhibited by Client 1.

A) Gambler’s fallacy.
B) Anchoring and adjustment bias.
C) Disposition effect.

Question #10 of 101 Question ID: 1431043

For your answer to the previous question, explain the psychological tendency most
likely exhibited by Client 1.

Question #11 of 101 Question ID: 1431044

Identify the psychological bias most likely being displayed by Client 2.

A) Illusion of control.
B) Mental accounting.
C) Regret aversion.
D) Confirmation bias.

Question #12 of 101 Question ID: 1431045

For your answer to the previous question, explain the psychological bias most likely
being displayed by Client 2.

Question #13 of 101 Question ID: 1431046

Using the Pompian behavioral model, identify the investor category to which Client 3
most likely belongs.

A) Independent individualist.
B) Friendly follower.
C) Active accumulator.

Question #14 of 101 Question ID: 1431047

Based on your answer to the previous question, and using the case facts, explain four
of the behavioral biases associated with the investor category to which Client 3 most
likely belongs (e.g., the passive preserver has behavioral biases of endowment, mental
accounting, loss aversion, etc.).

Question #15 of 101 Question ID: 1436151

Simms is currently preparing an investment profile for his new client, James Jenkins.
Identify one cognitive bias and one emotional bias typical to Jenkins's psychological
personality. Justify your answer by providing one reason for determining each of
those biases.

Overview for Questions #16-20 of

Question ID: 1431128
101

TOPIC: INSTITUTIONAL INVESTORS

TOTAL POINT VALUE FOR THIS QUESTION SET IS 10 POINTS

The Astney Foundation was funded in 1951 by the heirs of a large brewing fortune.
The foundation's sole purpose is to support training for gifted young skiers in the
United States in perpetuity. Yearly grants are provided to children between the ages
of 9 and 15 to cover training, living accommodations, and education at Astney
Mountain School. The $25 million portfolio is expected to generate a real return of 4%
and cover operating expenses of 0.75%. General inflation is estimated at 2.5%, while
costs covered by the foundation are expected to increase at 3.5%. The foundation is
tax exempt, subject to no minimum payout requirement, and the trustees have
expressed a strong desire to generate a 3% annual income return.

Question #16 of 101 Question ID: 1431129

State the return objective of the foundation.

Question #17 of 101 Question ID: 1431130

Calculate the foundation's required annual nominal rate of return.

Question #18 of 101 Question ID: 1431131

Calculate the dollar amount that can be distributed over the coming year that is
consistent with the foundation's long-term goals.

Question #19 of 101 Question ID: 1431132

Discuss how the foundation's time horizon and inflation affect its risk tolerance. The
perpetual time horizon of the foundation increases its ability to bear risk.
Question #20 of 101 Question ID: 1431133

Explain how two other factors from the case information directly affect the risk
objective.

Overview for Questions #21-28 of

101 Question ID: 1436177

TOPIC: FIXED INCOME

TOTAL POINT VALUE OF THIS QUESTION SET IS 15 POINTS

Winnifred Cline is an analyst working for the fixed income investment management
team of a large multi-strategy hedge fund denominated in U.S. dollars. She is
responsible for monitoring portfolio exposure to fixed income risk factors and helping
managers construct portfolio positions based on their active view of fixed income
markets.

Cline is reviewing a recent yield curve trade in zero-coupon German government

bonds. The positions originally taken by the investment team are provided below in
Exhibit 1.

Exhibit 1: Yield Curve Trade in Zero-Coupon German Government Bonds

Par Value (€M) Maturity (years) Price Yield Modified Duration Convexity

-60 3 101.607 0.53% 3.02 12.2

10 9 96.904 0.35% 8.97 88.8

Shortly after placing the trade, 3-year yields fall by 10 basis points and 9-year yields
fall by 30 basis points.

Cline notices that the yields on short-term German government bonds are negative.
She asks Alex Carr, a senior fixed income portfolio manager, how negative yields have
impacted fixed income investment management markets. Carr makes the following
two statements:

Statement 1: "Zero-coupon bonds with negative yield are expected to have a

negative rolldown return."

Statement 2: "Negative yields mean that the swap carry trade has reversed. To
 earn positive swap carry, now an investor must receive floating
and pay fixed."

Cline notes that the U.S. has lower interest rates than the interest rates in the
countries for the foreign currencies held within the portfolio. She also notes that the
fund does not hedge exposure to those foreign currencies by selling them forward
and buying U.S. dollars. When Cline inquires with Carr about it, Carr responds by
stating that the managers do not hedge foreign currency exposure in the fund
because they believe that the relevant foreign currency markets exhibit forward rate
bias.

Question #21 of 101 Question ID: 1431084

Based on the data in Exhibit 1, which of the following yield curve scenarios are
investment managers most likely expecting?

A) Bear steepening.
B) Bear flattening.
C) Bull steepening.
D) Bull flattening.

Question #22 of 101 Question ID: 1436160

Justify your selection to the previous question.

Question #23 of 101 Question ID: 1431086

Calculate the net profit or loss, to the nearest €'000, from the trade in the zero-
coupon German government bonds after the subsequent change in the yield curve.

Question #24 of 101

Question #24 of 101 Question ID: 1431087

For Statement 1, regarding the impact of negative yields made by Carr, select
whether it is correct or incorrect.

A) Correct.
B) Inorrect.

Question #25 of 101 Question ID: 1431088

For the previous question, justify your selection.

Question #26 of 101 Question ID: 1431089

For Statement 2, regarding the impact of negative yields made by Carr, select
whether it is correct or incorrect. Justify your selection.

A) Correct.
B) Incorrect.

Question #27 of 101 Question ID: 1436161

Justify your selection for the previous question.

Question #28 of 101 Question ID: 1431091

Explain how forward rate bias existing in the foreign currency markets relevant to the
fund justifies the managers' view that foreign currency exposure in the fund should
not be hedged.
Overview for Questions #29-33 of
101 Question ID: 1436175

TOPIC: ASSET ALLOCATION

TOTAL POINT VALUE OF THIS QUESTION SET IS 14 POINTS

Martin Bradbury is an investment advisor with Sandra Jones Associates, an

investment management firm based in Gettysburg, Pennsylvania. Eleanor Carter is a
client with whom Bradbury is in discussion with a view to developing an appropriate
strategic asset allocation. Carter has $1.25 million to invest, and Bradbury assesses
that she has a below-average level of risk tolerance (λ = 6).

Exhibit 1 presents key statistics on four possible strategic asset allocations for Carter
(all are efficient portfolios, derived using a mean-variance optimization technique).
The Sharpe ratios are calculated assuming a risk-free rate of 2.5% (and all return
figures are in pretax nominal terms).

Exhibit 1: Strategic Asset Allocations

Asset
A B C D
Allocation

Expected
3.8% 6.7% 9.6% 12.9%
return

Standard
3.7% 5.9% 10.5% 16.8%
deviation

Sharpe
0.351 0.712 0.676 0.619
ratio

MSCI
World ex.
4.7% 7.6% 13.5% 22.9%
USA
weighting

Carter will need to make a loan payment of $40,000 in 12 months' time, which will
necessitate a withdrawal of funds from the portfolio at that point. Bradbury ascertains
that Carter's goal is that the real value of the portfolio, having made this payment,
should not fall below its current level—assuming an inflation rate of 2%. Withdrawals
from the portfolio will be taxed at 20%.

Bradbury also advises Frank Mosta, a childless widower who recently retired with total
assets of $12 million. Mosta has two goals that he wishes to achieve during his
retirement.

Goal 1: Mosta wishes to have a 90% chance of transferring $9 million to

his sister's children in 12 years.

Goal 2: Mosta wishes to have a 70% chance of being able to donate $18
million to a foundation in 20 years.

Bradbury recommends the adoption of a goals-based portfolio construction

approach, and he develops a set of modules (subportfolios) that are shown in Exhibit
2. Bradbury suggests that any excess capital should be invested in Module W.

Exhibit 2: Subportfolio Modules Under Various Horizon and Probability Scenarios

Module W X Y Z

Expected return 5.2% 7.2% 8.6% 9.4%

Standard deviation 4.2% 6.1% 8.8% 11.4%

Annualized Minimum Expectation Returns

Time Horizon (Years): 12

Required success: 90% 3.7% 4.9% 5.3% 5.2%

80% 4.2% 5.7% 6.5% 6.6%

70% 4.6% 6.3% 7.3% 7.7%

60% 4.9% 6.8% 8.0% 8.6%

Time Horizon (Years): 20

Required success: 90% 4.0% 5.5% 6.1% 6.1%

80% 4.4% 6.1% 6.9% 7.3%

70% 4.7% 6.5% 7.6% 8.1%

60% 5.0% 6.9% 8.1% 8.8%

Question #29 of 101 Question ID: 1431062

Based only on risk-adjusted expected returns for the asset allocations, identify which
allocation in Exhibit 1 Bradbury should recommend for Carter.
A) Allocation A.
B) Allocation B.
C) Allocation C.
D) Allocation D.

Question #30 of 101 Question ID: 1431063

Justify your choice of allocation in the following space.

Question #31 of 101 Question ID: 1431064

Identify which allocation in Exhibit 1 Bradbury should recommend for Carter in order
to minimize the likelihood that the portfolio fails to meet her goal regarding real
value.

A) Allocation A.
B) Allocation B.
C) Allocation C.
D) Allocation D.

Question #32 of 101 Question ID: 1431065

Justify your choice in the following space and state any assumptions you have made
including calculations.

Question #33 of 101 Question ID: 1431066

State and justify the overall asset allocation for Mosta given his two goals and
Bradbury's suggestion for investing any excess capital. Your answer should be in
terms of the percentage of total assets invested in each module.

Overview for Questions #34-41 of

101 Question ID: 1436179

TOPIC: EQUITY

TOTAL POINT VALUE OF THIS QUESTION SET IS 14 POINTS

Mari Fujimoto, CFA, is an equity portfolio manager. After a period of weak equity
returns, the current economic environment is now one of strong equity returns and
rising interest rates.

This morning, Fujimoto is meeting with new client, Ken Liu. Liu does not believe in
market efficiency and is not overly concerned about management fees. Liu wants to
invest in only specific markets and to avoid investing in stocks pertaining to alcohol
and tobacco.

Wilson plans that his portfolio be invested in some combination of these three asset
classes.

Additionally, Fujimoto manages an index fund for an institutional client. The fund has
a diversified and stable holding of stocks. Fujimoto would like to begin engaging in
securities lending whereby the fund would lend some of its shares in exchange for
cash collateral and a lending fee. She feels it would be an excellent way to generate
additional portfolio income for the client.

Over time, Fujimoto engages in two general types of transactions for the index fund:

Transaction type 1: periodic reweighting of the stocks in the index

Transaction type 2: adding and deleting stocks in the index

Fujimoto is giving a presentation on the role of equities in a portfolio. One of her

colleagues has drafted the following two statements for her to review:

Statement 1: Over both short and long periods of time, dividends have
comprised a significant component of total returns for
equity investors.

Statement 2: During periods of market crisis, correlations across asset

 classes and among equities themselves often decrease.

Question #34 of 101 Question ID: 1431098

State whether Liu's portfolio is likely to be passively or actively managed.

A) Passively managed.
B) Actively managed.

Question #35 of 101 Question ID: 1431099

Justify your choice with two reasons.

Question #36 of 101 Question ID: 1436163

Identify and discuss two additional factors that Fujimoto should consider before
engaging in securities lending.

Question #37 of 101 Question ID: 1431101

State the correct term to describe each transaction type that Fujimoto has
undertaken for the index fund.

Question #38 of 101 Question ID: 1431102

Identify whether Statement 1 is correct or incorrect.

A) Statement 1 is correct.
B) Statement 1 is incorrect.

Question #39 of 101 Question ID: 1431103

If you chose "incorrect," justify why or rewrite. If you chose "correct," enter that in the
following space.

Question #40 of 101 Question ID: 1431104

Identify whether Statement 2 is correct or incorrect.

A) Statement 2 is correct.
B) Statement 2 is incorrect.

Question #41 of 101 Question ID: 1431105

If you chose "incorrect," justify why or rewrite. If you chose "correct," enter that in the
following space.

Overview for Questions #42-46 of

101 Question ID: 1436176

TOPIC: FIXED INCOME

TOTAL POINT VALUE OF THIS QUESTION SET IS 14 POINTS

Jack Walsh manages the assets for a large European airline's defined benefit (DB)
pension plan. The DB plan is currently underfunded with a deficit of £3.5 billion. The
DB plan's projected benefit obligation (PBO) is currently £16 billion and has an
estimated duration of 12.
The plan assets are split into two portions: return seeking and liability matching. The
return-seeking assets (equity-based ETFs and alternative investments) are held to
generate returns in excess of risk-free assets and comprise 56% of the plan assets.
The liability-matching assets (UK government treasury bonds [gilts] and investment-
grade corporate bonds) comprise the remaining 44% of plan assets and have a
duration of 13.

Exhibit 1 provides futures pricing data.

Exhibit 1

UK Long Gilt Futures Specifications

Futures price £118.50

Futures contract size £100,000

CTD 2.50% coupon 19 years to redemption

CTD price £96.32

CTD conversion factor 0.8017

CTD modified duration 14.95

Walsh also considers eliminating the duration gap by using over-the-counter (OTC)
interest rate swaps shown in Exhibit 2.

Exhibit 2

£Fixed vs. £LIBOR Interest Rate Swap

Fixed side duration 12.5

Floating side duration 0.5

Walsh believes that interest rates will rise. Ideally, he would hedge less than 100% of
the duration gap to benefit the DB plan if his belief about interest rates is correct.
However, the plan trustees require him to hedge 100% of the duration gap.

The plan trustees monitor the performance of the return-seeking portion of the
portfolio relative to pre-determined indexes. The trustees use two indexes to monitor
the performance of the liability-matching portion: a UK investment-grade bond index
and a UK government bond index. Walsh aims to minimize tracking risk but believes it
is more difficult to do so in fixed income markets compared to other major asset
classes such as public equity.
Question #42 of 101 Question ID: 1431078

Calculate the number of futures contracts that Walsh must buy/sell to hedge the
duration gap (indicate a plus sign for buy or a minus sign for sell).

Question #43 of 101 Question ID: 1436157

Select the type of swap position (pay fixed or receive fixed) that Walsh would use as
an alternative to the futures transaction in the previous question.

A) Pay fixed.
B) Receive fixed.

Question #44 of 101 Question ID: 1431080

Calculate the notional principal of the swap that Walsh would use as an alternative to
the futures transaction in Question 42.

Question #45 of 101 Question ID: 1431081

Identify a derivative overlay that will enable Walsh to benefit from his forecast
change in interest rates while remaining fully hedged if his forecast turns out to be
incorrect. Explain how this product will allow him to benefit from his forecast while
remaining fully hedged.

Question #46 of 101 Question ID: 1436158

Discuss two reasons why tracking risk is difficult to eliminate, even for fixed income
portfolios that aim to fully replicate the index.
Overview for Questions #47-52 of
101 Question ID: 1436174

TOPIC: CAPITAL MARKET EXPECTATIONS

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Maria Gonzales is a trainee analyst with Southern Corp, a large investment

management firm. She is currently working with the capital market forecasts teams,
who generate expected return and covariance projections for use in the asset
allocation and stock selection processes.

Gonzales has been comparing notes with Romola Roberts, who is a more experienced
member of this team, and in a conversation with her, Gonzales has made the
following statement: "The use of the shrinkage estimator approach to parameter
estimation will result in smaller values being used for the estimated covariances
between markets than the values observed in the historical covariance matrix."

Roberts explains to Gonzales the use of the Singer-Terhaar ICAPM-based approach to

the estimation of market expected returns. She provides an illustration (for the
purpose of the exercise, the domestic risk free is assumed to be 2.5%):

Equities in the country of Zubrowka are predicted to have a standard

deviation of 22% per annum, and a correlation with the global investable
market of 0.63. The Zubrowka equity market has been estimated as 75%
integrated with the global market, and the risk-free rate in Zubrowka is
currently 4.3%. The global market Sharpe ratio can be assumed to be 0.32

Pamèla Gonzales, Maria's sister, has a $3 million U.S. equity portfolio. She is
considering rebalancing the portfolio based on an assessment of the risk and return
prospects facing the U.S. economy. To help in the assessment, the information in
Exhibit 1, pertaining to U.S. investment markets and the economy, has been provided
by Maria.

Exhibit 1: U.S. Capital Markets Data

10-Year Historical Current Expectations

Average 10-year 10-year

government bond government bond
yield: 5.3% yield: 3.1%

Average annual equity Year-over-year

return: 6.2% equity return:
 2.4%

Year-over-year
Average annual
inflation rate: Expected annual inflation: 1.4%
inflation rate: 2.4%
3.1%

Equity market P/E

Current equity Expected equity market P/E in one year:
(beginning of period):
market P/E: 13.2 12.5
14.0

Average annual
Expected annual income return: 1.7%
income return: 2.2%

Average annual real Expected annual real earnings growth:

earnings growth: 5.8% 4.8%

Expected annual change in shares

outstanding (due to net repurchases): –
0.5%

Question #47 of 101 Question ID: 1431055

State whether Gonzales's statement regarding shrinkage estimators is correct or

incorrect.

A) The statement is correct.

B) The statement is incorrect.

Question #48 of 101 Question ID: 1431056

If you chose "incorrect," explain what is wrong with it.

Question #49 of 101 Question ID: 1431057

Compute the expected percentage return from Zubrowka equities that should be
computed by Roberts based on the Singer-Terhaar financial equilibrium model.
Question #50 of 101 Question ID: 1431058

Calculate the historical U.S. equity risk premium using the bond yield plus risk
premium method.

Question #51 of 101 Question ID: 1431059

Calculate the expected annual U.S. equity return using the Grinold-Kroner model.

Question #52 of 101 Question ID: 1436153

Using your answer to the previuos question, calculate the expected annual U.S.
equity risk premium. Provide your answer as a percentage.

Overview for Questions #53-57 of

Question ID: 1436180
101

TOPIC: TRADING, PERFORMANCE EVALUATION, AND MANAGER SELECTION

TOTAL POINT VALUE OF THIS QUESTION SET IS 11 POINTS

Callisto Funds, Inc., offers a range of actively-managed equity funds that are
aggressively marketed to asset managers for inclusion in the portfolios they manage
on behalf of their high net worth clients.

Meryl Andrews works at Amalthea Asset Management as a relationship manager. She

has recommended many of Callisto's funds to her clients, as elements in their multi-
asset class portfolios, but has recently been disappointed by the returns that some of
these funds have produced (as have her clients).

Callisto's Latin Opportunity Fund (LOF) is benchmarked against the S&P Latin
American 40 index. Data for the fund and the benchmark for the last calendar year
are given in Exhibit 1:
Exhibit 1 – Performance of the Callisto Latin Opportunity Fund and its
Benchmark for the last calendar year

LOF Benchmark

Weight Return Weight Return

Brazil 59.0% 31.0% 62.0% 31.2%

Chile 11.0% -14.8% 8.7% -16.9%

Colombia 5.0% 29.4% 2.6% 31.0%

Mexico 19.0% 12.4% 22.5% 11.2%

Peru 6.0% 2.2% 4.2% 4.8%

Total 100.0% 100.0% 21.4%

Andrews undertakes an attribution analysis of the performance of the LOF in this

period, focussing on the country-level data provided in exhibit 1. For each country she
calculates attribution, selection, and interaction effects, using the Brinson-Fachler
methodology.

Andrews computes the allocation effect for Mexico in the last calendar year as being
-0.39%, which she justifies by saying that "Mexico was underweighted in the LOF,
compared to the benchmark, thus we would expect a negative value in respect of
allocation".

Question #53 of 101 Question ID: 1431140

Identify whether the form of attribution analysis being conducted by Andrews is best
described as a micro attribution or macro attribution.

A) Micro.
B) Macro.

Question #54 of 101 Question ID: 1431141

Justify your choice of micro or macro.

Question #55 of 101 Question ID: 1431142

State which one of the following five countries had the most adverse selection effect
in the last calendar year.

A) Brazil.
B) Chile.
C) Colombia.
D) Mexico.
E) Peru.

Question #56 of 101 Question ID: 1431143

Critique Andrews's remark regarding Mexico's allocation effect.

Question #57 of 101 Question ID: 1431144

Compute the correct value for Mexico's allocation effect.

Overview for Questions #58-63 of

101 Question ID: 1436172

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

TOTAL POINT VALUE OF THIS QUESTION SET IS 18 POINTS

Rowan Brothers is a full-service investment firm offering portfolio management and

investment banking services. For the last 10 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 for whom he has full discretion is
Shelby Pavlica, a widow in her late 60s whose husband died and left assets of over $7
million in a trust. The assets are to be used solely for her benefit.

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, a fact
previously not known by her children.

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, King explains his reasoning for 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 for Pavlica's portfolio is 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.

Question #58 of 101 Question ID: 1431151

In discussing Pavlica's spending and medical condition with Pavlica's children, did King
violate any CFA Institute Standards of Professional Conduct?

No. Because the children are the remaindermen, King is obligated to manage the
A)
trust in the best interest of both Pavlica and the children.
B) Yes, because he violated his client’s confidentiality.
C) Yes, because he created a conflict of interest between himself and his employer.

Question #59 of 101 Question ID: 1431152

In reallocating the portfolio after the meeting with Pavlica's children, did King violate
any CFA Institute Standards of Professional Conduct?

A) No, because King has discretion over the portfolio.

B) Yes, he violated Standard III(A) Loyalty, Prudence, and Care.
C) No, because he had a reasonable basis for making adjustments to the portfolio.

Question #60 of 101 Question ID: 1431153

In his statements to Pavlica after the reallocation, did King violate any CFA Institute
Standards of Professional Conduct?

A) No.
B) Yes, because he misrepresented the expected performance of the strategy.
Yes, because he met with her before their annual meeting, which is unfair to clients
C)
who only meet with King annually.

Question #61 of 101 Question ID: 1431154

Did King's actions with regard to allocating the private placement and the sale of VNC
stock violate any CFA Institute Standards of Professional Conduct?

Private placement VNC sale

A) Yes Yes

B) No No

C) No Yes

Question #62 of 101 Question ID: 1431155

According to the CFA Institute Standards of Professional Conduct, which of the

following statements is most correct concerning King's directorship with ShaleCo?

A) King may not accept the directorship because it creates a conflict of interest.
B) King may accept the directorship as long as it is disclosed to clients and prospects.
King may accept the directorship as long as it is disclosed to his employer, clients,
C)
and prospects.

Question #63 of 101 Question ID: 1436173

Does the fee structure at Rowan Brothers and King's disclosure of the compensation
structure violate any CFA Institute Standards of Professional Conduct?

Fee structure Disclosure

A) No Yes

B) Yes No

C) No No

Overview for Questions #64-67 of

101 Question ID: 1431157

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Garrett Keenan, CFA, is employed by Gold Standard Bank (GSB), in the Capital Markets
Division. The GSB Board of Directors has recently made two decisions: a leveraged co-
invest fund is to be created for the benefit of senior-level employees of GSB, and a
hedge fund is to be constructed which will be marketed to high net worth Trust
Department clients and prospects. Both of the new entities will be fund-of-funds (FOF)
managed on behalf of GSB by "third party" managers that Keenan will select.

Keenan first researched the available pool of hedge fund managers, and compiled a
report on a subset that was based primarily on historical performance record. The 60
managers selected for further review were tiered into three groups according to their
3-year track record. Of the 20 managers in the highest performing tier, Keenan
selected 15 managers for the employee leveraged co-invest FOF. The other five
managers in the top tier were selected along with the 20 hedge fund managers in the
second tier for the FOF to be marketed to high net worth trust clients.

While screening hedge fund managers, Keenan came across his college friend, John
Carmichael, one of the principals at the hedge fund management firm Bryson
Carmichael (BC). Because BC's track record met Keenan's criteria for inclusion in one
of the FOFs, BC was selected. Upon being informed of this development, Carmichael
called Keenan to express his appreciation, and during that conversation, offered
Keenan the use of Carmichael's mountain house resort. Over the next year, Keenan
and his family spent two long weekends at Carmichael's mountain house. In
appreciation for his stay, Keenan promised to take Carmichael's two children to Walt
Disney World (free of charge) during their planned upcoming summer vacation
(assuming Keenan's wife can take time off from her independent medical practice).
Carmichael accepted this invitation, but was told by Keenan to keep the invitation
confidential.

Another hedge fund manager being considered for inclusion was Barry Grant. Grant
had been actively soliciting investors for his hedge fund and offered to pay Keenan a
personal fee of $200 if Keenan accepted Grant's fund into one of GSB's FOFs. Because
Grant's fund performance was within Keenan's acceptable guidelines, Keenan refused
to accept the fee. However, Keenan told Grant that if his fund were able to beat the
benchmark return by at least 1% during the first annual measurement period, he
would be happy to accept his one-time fee. Keenan later mentioned this arrangement
to his direct supervisor during their weekly meeting.

Once Keenan had finished the manager selection process, he was asked to offer a
training seminar to the Trust Department's sales force. In that training, Keenan
reviewed the agreed upon forms of compensation that the hedge funds would
receive: (a) a 2% fee on assets under management, and (b) 20% of the returns over a
high water mark. While the sales force was instructed to inform prospective FOF
clients that "past performance is no guarantee of future results," Keenan
recommended that the sales force emphasize positive rather than negative aspects of
the fee earned on returns over the high water mark. Keenan said, "Your clients should
not worry about the managers failing to outperform each year, because the profits on
returns over the high water mark are how they make their real money." Keenan also
instructed the sales force to emphasize the combined number of CFA charterholders
on the management teams of the hedge funds in the FOF and provide a factual
description of the requirements to become CFA charterholders.

Question #64 of 101 Question ID: 1431158

During his initial selection of the managers for the two FOFs, which of the following
Standards did Keenan least likely violate?

A) Independence and Objectivity.

B) Performance Presentation.
C) Fair Dealing.
Question #65 of 101 Question ID: 1431159

By accepting the use of John Carmichael's mountain house, Keenan:

A) violated the Diligence and Reasonable Basis Standard.

B) violated the Independence and Objectivity Standard.
C) did not violate a Standard.

Question #66 of 101 Question ID: 1431160

Assuming that Grant's fund beats the benchmark return by 1.5% the first year and
Keenan receives the $200 fee, the Additional Compensation Arrangement Standard
was:

A) not violated because the amount of the one-time fee was not material.
B) not violated because Keenan disclosed the fee arrangement to his supervisor.
C) violated as Keenan failed to get the written consent from Grant and his supervisor.

Question #67 of 101 Question ID: 1431161

In his presentation to the bank Trust Department sales force, Keenan:

violated the Misrepresentation Standard by describing the hedge funds’ fee

A)
structure as a mechanism for delivering better returns.
violated the Misrepresentation Standard by mentioning the number of CFA
B)
charterholders on the FOF management teams.
C) was in compliance with the Standards.

Overview for Questions #68-71 of

101 Question ID: 1431134

TOPIC: INSTITUTIONAL INVESTORS

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Citlalli Aquinox and Sandra Nguyen work for an investment consulting company called
Hamilton Consultants. Hamilton provides expertise about strategy, asset allocation,
and liquidity management to various types of institutional investors globally.
Hamilton's current customer set includes defined benefit pension plans,
endowments, foundations, and insurance companies (both life insurance and non-
life). Furthermore, Hamilton is seeking to take on clients who are sovereign wealth
funds.

Hamilton has recently hired a new analyst named William Lara. While explaining asset
allocation and sovereign wealth funds to Lara, Aquinox makes the following
statement:

Budget stabilization sovereign wealth funds should attempt to earn more

than the inflation rate while preserving capital. These funds should
generally invest in the same natural resource, commodity, or industry
from which the nation's revenues are derived, in order to provide price
support to those resources or industries and thus support the national
interests. Savings funds should invest for the very long term in order to
provide support for future generations.

Nguyen points out that savings funds, reserve funds, and pension reserve funds all
invest heavily in private equity and real assets, because these funds all have low
liquidity needs. Nguyen states that savings funds generally have a lower allocation to
alternative investments than do reserve funds.

After studying the most common asset allocation strategies for institutional investors,
Lara makes a report to Aquinox and Nguyen that includes the following statements:

Statement 1: Norway's Sovereign Wealth Fund has the potential for market
outperformance due to a significant exposure to alternative
investments and many actively managed assets.

Statement 2: The main difference between the Canada Pension Plan and the
Yale University Endowment is that the latter manages its assets
internally.

Statement 3: The Yale University Endowment strategy includes a high allocation

to alternative investments and significant active management,
which gives it the potential for market outperformance.

Statement 4: Liability-driven asset allocation explicitly recognizes liabilities as

part of the investment process, and focuses on managing surplus
 volatility as well as on maximizing expected surplus.

Nguyen meets with Ana Barragan, who manages the corporate defined benefit
pension plan for an external client. Barragan is seeking more clarity on the factors
that increase or decrease the present value of the pension liability, and states:

I think that advances in medicine that increase human lifespan should

increase the present value of the pension liability, because my client's
pension plan pays benefits every year that former employees are retired.
In contrast, employee turnover will reduce the pension liability, because it
reduces the probability of employees' benefits vesting. Not only do
employees who work more years for the company have a higher
probability of vesting, but the number of years that they work increases
the liability—especially if there are salary increases during that period.
Higher expected investment returns will reduce the pension liability. I
think that the funds' risk tolerance should begin to decrease as
employees move into retirement: the investment horizon will become
shorter with an increasing proportion of beneficiaries in retirement.

George Fritz, another employee at Hamilton Consultants, specializes in consulting for

university endowments and private foundations. George makes the following
comments to his supervisor:

Fundraising from donors reduces the net spending rate for endowments,
whereas foundations are generally required to spend all the donations in the
year in which they are received.
Compared to foundations, endowments generally provide a smaller portion of
the operating budget of the organization that they fund.
Larger university endowments are more likely than smaller endowments to
invest in traditional investments with a home bias.
While foundations generally should spend a minimum of 5% of plan assets plus
investment expenses, university endowments' spending requirements are
generally lower.
Both foundations and endowments allocate significant portions of assets to
alternative investments.
Smaller foundations generally allocate a larger portion of assets to alternative
investments than do larger foundations.
Mission-related investing or impact investing is becoming more common among
endowments; furthermore, it is more common for endowments than among
foundations.
Question #68 of 101 Question ID: 1431135

Which of the following is most accurate regarding the statements that Aquinox and
Nguyen made?

Aquinox was wrong in stating that budget stabilization funds should seek to
A) preserve capital. Nguyen was wrong in stating that pension reserve funds invest
heavily in private equity and real assets.
Aquinox was wrong in stating that budget stabilization funds should invest in the
resources, commodities, or industries to which the national economy is heavily
B)
linked. Nguyen was wrong in stating that savings funds take a lower allocation to
alternative investments than do reserve funds.
Aquinox was wrong in stating that budget stabilization funds should seek to earn a
rate higher than inflation while also seeking to preserve capital. Nguyen was wrong
C)
in stating that due to low liquidity needs, savings funds and reserve funds generally
invest heavily in private equity and real assets.

Question #69 of 101 Question ID: 1431136

How many of the statements that Lara made to Aquinox and Nguyen were most likely
correct?

A) Only one statement was correct.

B) Two of the statements were correct.
C) All three statements were correct.

Question #70 of 101 Question ID: 1431137

Regarding Barragan's statements about the factors that change the present value of
pension liability, and the risk tolerance of the fund, Barragan is least likely to be
correct in his statement about:

A) expected returns.
B) employee turnover.
C) the proportion of retired lives.
Question #71 of 101 Question ID: 1431138

Fritz is most accurate in stating that:

small foundations invest in alternative investments to a proportionally greater

A)
extent than do larger foundations.
mission-related investing or impact investing is more common among endowments
B)
than among foundations.
private foundations are generally required to spend all donations in the year in
C) which they are received, whereas donations to endowments reduce the net
spending rate.

Overview for Questions #72-75 of

101 Question ID: 1436178

TOPIC: FIXED-INCOME PORTFOLIO MANAGEMENT

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Daniel Castillo and Ramon Diaz are senior investment officers at Advanced Advisors
(AA), a large U.S.-based firm. AA uses numerous quantitative models to invest in both
domestic and international fixed income securities.

AA offers investment funds that take long-only positions in varying fixed income
styles. For example, they offer both a low- and high-interest rate risk fund. Current
statistics of the funds are provided in Exhibits 1 to 3 below.

Exhibit 1: Bond Strategy Fund Details

Lower Duration Strategy Higher Duration Strategy

Duration 2.57 7.32

Convexity 21.56 195.62

Expected annual return 3.55% 8.45%

Expected monthly σ 0.62% 1.13%

Exhibit 2: Lower Duration Strategy (Further Details)

Average coupon rate 3%

Portfolio value per $100 par $108.60

Projected portfolio value in 1 year (assuming static yield curve) $109.20

Exhibit 3: High Duration Portfolio: Spread Measures (Basis points)

Yield spread 211.45

G-spread 209.95

I-spread 208.25

z-spread 210.11

Option-adjusted spread 210.11

Castillo believes that the economy is going to enter an economic recovery that is not
currently fully priced into fixed income security markets. He gathers data on four CDS
Index (CDX) contracts, provided in Exhibit 4 below.

Exhibit 4: Available CDX Contracts

Contract Underlying Tenor (years) CDS Spread (basis points)

1 CDX IG Index 5 125

2 CDX IG Index 10 130

3 CDX HY Index 5 440

4 CDX HY Index 10 400

Question #72 of 101 Question ID: 1431093

Diaz realizes he also needs to consider downside risk in the longer-duration strategy.
He decides to analyze what will happen if there is an immediate 60 basis point
increase in interest rates. Using the data in Exhibit 1, the expected change in value of
the longer-duration portfolio is closest to:

A) −4.0%.
B) −4.4%.
C) +4.8%.
Question #73 of 101 Question ID: 1431094

Diaz has yet to complete his computation of expected return of the low duration
portfolio. Using the data in Exhibit 2, the rolling yield on this portfolio is closest to:

A) 0.55%.
B) 2.76%.
C) 3.31%.

Question #74 of 101 Question ID: 1431095

Using the data in Exhibit 3, which of the following comments is least accurate?

A) Swap rates are greater than the equivalent Treasury spot rates.
B) The high duration portfolio contains mortgage-backed securities.
The benchmark government security with closest maturity to the maturity of the
C)
portfolio has a lower maturity than the portfolio.

Question #75 of 101 Question ID: 1431096

Given Castillo's view on the economy, the least appropriate relative value trade in the
CDX contracts listed in Exhibit 4 is to:

A) buy protection on contract 1, sell protection on contract 3.

B) buy protection on contract 3, sell protection on contract 4.
C) sell protection on contract 3, buy protection on contract 4.

Overview for Questions #76-79 of

101 Question ID: 1431145

TOPIC: PORTFOLIO PERFORMANCE EVALUATION

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Walker and Nero are employees with Zimmer Advisors. Zimmer offers investment
consulting services to clients in North America. Walker and Nero's primary
responsibility is evaluating the performance of investment managers that Zimmer's
clients are considering. Grunder Preparatory School has retained Zimmer to advise
the investment committee of its endowment fund.

Grunder has most of its portfolio in large-cap equities and the investment committee
realizes this investment strategy is extremely competitive so it asks Zimmer to
evaluate its large-cap manager compared to the manager's competitors. As a result,
Walker and Nero benchmark the performance of the school's large-cap equity
manager against the median manager from the manager's peer-group, using data
provided by a popular investment consultant.

Grunder's investment committee then asks Walker and Nero to evaluate the
performance of the Knight and Elk funds. It also asks for advice regarding additional
metrics that can be used in evaluating manager performance. The most recent risk
and return measures for Knight and Elk are shown below. The T-bill return over the
same time period was 3.0%. The return on the S&P 500 was used as the market index.

Knight Market Index

Return 6.80% 6.60%

Beta 0.90 1.00

Standard deviation 32.6 31.0

Question #76 of 101 Question ID: 1431146

Which of the following statements regarding the use of the median manager's results
as a benchmark for evaluating performance of a portfolio is most likely true?

A) It is not possible to identify the median manager.

B) The performance of the median manager is subject to upward bias.
The weights of individual securities required to replicate the median manager
C)
cannot be known.
Question #77 of 101 Question ID: 1431147

The Treynor ratio for the Knight fund is closest to:

A) 0.90.
B) 4.22.
C) 7.56.

Question #78 of 101 Question ID: 1431148

The Sharpe ratio for the Knight fund is closest to:

A) 0.21.
B) 0.12.
C) 0.90.

Question #79 of 101 Question ID: 1431149

Which performance measure would Walker and Nero choose if they want to consider
the impact of both market-related variability of returns and the variability of active
management?

A) Sharpe ratio.
B) Treynor ratio.
C) Information ratio.

Overview for Questions #80-85 of

101 Question ID: 1436164

TOPIC: ALTERNATIVE INVESTMENTS

TOTAL POINT VALUE OF THIS QUESTION SET IS 18 POINTS

Dominique Fred works for a large state pension fund. The fund is well diversified in
regard to domestic and foreign equities, as well as in terms of durations and credit
quality of fixed income. Fred has decided to allocate a small portion of the portfolio to
alternative investments. In discussing his proposal to diversify into this asset class,
Fred makes the following statements:

Statement 1: "Investments in alternative investments provide proven reduction

in risk, as evidenced by their reported lower standard deviations."

Statement 2: "There are multiple categories of alternative investments that

include: hedge funds, private equity, venture capital, private debt,
private real estate, real assets, and commodities."

Statement 3: "The various types of alternative investments produce higher

long-run returns than do traditional asset classes."

Fred's supervisor, Francesco Arnulfo, counters that it isn't enough to simply add
alternative investments to a portfolio: they also need to consider the diversification
benefits, and the drawbacks, of each type of alternative investment. Arnulfo points
out that adding private equity will improve the fund's Sharpe ratio, due to the
relatively low standard deviation of private equity, and the low correlation between
private equity and public equity. Fred argues that a small allocation to farmland,
paying the farmer a salary for tending and selling the crops, would be a low risk way
to diversify without execution risk or commodities risk. Arnulfo interjects stating
owning farmland but leasing the land to the farmer was the way to avoid execution
and commodity risk. Arnulfo states that while commodities are a bad hedge for
inflation, they generally have higher returns than equities; but Fred counters that
commodities are actually good as inflation hedges.

Arnulfo and Fred decide to consult with Fullara Patel, who was recently hired away
from another fund where she had worked in alternative investments. Patel points out
that a common way to understand the risk of alternative investments is to look at the
risk factors associated with that particular class of investment: the risk factors of
private equity are generally similar to those of public equity; the risk factors of private
credit are generally similar to those of public fixed income securities; and the risk
factors of private real estate are generally similar to those of public real estate. Patel
argues that it isn't enough to simply invest in a private alternative investment with
lower statistical variance and correlation: true diversification also includes diversifying
among risk factors.

Patel further points out that, at least at the beginning when learning more about
alternative investments, they should invest through a fund-of-funds. Patel states that
with a fund-of-funds, they can gain exposure to multiple strategies and assets, while
still including each investment separately on their accounting statements, and without
having to pay an additional level of management fees. She also noted that a fund-of-
one would give them more control over the investment than would a fund-of-funds.

Arnulfo points out that investments in some alternatives not only require longer time
horizons due to lower liquidity, but they also require that the investor be able to
invest the committed capital when the general partner (GP) requests it. While
discussing this with his employees, Arnulfo expresses his concern that the GP might
decide not to use all of the committed capital. Fred counters that if the limited
partners (LPs) are required to have the committed capital available, the GP should be
required to use it. Patel interjects and states that the GP might not draw down all the
capital that the LPs commit to providing, and clarifies that while the GP can use less
than the amount committed, they cannot use more than the amount of capital
committed. Arnulfo isn't convinced, and is worried that if the GPs can use less than
the capital committed, there might be nothing to stop the GP from requiring an
amount greater than the committed capital.

Arnulfo, Patel, and Fred decide that the best strategy may be to begin with their
current allocation to traditional assets, and simply add alternative investments.
Arnulfo proposes that they perform a Monte Carlo simulation (MCS), but that in
addition to average returns and variances, they should account for properties such as
mean reversion, unstable correlations, and fat tails. He further states that including
constraints such as liquidity would only reduce the accuracy of a powerful statistical
tool like MCS.

Patel proposes that instead of modeling the asset classes by their mean and variance,
they should look at the risk factors and the factor return expectations. She believes
that they should also add liquidity as a risk factor, with a risk budget for all the risk
factors. Fred thinks that mean variance optimization (MVO) would underweight
alternative investments because the index returns for private equity, venture capital,
and hedge funds are likely to be higher than actual returns due to survivorship bias.

Question #80 of 101 Question ID: 1431112

In regard to statements 1, 2, and 3 that Fred made to his boss, it would be most
accurate to state that:

A) two of the statements are correct.

B) all three of the statements are correct.
C) only one of the statements is correct.

Question #81 of 101 Question ID: 1431113

It would be most accurate to state that Arnulfo is correct regarding:

A) farmland, while Fred is correct regarding commodities.

B) farmland and private equity, while Fred is correct regarding commodities.
C) private equity and commodities, while Fred is correct regarding farmland.

Question #82 of 101 Question ID: 1431114

Using the risk-factor approach suggested by Patel, it would be least accurate to state
that:

A) hedge funds risk factors are similar to those of equity.

B) private credit is exposed to duration and credit spreads.
C) private equity has many of the same risk factors as public equity.

Question #83 of 101 Question ID: 1436165

Patel is most accurate in regard to:

A) the fund-of-one giving more control than a fund-of-funds.

B) the fund-of-funds avoiding an extra level of management fees.
the fund-of-funds allowing all the investments in the portfolio to be included on
C)
their own balance sheet.

Question #84 of 101 Question ID: 1431116

In regard to the limited partners' obligation to provide the capital committed, and the
general partner's obligation to draw down that capital, the most accurate statement is
made by:

A) Fred.
B) Patel.
C) Arnulfo.

Question #85 of 101 Question ID: 1431117

With regard to MCS and MVO, the most accurate statement(s) is/are made by:

A) Fred.
B) Patel.
C) Arnulfo.

Overview for Questions #86-89 of

101 Question ID: 1436154

TOPIC: DERIVATIVES

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Ilias Chair works for a derivatives trading and advisory company. He is currently
looking at aircraft manufacturers with the view of implementing some derivative
strategies.

Chair is analyzing the financial performance of Glowing Aeronautics. A review of

industry press reveals that Glowing is in a tender for a very large order of passenger
aircraft for a national airline in the Middle East. Winning the order would result in
steeply rising earnings. Losing the order to its main rival (AirTaxi) would result in a
dramatic decline to its potential order book.

Chair is also looking at the implications of covered calls and protective puts on
Glowing in order to advise clients holding Glowing stock.

Exhibit 1: Glowing Aeronautics Traded Options Details

Option Type Strike Price Premium

Put $14 $2

Call $26 $2

Current stock price $20

One of Chair's clients holds the stock of AirTaxi and is concerned about the downside
potential if the company was to lose the bid to Glowing Aeronautics. The client wishes
to hedge downside risk with minimal outlay. Chair seeks the advice of two colleagues
who offer the following statements:

Bright "I'd consider using a collar. A collar can be constructed by taking a

Samuel: covered call and adding a long put option."

"A collar will hedge downside risk at the expense of capping upside
Conor
potential. A collar can be constructed by taking a protective put and
Matterson:
selling a call option."

The following information applies to AirTaxi traded options:

Exhibit 2: AirTaxi Traded Options Details

Option Type Strike Premium Option Type Strike Premium

Call €26 €5.00 Put €26 €0.80

Call €30 €1.70 Put €30 €1.54

Call €34 €1.00 Put €34 €5.20

Question #86 of 101 Question ID: 1431068

Using the data in Exhibit 1, which of the following is most accurate in relation to a
covered call and protective put positions on Glowing Aeronautics?

The maximum gain of the covered call is equal to the maximum gain of the
A)
protective put.
The breakeven point of the covered call is higher than the breakeven point of the
B)
protective put.
The maximum gain of the covered call exactly offsets the maximum loss of the
C)
protective put.
Question #87 of 101 Question ID: 1431069

Which of the following strategies will best exploit Chair's market expectations on
Glowing Aeronautics with regard to the potential Middle East order?

A) Bull spread.
B) Covered call.
C) Long straddle.

Question #88 of 101 Question ID: 1431070

Which of Chair's colleagues' comments regarding the collar is most accurate?

A) Samuel’s comment.
B) Matterson’s comment.
C) Both Samuel and Matterson’s comments.

Question #89 of 101 Question ID: 1436155

Using the data in Exhibit 2, if Chair's goal was to minimize the maximum potential loss
on an AirTaxi trading strategy, which of the following strategies would he choose?

A) 26/34 bull call spread.

B) 26/34 bear put spread.
C) Long straddle with a strike of €30.

Overview for Questions #90-93 of

101 Question ID: 1431106

TOPIC: EQUITY PORTFOLIO MANAGEMENT

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Redwood Advisors has managed fixed income portfolios for its clients for over two
decades. The firm recently hired a team of three new equity managers in the hopes of
expanding its investing expertise into equities. Specifically, the firm would like to
establish a hedge fund that will allow its new equity managers to engage in pairs
trading.

The new equity team decides early on that they should strive to minimize market
impact costs when performing trades. Each team member makes the following
comments regarding the best ways to accomplish that goal.

"We should seek to grow our assets under management (AUM) as

Jeff: much as possible and engage in high turnover trading of small-
cap stocks."

"I agree with Jeff when it comes to the AUM, but I think we should
Mary:
engage in low turnover trading of large-cap stocks instead."

"I think we should pursue a more conservative AUM figure while

Karen:
engaging in low turnover trading of large-cap stocks."

When describing their hedge fund strategy to a sophisticated potential investor, the
team brings up the terms active share and active risk. They explain that, while
pursuing their chosen strategy, they will exhibit a certain type of active share/active
risk combination. They use Exhibit 1 to indicate to the investor which type of
combination they are most likely to exhibit.

Exhibit 1: Active Risk/Active Share Combinations

Combination Active Risk Active Share

1 High High

2 Low High

3 Low Low

The team then turns their attention to generating consistent active returns for the
hedge fund. They decide that the manager with the highest expected active annual
return should lead the effort. They utilize Exhibit 2 and the fact that each manager will
make 110 independent decisions per year to make that determination.

Exhibit 2: Equity Manager Characteristics

Manager Transfer Coefficient Information Coefficient Active Risk (%)

 Jeff 0.45 0.2 6.25

Mary 0.5 0.15 6.75

Karen 0.55 0.1 6.25

Question #90 of 101 Question ID: 1431107

Which portfolio construction approach would be most appropriate for the hedge fund
that Redwood Advisors would like to establish?

A) Long only.
B) Short only.
C) Market neutral.

Question #91 of 101 Question ID: 1431108

Which manager is most accurate with respect to minimizing the market impact costs
the fund will realize when executing trades?

A) Jeff.
B) Mary.
C) Karen.

Question #92 of 101 Question ID: 1431109

Which combination of active risk and active share will the equity team most likely
display in the pursuit of the firm's chosen hedge fund strategy?

A) 1.
B) 2.
C) 3.
Question #93 of 101 Question ID: 1431110

Which manager will lead the team's effort to generate consistent active returns within
the new fund?

A) Jeff.
B) Mary.
C) Karen.

Overview for Questions #94-97 of

101 Question ID: 1431072

TOPIC: DERIVATIVES AND CURRENCY MANAGEMENT

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Patrick McCormick is a high net worth investor located in Ireland. Patrick holds a
portfolio €60m comprising of 70% of U.S. equity and 30% U.K. equity. Exhibit 1 gives
the performance of his portfolio over a calendar year.

Exhibit 1: Patrick's Portfolio Performance

Value at start of year €60,000,000

U.S. equity return ($) 5%

U.K. equity return (£) 6%

Exchange rates:

Start of year EUR/GBP 0.9025

End of year EUR/GBP 0.9050

Start of year USD/EUR 1.1040

End of year USD/EUR 1.0080

Patrick's wife Niamh holds her own overseas investments and was rather surprised
about the impact of exchange rates on Patrick's investment returns. Niamh feels that
exchange rate changes are difficult to predict and has decided to hedge her Canadian
equity investment for the calendar year using forward currency contracts. Niamh has
assumed her Canadian equity return will be 4% for computing the notional principal
on the currency forward. The table below gives the performance of her portfolio over
a calendar year.

Exhibit 2: Niamh's Portfolio Performance

Value of Canadian equity portfolio (at start of year) €20m

Canadian equity return (CAD) 10%

Exchange rate CAD/EUR start of year 1.4285

12 month forward point quote (at start of year) −300

Exchange rate CAD/EUR (at end of year) 1.4545

Niamh would like to compute the standard deviation of her CAD portfolio assuming it
is left unhedged in order to decide whether she will hedge her returns using forward
currency contracts.

Exhibit 3: Expected Risk Metrics

Return on CAD portfolio 10%

Standard deviation of CAD portfolio returns 5%

Forex return −1.8%

Standard deviation of foreign currency returns 4.5%

Correlation of CAD portfolio returns and currency returns 0.7

Question #94 of 101 Question ID: 1431073

Using the data in Exhibit 1, the return on Patrick's portfolio in his domestic currency is
closest to:

A) 10.4%.
B) 11.8%.
C) 12.4%.

Question #95 of 101 Question ID: 1431074

Which of the following factors is least likely to increase the importance of hedging
exchange rate risk on overseas investments?

A) The overseas portfolio is heavily invested in fixed income products.

B) The overseas portfolio is expected to be held for a long period of time.
A strong positive correlation between asset returns measured in the foreign
C)
currency and returns from the foreign currency.

Question #96 of 101 Question ID: 1431075

Using the data in Exhibit 2, and assuming Niamh enters a forward contract at the
rates given in the table, the return on the portfolio in her domestic currency is closest
to:

A) 8.0%.
B) 12.1%.
C) 12.4%.

Question #97 of 101 Question ID: 1431076

Using the data in Exhibit 3, the standard deviation of Niamh's portfolio of CAD equity
in her domestic currency is closest to:

A) 6.7%.
B) 8.8%.
C) 9.5%.

Overview for Questions #98-101 of

101 Question ID: 1431049

TOPIC: ECONOMICS

TOTAL POINT VALUE OF THIS QUESTION SET IS 12 POINTS

Gofton Asset Management (GAM) is an investment firm based in the United States.
GAM creates and manages diversified pooled funds for a wide range of mid- to large-
size institutional clients. The funds contain allocation ranges for a number of major
asset classes, including U.S. equities, foreign equities, domestic bonds, and
international private bonds. GAM frequently reviews and reconstitutes the funds to be
aligned with the requirements set forth by the institutional clients in their investment
policy statements.

Maria Delgado, CFA, chief economic strategist at GAM, oversees the selection of asset
classes based on the risk and return expectations of each fund. Recently, Delgado has
been assigned the task of conducting an economic analysis of the impact of monetary
and fiscal policies on the performance of U.S. real estate. In an attempt to offer some
diversification benefits to its clients, GAM has decided to consider the possibility of
including real estate-based products in its funds.

With a view to better understand current monetary policies, Delgado has performed
some intense research on the stance adopted by the U.S. Federal Reserve Bank over
the recent months. As part of her analysis, she has collected key economic
information from the Federal Reserve Bank's most recent financial projections to
forecast next year's Fed Funds Rate. Exhibit 1 shows selected data from the Federal
Reserve Bank's financial projections.

Exhibit 1: Selected Data from the Federal Reserve Bank

Neutral rate 2%

Inflation target 3%

Expected inflation 1%

Expected real GDP growth rate 4%

Real GDP growth trend 3.5%

Delgado observes that the Federal Reserve Bank has adopted quantitative easing over
the past decade. Through open market operations, the bank has tried to help
stimulate the economy. Nevertheless, economic growth and inflation have remained
low with consumer discretionary spending falling sharply. The increase in money
supply generated through quantitative easing was mostly used to fund dividend and
stock buybacks rather than support capital projects. With inflation expectations
remaining low, Delgado reads from the bank's most recent minutes of meeting that a
rate cut is very much likely. Delgado is now concerned that interest rates might soon
be in negative territory. She believes that negative interest rates will significantly
complicate the process of building capital market expectations on U.S. real estate.
In her quest to understand the impact of quantitative easing and evaluate the likely
impact of negative interest rates, Delgado sought advice from her colleague, John
Henderson, CFA, a fixed income specialist. Henderson made the following comments:

Comment 1: With quantitative easing, there was an increase in the Federal

Reserve Bank's balance sheet, bank reserves have dramatically
declined, and yields on government bonds have dropped.

Comment 2: Negative interest rates would encourage individuals to hold

currencies which would eventually drain deposits and reserves from
the banking system.

Henderson added that analyzing monetary policies would on its own not be sufficient
when trying to forecast price movements in asset classes, including U.S. real estate.
Delgado agreed that it was essential to evaluate existing fiscal policies and analyze the
federal budget to have a more profound overview on how U.S. real estate will react.
With the U.S. economy showing some signs of recovery over the past year, the federal
budget has remained largely in deficit.

Delgado observed that: "Given the current federal budget deficit, it is clear that the
government has chosen to adopt fiscal expansion with the intention of creating new
jobs across a range of industries."

Henderson's observations were that: "The federal budget deficit, on a stand-alone

basis, provides no clear guidance as to the current fiscal stance of the government.
Upon evaluating the federal budget status in the context of prevailing economic
spectrum, we can conclude that the government will be expecting higher tax receipts
and increased federal spending this year."

In her quest for further technical advice, Delgado sought Henderson's expertise to
explain the impact of monetary and fiscal policies on the yield curve. Henderson
explained that monetary and fiscal strategies might support or conflict with each
other. With regard to their combining impact on the yield curve and the economic
environment, he made the following statements:

Statement 1: If monetary policy is expansionary and fiscal policy is restrictive,

the yield curve is moderately steep and the economic implications
are less clear.

Statement 2: If both monetary and fiscal policies are expansionary, the yield
curve is steep and the economy will likely expand.

Statement 3: If monetary policy is restrictive and fiscal policy is expansionary,

the yield curve is moderately inverted and the economic
 implications are less clear.

In conclusion, Henderson explained that it was fundamental to consider the impact of

globalization on U.S. real estate, as a whole. He then went on identifying a number of
macroeconomic linkages which could potentially result in convergence in business
cycles among global economies.

Question #98 of 101 Question ID: 1431050

Using the data provided in Exhibit 1 and the Taylor Rule method, the nominal short-
term interest rate target is closest to:

A) 2.25%.
B) 2.75%.
C) 3.75%.

Question #99 of 101 Question ID: 1431051

Which of the comments made by Henderson is/are most accurate regarding the
impact of quantitative easing and negative interest rates?

A) Comment 1.
B) Comment 2.
C) Neither Comment 1 nor Comment 2.

Question #100 of 101 Question ID: 1431052

Concerning the federal budget deficit, the most likely correct observation was made
by:

A) Henderson regarding tax receipts.

B) Delgado regarding fiscal expansion.
C) Henderson regarding federal spending.
Question #101 of 101 Question ID: 1431053

Which of Henderson's statements with respect to the impact of monetary and fiscal
policies on the yield curve is least likely correct?

A) Statement 1.
B) Statement 2.
C) Statement 3.