CFA Level III practice questions

Question 1

An analyst uses the Grinold–Kroner model with an expected dividend yield of 2.2%, expected share buyback of 0.8%, inflation of 2.0%, real earnings growth of 1.8% and no repricing. The expected equity return is closest to:

1. A4.8%
2. B6.0%
3. C6.8%
4. D8.6%

Question 2

An investor with several distinct, prioritised objectives and different time horizons is best served by:

1. AAsset-only mean–variance optimisation
2. BLiability-relative allocation
3. CGoals-based allocation
4. DA single risk-parity portfolio

Question 3

The principal criticism of unconstrained mean–variance optimisation is that it:

1. ACannot handle more than two assets
2. BProduces highly concentrated portfolios sensitive to input estimation error
3. CIgnores correlation between assets
4. DRequires normally distributed returns to be computed at all

Question 4

Which factor argues most strongly for a wider rebalancing corridor around a target allocation?

1. AHigher asset class volatility
2. BHigher transaction costs
3. CHigher correlation with the rest of the portfolio
4. DA shorter investment horizon

Question 5

An analyst forecasts long-run returns using only the most recent five years of data during a strong bull market. This most likely reflects:

1. AThe ex post risk trap
2. BStatus quo bias
3. CData measurement error
4. DModel uncertainty

Question 6

A portfolio has an active share of 0.75 but active risk of only 2%. This combination most likely describes:

1. AA concentrated sector-rotation strategy
2. BA diversified stock picker with limited factor tilts
3. CA closet indexer
4. DA leveraged long-short fund

Question 7

In immunising a single liability, the manager should match the present value and duration of the liability while:

1. AMaximising portfolio convexity
2. BMinimising portfolio convexity
3. CMaximising portfolio yield
4. DMatching the liability's cash flows exactly

Question 8

An endowment with a perpetual horizon and a 5% spending rule is best positioned to bear:

1. ALow liquidity risk and high liability risk
2. BHigh illiquidity and equity risk relative to most institutions
3. CRegulatory capital constraints similar to an insurer
4. DA duration-matched fixed income mandate

Question 9

An order for 10,000 shares is placed at a decision price of $50. 8,000 shares fill at an average of $50.40 and the order is cancelled with the price at $51. Implementation shortfall includes:

1. AOnly the realised price impact on the 8,000 shares
2. BRealised impact plus commissions only
3. CRealised impact, commissions and the opportunity cost on the 2,000 unfilled shares
4. DOnly the commission paid

Question 10

Compared with a defined benefit pension plan, a sovereign wealth fund most distinctively faces:

1. AA contractual liability stream
2. BA public policy mandate and political scrutiny
3. CA regulatory solvency ratio
4. DMandatory annual distributions

Question 11

A manager overweighted a sector that outperformed the benchmark but selected stocks within it that underperformed. Brinson attribution will show:

1. APositive allocation and positive selection
2. BPositive allocation and negative selection
3. CNegative allocation and positive selection
4. DNegative allocation and negative selection

Question 12

An investor allocates to one of many specialist managers within a diversified programme. The most appropriate appraisal measure is:

1. AThe Sharpe ratio
2. BThe information ratio
3. CTotal return
4. DThe Sortino ratio using total risk

Question 13

Hiring a manager who subsequently proves to have no skill is best described as:

1. AA Type I error
2. BA Type II error
3. CA style drift
4. DA benchmark misfit

Question 14

Under the GIPS standards, a firm claiming compliance must:

1. AInclude all fee-paying discretionary portfolios in at least one composite
2. BInclude only its flagship strategies
3. CPresent a minimum of three years of history
4. DExclude terminated portfolios from historical composites

Question 15

Which type of due diligence failure most commonly causes catastrophic investor loss?

1. AInvestment due diligence
2. BOperational due diligence
3. CBenchmark selection
4. DFee negotiation

Question 16

An investor buys stock at $48 and writes a call with a $52 strike for a $2 premium. The maximum gain on the covered call is:

1. A$2
2. B$4
3. C$6
4. DUnlimited

Question 17

A zero-cost collar on a long equity position produces:

1. AUnlimited upside with limited downside
2. BBounded upside and bounded downside
3. CUnlimited downside with limited upside
4. DThe same payoff as the underlying

Question 18

A manager holds a $50m portfolio with a beta of 1.1 and wants a beta of 0.7. Futures with a beta of 0.95 have a contract value of $250,000. The required position is closest to:

1. ABuy 84 contracts
2. BSell 84 contracts
3. CSell 21 contracts
4. DBuy 21 contracts

Question 19

Which condition most strongly argues for leaving foreign currency exposure unhedged?

1. AA short investment horizon
2. BHigh correlation between the currency and the asset return
3. CA long horizon and low correlation between currency and asset returns
4. DHigh hedging cost combined with a short horizon

Question 20

A domestic investor earns 8% on a foreign asset while the foreign currency appreciates 3%. The domestic-currency return is closest to:

1. A5.00%
2. B11.00%
3. C11.24%
4. D24.00%

Question 21

A firm wishes to state that it complies with the Asset Manager Code. It may do so only if it:

1. AAdopts the provisions it considers relevant to its business
2. BAdopts the Code in its entirety
3. CObtains CFA Institute pre-approval of its policies
4. DEmploys at least one CFA charterholder

Question 22

A manager directs client brokerage to a broker that provides research used across all client portfolios. Under Standard III(A) this is:

1. AProhibited in all circumstances
2. BPermitted, provided best execution is sought and the benefit accrues to clients
3. CPermitted only if the client pre-approves each trade
4. DPermitted only for institutional clients

Question 23

A firm materially changes its investment process without informing existing clients. This most likely violates:

1. AStandard V(B) Communication with Clients
2. BStandard III(C) Suitability
3. CStandard VI(C) Referral Fees
4. DStandard IV(C) Responsibilities of Supervisors

Question 24

At Level III, suitability under Standard III(C) is assessed:

1. ASecurity by security in isolation
2. BIn the context of the client's total portfolio
3. COnly at the time the IPS is written
4. DBy reference to the benchmark alone

Question 25

A manager uses a proprietary risk model with known limitations in stressed markets and does not mention them to clients. This is best described as:

1. AAcceptable, since the model is proprietary
2. BA violation of Standard V(B), which requires disclosure of significant limitations
3. CA violation of Standard I(B) Independence
4. DAcceptable if the model is independently validated

Question 26

A manager expects the yield curve to steepen with short rates unchanged. The most appropriate position is:

1. AExtend duration across the curve
2. BBuy the short end and sell the long end
3. CSell the short end and buy the long end
4. DA duration-neutral butterfly

Question 27

Relative to a duration-matched bullet, a barbell portfolio will outperform when the yield curve:

1. AShifts in a parallel fashion
2. BFlattens
3. CSteepens
4. DRemains unchanged

Question 28

A credit portfolio has spread duration of 4.5 and spreads widen by 30 basis points over a year in which spread carry is 2.0%. Ignoring defaults, excess return is closest to:

1. A−1.35%
2. B+0.65%
3. C+2.00%
4. D+3.35%

Question 29

Which execution benchmark is most vulnerable to manipulation by the trader being measured?

1. AArrival price
2. BVWAP computed over the trader's own participation window
3. CPrevious close
4. DImplementation shortfall

Question 30

Compared with a fundamental concentrated strategy, a quantitative multifactor equity strategy typically exhibits:

1. AHigher active share and higher idiosyncratic risk
2. BLower active share and risk sourced primarily from factor tilts
3. CIdentical active share and active risk
4. DLower active risk and higher stock-specific risk

Question 31

A fund has paid-in capital of $100m, distributions of $40m and a remaining net asset value of $90m. TVPI is:

1. A0.40×
2. B0.90×
3. C1.30×
4. D2.25×

Question 32

Under a European (whole-fund) waterfall compared with an American (deal-by-deal) waterfall, the general partner receives carried interest:

1. AEarlier, with a higher clawback risk
2. BLater, with a lower clawback risk
3. CEarlier, with a lower clawback risk
4. DAt the same time under both structures

Question 33

A general partner uses a subscription-line credit facility to delay capital calls. The most direct effect on reported performance is:

1. ATVPI rises and IRR is unchanged
2. BIRR rises and TVPI is broadly unchanged or slightly lower
3. CBoth IRR and TVPI rise
4. DBoth measures fall

Question 34

A covenant-lite loan compared with a traditional maintenance-covenant loan most likely implies:

1. AHigher expected recovery for the lender
2. BLower expected recovery, because intervention is delayed
3. CNo difference in expected recovery
4. DHigher recovery but greater default probability

Question 35

A brownfield infrastructure asset with a regulated revenue framework will most likely display:

1. AEquity-like returns and high cyclical sensitivity
2. BBond-like returns and low cyclical sensitivity
3. CEquity-like returns and low cyclical sensitivity
4. DHigh construction risk

Question 36

A client has a high-priority goal three years away and a lower-priority aspirational goal thirty years away. Goals-based allocation would fund the near-term goal with:

1. AA high-equity sub-portfolio to maximise expected value
2. BA low-risk sub-portfolio regardless of overall risk tolerance
3. CThe same allocation as the aspirational goal
4. DIlliquid private assets for the return premium

Question 37

A senior executive holds substantial employer stock and derives employment income from the same firm. The most appropriate recommendation is:

1. AIncrease the employer stock position to align interests
2. BReduce the concentration because human and financial capital are correlated
3. CHold the position because it is tax-efficient
4. DHedge only the employment income

Question 38

An asset returns 6% annually and is taxed at 30% on an accrual basis. Over ten years the after-tax accumulation factor is closest to:

1. A1.34×
2. B1.51×
3. C1.79×
4. D1.26×

Question 39

Asset location refers to the decision about:

1. AWhich countries to invest in
2. BWhich account type holds each asset class
3. CThe proportion held in each asset class
4. DThe custodian used for each holding

Question 40

A lifetime gift is most likely to dominate a bequest when the recipient has:

1. AA higher tax rate and a short horizon
2. BA lower tax rate and a long horizon
3. CThe same tax rate and a short horizon
4. DA higher tax rate and a long horizon