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CFA Level 3 Exam Questions and Answers 2024( A+ GRADED 100% VERIFIED).
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CFA Level 3GIPS Input Requirements - ANS -All data must be captured and documented based on fair
value, using trade date accounting, and including accrued income for fixed income securities.
-If market value of a security does not exist, the preferred value approach sequence is the
following:
1) Prices of similar assets in active markets.
2) Prices of similar assets in inactive markets.
3) Observable market inputs other than prices (e.g., PE, div yield)
4) Subjective, unobservable inputs (e.g., discounted cash flow)
-Basic GIPS requires valuing portfolios at least monthly and on the date of all large external
cash flows (ECFs). Large is anything big enough to materially distort the computation of account
or composite return.
GIPS Presentation and Reporting Requirements - ANS Initial report must include at least 5
years unless that composite's strategy has existed for less than 5 years. Thereafter, add at least
1 year to the composite presentation record until at least a rolling 10-year history is included.
GIPS Real Estate Reporting Requirements - ANS -Liquid marketable securities such as REITS,
MBS, and Evergreen Funds remain under the regular provisions of GIPS.
-Basic GIPS requires monthly valuation and measurement.
-RE valuation is quarterly and can be done internally by the firm.
-At lest every 12 months, the valuation must be done by a qualified external source. The
external valuation can be as infrequent as every 36 months if the client agrees. In that case, the
GIPS report must also disclose the percentage of composite assets valued externally each year.
-For CEFs, return must be computed and presented since inception of the fund using IRR
(SI-IRR) and continued until the fund is liquidated. ECFs for RE used to calculate SI-IRR must
be at least quarterly.
GIPS Private Equity Reporting Requirements - ANS -Basic GIPS requires monthly valuation
and measurement.
-Must be valued annually with return reported both gross and net of fees.
-For CEFs, return must be computed and presented since inception of the fund using IRR
(SI-IRR) and continued until the fund is liquidated. ECFs for PE used to calculate SI-IRR must
be daily.
Behavioral Finance - ANS -Descriptive of how investors behave.
-It assumes investors have cognitive limits and emotional biases.
-Therefore, market prices may not be efficient.
-The focus is how to help investors make decisions that more closely approximate the "optimal"
decisions of traditional finance in spite of the investors' biases and feelings.
,Traditional Finance - ANS -Normative, describing what investors should do.
-Asumes investors are rational, risk-averse, apply utility theory to maximize satisfaction, and that
market prices are efficient.
4 Axioms of Utility Theory - ANS 1) Completeness: Choices and preferences are known.
2) Transitivity: Rankings are applied consistently.
3) Independence: Utilities are additive and divisible.
4) Continuity: Indifference curves are smooth and unbroken.
Utility Theory - ANS Assumes investors are risk averse and feel diminishing marginal utility of
wealth, which has 2 implications:
1) An investor's indifference curves will be convex. In order to accept additional equal
increments of risk, an investor must expect increasing increments of return. Investors will vary
their risk aversion and those with high risk aversion will select portfolios with lower risk/return,
while investors with low risk aversion will select portfolios with higher risk/return.
2) Investors will have concave utility functions. As an investor adds equal increments of wealth,
the investor's level of satisfaction (utility) increases but at a diminishing rate.
Prospect Theory - ANS Proposed by behavioral finance may better explain investor behavior, it
assumes:
-Investors focus on perceived gain or loss (change in wealth), not the level of wealth.
-Perception of gain or loss depends on the reference point used (e.g. year-end price or original
cost basis).
-Gain or loss is not "real" until it is realized.
-Subjective decision weights (low probability events are given too much weight) replace
objective probability.
-Decisions are made in stages.
The result is that it assumes investors are risk averse when facing gains (and therefore sell
winners too soon) but are loss averse and risk seeking when facing losses (and therefore hold
losers too long).
BF Details: Decision Making in Two Phases - ANS -Editing Phase: Codification, combination,
segregation, cancellation, simplification, and dominance. This can lead to an anomaly known as
the isolation effect.
-Evaluation Phase: Investors probability weight expected outcomes to determine utility.
However, the probabilities are not simple objective probabilities, but adjusted probabilities.
Isolation Effect - ANS An anomaly where investors focus on one factor or outcome while
unconsciously eliminating or subconsciously ignoring others. As a result, the presentation of
data can affect the decision made even if the underlying economics are the same.
,Bounded Rationality - ANS Investors have limits in their ability to reach optimal decisions.
Satisfice - ANS Investors gather enough information and perform enough analysis to reach an
acceptable (but not optimal) decision.
Traditional Finance Conclusion that Markets are Efficient - ANS The Price is Right: Suggests
asset prices reflect all available information and adjust instantaneously to fully incorporate the
value of new information. Therefore, the function of the portfolio manager is to allocate an
investor's portfolio to asset classes that are consistent with the client's objectives and
constraints.
No Free Lunch: Implies managers cannot generate excess return (alpha) consistently. All
information is instantaneously and accurately incorporated into prices, so whether asset prices
change depends on the release of new information. Because information enters the market
randomly, changes in prices must also be random, making excess returns impossible to forecast
consistently.
Weak-Form Efficiency - ANS Prices reflect all past price and volume data. Managers cannot
consistently generate excess returns using technical analysis.
Semi-Strong-Form Efficiency - ANS Prices reflect all public information. New information is
immediately reflected in asset prices. Managers cannot consistently generate excess returns
using technical or fundamental analysis.
Strong-Form Efficiency - ANS Prices reflect all information, public and private. No analysis
based on inside and/or public information can consistently generate excess returns.
Consumption and Savings - ANS The behavioral life-cycle model says that individuals are
subject to framing, self-control bias, and mental accounting. Therefore, they will not achieve the
optimal balance of short-term consumption and long-term investing.
-Framing
-Self-Conrol Bias
-Mental Accounting
Behavioral Asset Pricing - ANS The required return on an asset is the risk-free rate, plus a
fundamental risk premium, plus a sentiment premium. The sentiment premium can be estimated
by considering analysts' forecasts. The greater the dispersion of analysts' forecasts, the greater
the sentiment premium. If these sentiment premiums are random and unpredictable, they
complicate asset allocation.
, Behavioral Portfolio Theory (BPT) - ANS Assumes investors structure their portfolios in layers
according to their goals. The composition of each layer of the portfolio is determined by the
interaction of 5 factors:
-If higher return is the goal, more assets are allocated to the higher return level.
-The higher return layer will hold higher risk assets.
-Lower risk investors will hold more diversified portfolios.
-Investors with a perceived information advantage will hold more concentrated positions.
-Investors who are highly loss averse will be reluctant to hold risky assets.
Portfolios can appear to be diversified and hold many assets but are sub-optimal from a TF
perspective because the correlation among asset layers is not considered. However, from a TF
perspective, a slightly less efficient portfolio investors can live with is better than an optimal
portfolio they abandon during a market setback.
The Adaptive Markets Hypothesis - ANS 5 Important Conclusions:
-Investors make decisions to help them survive (satisfice) rather than to maximize utility (make
theoretically optimal decisions).
-Investors must adapt to survive.
-Because participants adapt, no investment strategy can continually outperform.
-Risk premiums will vary over time as (1) the general level of investor risk aversion increases or
decreases and (2) the level of competition in the market decreases or increases.
-Assets can be temporarily misplaced, allowing active management to add value.
Emotional Biases Definition - ANS Caused by individuals' psychological predispositions. Not
deliberate; it is more of a spontaneous reaction and it is more difficult to overcome.
Emotional Biases List - ANS -Loss Aversion Bias
-Overconfidence Bias
-Self-Control Bias
-Status Quo Bias
-Endowment Bias
-Regret-Aversion Bias
Cognitive Errors - ANS The result of mechanical or physical limitations; they result from the
inability to analyze all information or from basing decisions on incomplete information. Easier to
overcome and respond to education.
Cognitive Errors Streaming from Believe Perseverance - ANS -Conservatism Bias
-Confirmation Bias
-Representativeness Bias
-Illusion of Control Bias
-Hindsight Bias
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