CFA-Level-II - Chartered Financial Analyst Level II (CFA Level II) Practice Test with Real Question by Killexams.com

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**** CFA-Level-II Description | CFA-Level-II Syllabus | CFA-Level-II Exam Objectives | CFA-Level-II Course Outline ****



**** SAMPLE Chartered Financial Analyst Level II (CFA Level II) 2021 Dumps ****

Question #540
Josh Atwell recently inherited a large sum of money and wants to invest a portion of the inheritance into a real
estate investment that provides a tax shelter. Atwell wants to take a limited management role in the real estate
investment, and avoid the expense of hiring professional project management. Also, Atwell requires that the real
estate investment generate high cash flows. Atwell hired Kellogg Investments to provide him potential real estate
investments. Kellogg created Exhibit 1 outlining alternative real estate investments, from which Atwell can make
his selection. Atwell's cost for any loan is 8%. The loan would be amortized over 20 years with annual payments.
His required rate of return is 11%.
After reviewing the potential real estate investments generated by Kellogg, Atwell decided against all of the
choices. Instead, Atwell requested a detailed report on the investment merits of an apartment complex. In Exhibit 2,
Kellogg details the operating income of a targeted apartment complex investment. Atwell will make an equity
contribution of $1,000,000. The loan-to-value ratio for the apartment complex investment would be 75%.
An adviser from Kellogg states that Atwell should purchase the apartment complex because the net present value of
the investment is positive. The adviser also states, however, that the investment's IRR is less than Atwell's required
rate of return. After reviewing the historical financial statements of the potential hotel investment, the advisor notes
its erratic net operating income. In fact, the hotel generated several years of growing cash flow followed by two
negative years and then a return back to a positive cash flow.
Based upon the information presented in Exhibit 2, the after-tax cash flow for year 2 is closest to:
A. $40,000.
B. $72,000.
C. $114,000.
Answer: B
Loan-to-value ratio is 75%, Atwell's equity contribution is $1M, so the total value is:
(Study Session 13, LOS 45.c)
Question #551
A client of Colby Nash, CFA, wants to add an alternative asset class to his portfolio. However, the client is
concerned that any investment in hedge funds may be far riskier and generate lower returns than is generally
expected. Nash believes the client's attitude toward hedge funds was influenced by negative press coverage
regarding fraud perpetrated by a few funds. Nash decided to conduct his own research on the risk/reward
characteristics of hedge funds. Nash generated a report (shown in Exhibit 1) comparing several hedge fund
strategies and a traditional investment benchmark; the S&P 500 index. Each hedge fund strategy is represented by
an individual fund, which is used to measure risk and return over a ten year period. Nash also created a correlation
matrix between hedge funds and the S&P 500 index, shown in Exhibit 2.
In addition to the statistics presented in the exhibits above, Nash created a hedge fund index to evaluate each fund's
performance. Nash recognized the fact that several shortcomings exist in creating an adequate hedge fund index. To
that end, Nash created an index in which all the hedge funds included in the index agreed to provide data that can
be verified by Nash. Nash also set up strict rules for inclusion and removal of hedge funds into and out of the
hedge fund index.
As a further improvement to his research, Nash created a positive risk-free rate benchmark to evaluate each hedge
fund. However, his review of academic research indicated thar the positive risk-free rate benchmark is only
appropriate for a limited number of hedge fund strategies. The current risk-free rate is 4%.
Nash conducted a personal interview with the portfolio manager of the Fixed Income Arbitrage hedge fund. The
portfolio manager disclosed that he exploited pricing inefficiencies between fixed income securities while hedging
exposure to interest rate risk. The portfolio manager utilizes a convergence trading strategy, which assumes that the
price difference between two similar assets will narrow in the future. The portfolio manager is willing to invest in
illiquid bonds if the opportunity presents itself. in reviewing the correlation matrix (Exhibit 2), Nash concluded that
the Fixed Income Arbitrage hedge fund would be an ideal addition to his client's current traditional investment
portfolio. Nash's rationale was that a low correlation between the hedge fund and the S&P 500 index will assure
that the fund's returns will be positive when the returns of the index are negative.
After reviewing Nash's research, the Director of Research at his firm inquired why he did not examine the value at
risk (VAR) measure for the various hedge fund strategies. Nash stated that VAR is an ineffective statistical
measure of risk when a hedge fund has high turnover or frequent changes in its strategy. In addition,
Nash stated his belief that when the only input is historical data, VAR does not provide a reliable estimate of future
risk.
Rather than comparing hedge funds against the S&P 500 index, Nash believes a hedge fund index may be more
appropriate. Which of the following is least likely to be a problem with the hedge fund index constructed by Nash?
A. Backfill bias.
B. Selection bias.
C. Autocorrelation.
Answer: B
Several problems exist with hedge fund index data. The problems include: hedge fund listing issues, exclusion of
certain hedge funds, data verification issues, turnover, survivor bias, backfill bias, estimation bias due to the closing
of funds to new investors, autocorrelation, and the short performance history of hedge funds. As discussed in the
problem, Nash recognized and addressed two issues: data verification and hedge fund selection. Therefore, these
issues would least likely be problems in this case. (Study Session 13, LOS 49.b)
Question #552
A client of Colby Nash, CFA, wants to add an alternative asset class to his portfolio. However, the client is
concerned that any investment in hedge funds may be far riskier and generate lower returns than is generally
expected. Nash believes the client's attitude toward hedge funds was influenced by negative press coverage
regarding fraud perpetrated by a few funds. Nash decided to conduct his own research on the risk/reward
characteristics of hedge funds. Nash generated a report (shown in Exhibit 1) comparing several hedge fund
strategies and a traditional investment benchmark; the S&P 500 index. Each hedge fund strategy is represented by
an individual fund, which is used to measure risk and return over a ten year period. Nash also created a correlation
matrix between hedge funds and the S&P 500 index, shown in Exhibit 2.
In addition to the statistics presented in the exhibits above, Nash created a hedge fund index to evaluate each fund's
performance. Nash recognized the fact that several shortcomings exist in creating an adequate hedge fund index. To
that end, Nash created an index in which all the hedge funds included in the index agreed to provide data that can
be verified by Nash. Nash also set up strict rules for inclusion and removal of hedge funds into and out of the
hedge fund index.
As a further improvement to his research, Nash created a positive risk-free rate benchmark to evaluate each hedge
fund. However, his review of academic research indicated thar the positive risk-free rate benchmark is only
appropriate for a limited number of hedge fund strategies. The current risk-free rate is 4%.
Nash conducted a personal interview with the portfolio manager of the Fixed Income Arbitrage hedge fund. The
portfolio manager disclosed that he exploited pricing inefficiencies between fixed income securities while hedging
exposure to interest rate risk. The portfolio manager utilizes a convergence trading strategy, which assumes that the
price difference between two similar assets will narrow in the future. The portfolio manager is willing to invest in
illiquid bonds if the opportunity presents itself. in reviewing the correlation matrix (Exhibit 2), Nash concluded that
the Fixed Income Arbitrage hedge fund would be an ideal addition to his client's current traditional investment
portfolio. Nash's rationale was that a low correlation between the hedge fund and the S&P 500 index will assure
that the fund's returns will be positive when the returns of the index are negative.
After reviewing Nash's research, the Director of Research at his firm inquired why he did not examine the value at
risk (VAR) measure for the various hedge fund strategies. Nash stated that VAR is an ineffective statistical
measure of risk when a hedge fund has high turnover or frequent changes in its strategy. In addition,
Nash stated his belief that when the only input is historical data, VAR does not provide a reliable estimate of future
risk.
Nash evaluated the hedge fund strategies using the positive risk-free rate benchmark. The positive risk-free rate
benchmark would be most appropriate for:
A. Long/Short Equity hedge funds.
B. Fixed Income Arbitrage hedge funds.
C. Equity Market Neutral hedge funds.
Answer: C
The positive risk-free rate benchmark can be justified by the fact that arbitrage strategies should be market neutral.
A market neutral fund should earn the risk-free rate. The Equity Market Neutral hedge fund employs a strategy that
is closest to a pure risk-free arbitrage. The investor expects the manager to use her skill to generate a return greater
than the risk-free rate. It should be understood that the Equity Market Neutral hedge fund manager must take on
some type of risk to generate excess returns. (Study Session 13, LOS 49-b)
Question #553
A client of Colby Nash, CFA, wants to add an alternative asset class to his portfolio. However, the client is
concerned that any investment in hedge funds may be far riskier and generate lower returns than is generally
expected. Nash believes the client's attitude toward hedge funds was influenced by negative press coverage
regarding fraud perpetrated by a few funds. Nash decided to conduct his own research on the risk/reward
characteristics of hedge funds. Nash generated a report (shown in Exhibit 1) comparing several hedge fund
strategies and a traditional investment benchmark; the S&P 500 index. Each hedge fund strategy is represented by
an individual fund, which is used to measure risk and return over a ten year period. Nash also created a correlation
matrix between hedge funds and the S&P 500 index, shown in Exhibit 2.
In addition to the statistics presented in the exhibits above, Nash created a hedge fund index to evaluate each fund's
performance. Nash recognized the fact that several shortcomings exist in creating an adequate hedge fund index. To
that end, Nash created an index in which all the hedge funds included in the index agreed to provide data that can
be verified by Nash. Nash also set up strict rules for inclusion and removal of hedge funds into and out of the
hedge fund index.
As a further improvement to his research, Nash created a positive risk-free rate benchmark to evaluate each hedge
fund. However, his review of academic research indicated thar the positive risk-free rate benchmark is only
appropriate for a limited number of hedge fund strategies. The current risk-free rate is 4%.
Nash conducted a personal interview with the portfolio manager of the Fixed Income Arbitrage hedge fund. The
portfolio manager disclosed that he exploited pricing inefficiencies between fixed income securities while hedging
exposure to interest rate risk. The portfolio manager utilizes a convergence trading strategy, which assumes that the
price difference between two similar assets will narrow in the future. The portfolio manager is willing to invest in
illiquid bonds if the opportunity presents itself. in reviewing the correlation matrix (Exhibit 2), Nash concluded that
the Fixed Income Arbitrage hedge fund would be an ideal addition to his client's current traditional investment
portfolio. Nash's rationale was that a low correlation between the hedge fund and the S&P 500 index will assure
that the fund's returns will be positive when the returns of the index are negative.
After reviewing Nash's research, the Director of Research at his firm inquired why he did not examine the value at
risk (VAR) measure for the various hedge fund strategies. Nash stated that VAR is an ineffective statistical
measure of risk when a hedge fund has high turnover or frequent changes in its strategy. In addition,
Nash stated his belief that when the only input is historical data, VAR does not provide a reliable estimate of future
risk.
Evaluate Nash's conversation with the Fixed Income Arbitrage hedge fund portfolio manager and Exhibit 2. Which
of following is least likely an investment risk of the hedge fund?
A. Leverage risk.
B. Credit spread risk.
C. Style drifts risk.
Answer: C
There is nothing in the case to suggest that style drifts are a problem. The correlation matrix indicates that the
portfolios returns are as expected relative to the other funds and the S&P 5U0 index. By definition the Fixed
Income Arbitrage hedge fund will generate a large part of its return by using leverage. This leverage can be as
much as 20 to 30 times the fund s capital base. The convergence trading strategy utilized by the Fixed Income
Arbitrage hedge fund takes advantage of credit spread anomalies. Thus, the risk of widening or narrowing credit
spreads must be monitored by the portfolio manager. The hedge fund invests in illiquid securities when the
opportunity presents itself. These investmentscan be difficult to price and can result in operational risks by
potentially inflating the valuation of these securities without any intent of fraud. (Study Session 13, LOS 50.a)
Question #554
Research associate Kate Sawyer is responsible for identifying the determinants of performance for her firm's
Progressive Fund (PF). All tests performed at
Sawyer's firm are examined at the 0.05 level of significance-Sawyer examines the following regressions using
monthly data observed for a 36 month period:
A colleague. Jack Lockhart, makes two recommendations to Sawyer:
Recommendation 1: My research indicates that inflation rate changes are highly correlated with the Wilshire 5000
stock index returns. Therefore, I recommend adding the inflation change variable to your regression.
Recommendation 2: My research indicates that the slope coefficients of your regression changed significantly after
the passage of Regulation Fair Disclosure, which took place in the middle of your 3-year sample period. Your
regression pools across two distinct sample periods. Therefore, I recommend correcting your current regression
equation (1) for model misspecification.
In her conversation with Lockhart, Sawyer explains that she is concerned that her regression equation (1) may
ignore other important determinants of performance for the Progressive Fund. Sawyer explains that she is aware
that the omission of important independent variables affects the quality of the parameter estimates of the regression.
She makes the following claims assuming the omitted variables arc correlated with the included variables:
Claim 1: The parameter estimates of equation (1) are unbiased.
Claim 2: The parameter estimates of equation (1) are inconsistent.
Regarding Claim 1 and Claim 2 made by Sawyer about the effects of omitted variables, indicate which claims are
correct.
A. Claim I only.
B. Claim 2 only.
C. Both Claim 1 and Claim 2.
Answer: B
Sawyer is incorrect with respect to Claim 1 and is correct with respect to Claim 2. If the omitted variables are
correlated with the included variables, then the omitted variable regression parameter estimates (i.e., from equation
(1)) will be biased and inconsistent. Desirable properties, on the other hand, are unbiasedness and consistency. An
estimator is unbiased if the expected value of the estimate equals the true population value. An estimator is
consistent if the estimate approaches the true population value as the sample size increases. The existence of
omitted variables (that are correlated with the included variables) destroys both of these desirable properties.
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