2009.CFA.Level.3.Examination

LevelIIITheMorningSessionofthe2009LevelIIICFA®Examinationhas11questions.Forgradingpurposes,themaximumpointvalueforeachquestionisequaltothenumberofminutesallocatedtothatquestion.QuestionTopicMinutes1234567891011PortfolioManagement–IndividualPortfolioManagement–IndividualPortfolioManagement–InstitutionalPortfolioManagement–InstitutionalPortfolioManagement–EconomicsPortfolioManagement–AssetAllocationPortfolioManagement–EquityInvestmentsPortfolioManagement–AlternativeInvestmentsPortfolioManagement–RiskManagementPortfolioManagement–MonitoringandRebalancingPortfolioManagement–PerformanceEvaluation269241119101715161518Total:180LevelIIIQuestions1and2relatetoPatriciaandAlexanderTracy.Atotalof35minutesisallocatedtothesequestions.Candidatesshouldanswerthesequestionsintheorderpresented.QUESTION1HASFOURPARTS(A,B,C,D)FORATOTALOF26MINUTES.PatriciaandAlexanderTracy,bothage59,areresidentsofCanada.Theyhavetwinsonswhowillenterafour-yearuniversityprograminoneyear.Patriciaisalong-timeemployeeofatelecommunicationscompany.Alexanderisaself-employedsalesconsultant.Alexander’sannualincomeisnowsteadyafteryearsofextremehighsandlows.TheTracyshavebuiltaninvestmentportfoliothroughsavinginAlexander’shighincomeyears.TheTracys’currentannualincomeisequaltotheirtotalexpenses;asaresult,theycannotaddtosavingscurrently.Theyexpectthatboththeirexpensesandincomewillgrowattheinflationrate.Allmedicalcosts,nowandinthefuture,arefullycoveredthroughgovernmentprograms.TheTracysworryaboutwhethertheyhavesavedenoughforretirement,andwhethertheywillbeabletomaintaintherealvalueoftheirportfolio.Inflationisexpectedtoaverage4%fortheforeseeablefuture.TheTracyshaveapproachedDarrenBriscoetohelpthemanalyzetheirinvestmentstrategyandretirementchoices.TheTracysdisagreeabouttheappropriateinvestmentstrategy.Patriciaprefersnotlosingmoneyovermakingahighreturn.Thisispartlyaresultofcontinuingregretforalossexperiencedinanequitymutualfundseveralyearsago.Alexander’shistoryofmakingfrequentchangesintheirportfoliogreatlyannoyedPatricia.ShethinksAlexanderfocusedonlyonpotentialreturnandpaidlittleattentiontorisk.TheTracyscurrentlyhavealltheirassetsininflation-indexed,short-termbondsthatareexpectedtocontinuetoearnareturnthatwouldmatchtheinflationrateaftertaxes.Afterretirement,theyarewillingtoconsiderchangingtheirinvestmentstrategyifnecessarytomaintaintheirlifestyle.TheTracysareeligibletoretirenextyearatage60.Iftheydo,Patriciawillreceiveannualpaymentsfromhercompany’sdefined-benefitpensionplanandbothPatriciaandAlexanderwillreceivepaymentsfromtheCanadiangovernmentpensionplan.Alexanderdoesnotparticipateinanycompanyorindividualretirementplan.BriscoehascompiledfinancialdataandmarketexpectationsfortheTracys’retirement,showninExhibit1.Currently,BriscoeestimatesthattheTracys’investmentportfoliowillgrowto1,100,000Canadiandollars(CAD)bytheirretirementdatenextyear.LevelIIIExhibit1FinancialDataandMarketExpectationsPatriciaandAlexanderTracyExpectedannualexpensesAnnualpensionincome(after-tax)Patricia’scompanyplanCombinedgovernmentpensionTotalannualpensionincomeExpectedannualinflationExpectedannualafter-taxportfolioreturnRetirementatAge60(2010)CAD125,000CAD40,000CAD40,000CAD80,0004%4%PensionincomefrombothPatricia’scompanyplanandthegovernmentpensionplanisfullyindexedforinflation.Briscoeexpectsataxrateof20%toapplytotheTracys’withdrawalsfromtheinvestmentaccount.TheTracysexpecttoearnnoemploymentincomeafterretirement.TheTracys’residenceisnotconsideredpartoftheirinvestableassets.TheTracyshavetheoptiontodelayretirementuntilage65.TheTracysintendtoretiretogether,whetheritisin2010atage60orin2015atage65.BriscoedeterminesthatiftheTracysretireatage60,theirrisktoleranceisbelowaverage.Iftheyretireatage60,theyplantopayofftheirmortgageandassociatedtaxesbywithdrawingCAD100,000fromtheirportfoliouponretirement.AnotherconsiderationfortheTracysrelatestofundinguniversityexpensesfortheirsons.IftheTracysretireatage60,eachsonwillreceiveascholarshipavailabletoretireefamiliesfromPatricia’scompanythatwillcoveralluniversitycosts.IftheTracysretireatage65,allpensionincomewouldincreaseandwouldalmostmeettheirannualspendingneeds.Iftheyretireatage65,theTracyswouldpayalluniversityexpensesfromtheirinvestmentportfoliothroughanarrangementwiththeuniversity.Thearrangement,coveringbothsons,wouldrequiretheTracystomakeasinglepaymentofCAD200,000atage60.A.i.PreparethereturnobjectivesportionoftheTracys’investmentpolicystatement(IPS)thatwillapplyiftheyretireatage60.ii.Calculatethepre-taxnominalrateofreturnthatisrequiredfortheTracys’firstyearofretirementiftheyretireatage60.Showyourcalculations.(12minutes)LevelIIIB.IndicatespecificfactorsfortheTracys,foreachofthefollowing,whichsupportBriscoe’sconclusionthattheTracys’risktoleranceisbelowaverage:i.ii.Abilitytotakerisk.Indicatetwofactors.Willingnesstotakerisk.Indicateonefactor.(6minutes)C.Preparethecurrent(2009)liquidityconstraintfortheTracys’IPS:i.ii.iftheyretireatage60.iftheyretireatage65.(4minutes)D.Preparethecurrent(2009)timehorizonconstraintfortheTracys’IPS:i.ii.iftheyretireatage60.iftheyretireatage65.(4minutes)LevelIIIQuestions1and2relatetoPatriciaandAlexanderTracy.Atotalof35minutesisallocatedtothesequestions.Candidatesshouldanswerthesequestionsintheorderpresented.QUESTION2HASONEPARTFORATOTALOF9MINUTES.PatriciaandAlexanderTracybothretiredfiveyearsagoatage65andtheirsonsnowsupportthemselves.Asaresultofbetterthanexpectedinvestmentreturnsoverthepastfiveyears,theTracys’investmentportfoliohassignificantlyincreasedinvalue.Theynowthinkthattheirfutureafter-taxinvestmentreturnswillexceedtheirexpensesfortheirremainingjointlifeexpectancy.Theirnewinvestmentobjectiveistomaximizetheassetstheirsonswillinherit,subjecttoareviewoftheTracys’risktolerancebytheirfinancialadvisor.Duringretirement,theTracys’medicalcostsarefullycoveredbythegovernment.TheTracyshavenoearnedincomeduringretirement.Theyhavepreviouslypaidoffalldebtandexpecttoremaindebt-free.Determinewhethereachofthefollowingmeasureshasincreased,decreased,orremainedunchangedfortheTracyssincejustpriortoretirement:i.ii.iii.impliedassetsimpliedliabilitiesrisktoleranceJustifyeachresponsewithonereason.AnswerQuestion2intheTemplateprovidedonpage11.(9minutes)