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CFA Level III Updated
What is the difference between qualified dividends and ordinary dividends for tax purposes?
Qualified dividends are taxed at preferential long-term capital gains rates (0%, 15%, or 20% depending on bracket) rather than ordinary income rates...
How should a portfolio manager approach currency management in a global portfolio?
Currency management ranges from fully hedged to unhedged, with strategic partial hedging as institutional default tuned to objectives.
What is enhanced indexing in fixed income?
Enhanced indexing tracks closely (TE 20-75 bps) while taking diversified relative-value bets for 15-50 bps alpha. Sources include new-issue concessions, fallen angels, roll-down, and sector rotation.
How do I calculate time-weighted return and why is it the standard for manager evaluation?
Time-weighted return chain-links sub-period returns between cash flows to measure pure investment performance independent of client cash flow timing — the GIPS standard...
How does GIPS treat significant cash flows in composites?
GIPS allows temporary removal of portfolios experiencing significant cash flows (exceeding pre-defined threshold) to avoid distorting composite returns. Requires written policy, consistent application, disclosure...
What investor protections should LPs seek in hedge fund investments?
Hedge fund investor protections: high-water mark, hurdle rate, clawback, lockups/gates, key-person clause, MFN, independent administrator, audits, side pocket governance, transparency. ODD is critical.
How does secondary market pricing work for PE interests and what is the NAV discount?
Secondary PE buyers purchase fund interests at a discount to NAV (5-15% normal, 30-50% stressed) reflecting NAV staleness, liquidity premium, unfunded calls, fees, and information asymmetry.
How does fine wine work as an investment class?
Investment-grade fine wine is a narrow segment — roughly the top 250 wines globally including first-growth Bordeaux, Burgundy grand crus, cult California...
Is art a legitimate investment asset class and how should I evaluate it?
Art as an investment has real return characteristics but is not a traditional financial asset. Long-run returns from the Mei Moses and Sotheby's Mei Moses indices suggest nominal 7-9% annual total returns...
How does mental accounting lead to suboptimal portfolio construction, and what is the measurable cost?
Mental accounting causes investors to manage separate mental accounts independently, ignoring cross-account diversification benefits. The measurable cost can exceed 1% annually in foregone returns because isolated account optimization prevents efficient risk allocation across the total portfolio.
What is a GP-led continuation fund, and how does it address alignment of interest between GPs and LPs?
A GP-led continuation fund transfers portfolio companies from an expiring fund into a new vehicle, offering existing LPs the option to cash out or roll over. Conflicts of interest are mitigated through independent valuations, lead secondary buyers, LPAC approval, and meaningful GP co-investment.
What fiduciary duties does ERISA impose on pension plan investment managers, and how do violations get enforced?
ERISA imposes four core fiduciary duties on pension plan managers: loyalty (exclusive benefit), prudence (expert standard), diversification, and plan document compliance. Violations trigger personal liability for losses, disgorgement of profits, excise taxes, and potential criminal penalties.
What is dispersion trading, and why is index implied volatility typically higher than the weighted average of component volatilities?
Dispersion trading sells index volatility (typically overpriced due to correlation risk premium) and buys single-stock volatility. The trade profits when realized correlations among index components are lower than the implied correlation embedded in index option prices.
How do pension funds use derivatives overlays in LDI to hedge interest rate risk without selling their return-seeking assets?
A derivatives overlay uses receive-fixed swaps, Treasury futures, or swaptions to synthetically extend portfolio duration, allowing pensions to maintain return-seeking assets while hedging liability interest rate risk. The overlay adds the duration gap without selling equities or alternatives.
How is portable alpha implemented in practice, and what are the key risks that can cause the strategy to fail?
Portable alpha combines a market-neutral alpha source with synthetic beta exposure through derivatives. The strategy failed during 2008 because hedge fund liquidity gates prevented margin funding, and assumed-zero correlations spiked as deleveraging drove all assets down simultaneously.
How should portfolio rebalancing be modified to account for tax costs, and when does the tax drag of rebalancing outweigh the benefit?
After-tax rebalancing uses wider bands, cash flow direction, and tax lot selection to minimize the tax cost of returning to target allocations. Pairing rebalancing sales with tax loss harvesting can often achieve tax-neutral rebalancing. Optimal tax-aware bands are 1.5-2x wider than pre-tax bands.
How does availability bias cause investors to overweight recent or vivid events in their forecasts?
Availability bias causes investors to estimate probabilities based on how easily examples come to mind rather than statistical base rates. Recent, dramatic, or media-saturated events feel more probable, leading to systematic misallocation and forecasting errors.
How does Monte Carlo simulation improve retirement planning compared to traditional deterministic projections?
Monte Carlo simulation captures sequence-of-returns risk and path dependency that deterministic models ignore. It produces a probability distribution of outcomes including ruin probability, making it far more informative for retirement planning than single-point projections.
How does factor-based asset allocation differ from traditional asset-class allocation?
Factor-based allocation decomposes portfolio returns into underlying risk factors and allocates to those directly, rather than thinking in traditional asset-class terms. The key insight is that different asset classes often share the same underlying factor exposures, making traditional diversification less effective than it appears.
What are the main estate planning and wealth transfer strategies tested on CFA Level III?
Estate planning for CFA Level III focuses on transferring wealth efficiently across generations while minimizing transfer taxes. Key strategies include lifetime gifting, generation-skipping transfers, trust structures, cross-border planning, and valuation discounts.
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