11. Market Efficiency/Behavioural Finance/CFA Flashcards
1
Q
CFA: What is mosaic theory?
A
States that an analyst may use MATERIAL PUBLIC INFORMATION OR NON-MATERIAL NON-PUBLIC INFORMATION in creating a larger picture than shown by any individual piece of information and the conclusions the analyst reaches become material only after the pieces are assembled
2
Q
CFA P17: Which of the following is least likely to be a violation of the CFA Code of Standards?
- Anderb failed to disclose to her employer her personal transactions
- Anderb breached her fiduciary responsibility to her clients
- Bates failed to enforce reasonable procedures for supervising and monitoring Anderb’s trading for her own account
- Bates allowed Anderb to use Jonelli as her broker for personal trades
A
- Anderb has been obtaining lower prices for her personal securities transactions than she gets her clients: breach of Standard III(A) - Loyalty, Prudence and Care.
- She violated Standard I(D) - Misconduct, by failing to adhere to company policy and hiding her personal transactions from her firm
- Bates violated Standard IV(C) - Responsibilities of Supervisors although the company had requirements for reporting personal trading, Bates failed to adequately enforce these procedures.
- There is no indication that the company has a prohibition against employees’ using the same broker they use for their personal accounts that they also use for client accounts so the answer is D
3
Q
CFA P19: Ward and offer for expenses to be paid
A
Correct answer is “to pay for all travel expenses”, which is the best course of action under Standard I(B) - Independence and Objectivity, to avoid a conflict of interest.
4
Q
CFA P21: Smithers is FA for XYZ, preparing purchase recommendation for JNI. which of the following is least likely to represent a conflict of interest for Smithers:
- S is on a retainer as a consultant to JNI
- XYZ holds for its own account a stubstantial common stock position in JNI
- S’s has material beneficial ownership of JNI through a family trust
- S’s brother-in-law is a supplier to JNI
A
Involves Standard VI(A) - Disclosure of Conflict.
- Employment relationship between analyst and company that is the subject of recommendation
- Beneficial interest of the analyst’s employer in the company’s stock
- Analyst’s own beneficial interest in the company stock.
- Relationship is through a relative which does not create a conflict of interest necessitating disclosure
5
Q
CFA P22: Misrepresenting track record. Has M violated the standards?
- Yes, because the statement about return ignores the risk preferences if his clients
- No, because M is not promising that he can earn 26% return in future
- No, because the statement is a trust and accurate description of M’s track record
- Yes, because the statement misrepresents M’s track record
A
Standard I(C) - Misrepresentation Although it may be true, it is misleading because the majority of the gain resulted from one client's large position taken against M's advice. -This statement misrepresents the investment performance the member is responsible for. He has not taken steps to present a fair, accurate and complete presentation of performance. C and B are incorrect. -A is incorrect because failing to disclose the risk preferences of clients does not make a statement misleading and is not a violation of the Standards in this context
6
Q
Muellers: Return Objective (4)
A
- Total return approach (cap appreciation + preservation)
- Preserving financial position on an inflation-adjusted basis is sufficient
- Long-life expectancy may lead to likely need for some growth in assets
- The future trust distribution will substantially alter their return requirements
7
Q
Muellers: Risk Tolerance (4)
A
- Middle stage of life cycle, given income, resources and long time horizon, can take on average or above average risk
- However, it has been stated they want minimal volatility
- Large holding of Andrea’s company needs to be reduced
- Future trust distribution will increase their ability to assume risk
8
Q
Muellers: Time Horizon and Liquidity
A
- TH: long time horizon, multi-stage: next five years (some assets, negative CFs because of college), following five years (some assets, positive CFs), beyond ten years (increased assets from trust, negative CFs)
- Liquidity: need 50 000 now for college + subsequent years which will exceed their current incomes, which can be meet either through liquidation of some of large company holding or income generation from portfolio. After college, low liquidity requirements until retirement
9
Q
Muellers: Taxes
A
- Preferable to wear capital gains than income tax (difference)
- The tax loss carry forward of $100 000 can offset taxes on gains up to that amount without cash outflow or reduction in asset base
10
Q
Muellers: Unique Circumstances
A
- Large asset holding is increasing risk, this needs to be reduced. Because of the tax carry forward, they can reduce it by up to 50% without having to pay capital gains tax
- Trust distribution in 10 years will significantly alter the risk they can take on, the required return, long term needs etc
11
Q
Mr Franklin: Risk Tolerance
A
- Given the assets and long-term goal, can take on ABOVE AVERAGE risk:
- Already aware of risks through his financial knowledge
- Still has long life expectancy
- Foundation already has a good asset base
12
Q
Mr Franklin: Return Requirements
A
- The current asset pool should generate sufficient income, and minor adjustment can be made if necessary
- Inflation-adjusted ENHANCEMENT OF THE CAPITAL BASE for the benefit of the foundation will be the primary goal, with tax minimisation a collateral goal
13
Q
Mr Franklin: Time Horizon, Liquidity
A
- TA: long-term because long life expectancy + foundation has virtually perpetual life span
- Liquidity: given the generation of income from current asset holdings, no additional liq requirements
14
Q
Mr Franklin: Taxes, Legal/Reg, Unique Circumstances
A
- Tax: highest tax-bracket, consider tax-sheltered investments, tax minimisation a specific goal
- Legal/Reg: funds under professional management are governed by state law and Prudent Person rule
- Unique Circumstances: large asset holding, foundation as recipient, freedom of action
15
Q
Mr Franklin: Justify a long-term asset allocation
A
- Stocks have been providing best returns, and since cap appreciation is the objective, will have greatest weighting. Consistent with income requirements
- Warehouse and personal residence are already significant so no further adjustments necessary. Good source of income. Could consider debt for tax purposes
- Given above average risk tolerance and long-term horizon, 70% stocks and 30% Fixed Income. International stocks for diversification, Municipal bonds for tax purposes
