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Mock Exam
A

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Level 3 Mock Exam — Questions
Section 1: Ethics (12 points)
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1A. Lynn Fiorina, CMT, is a securities technical analyst following energy stocks and a rising star at
her firm. Her boss has been carrying a “buy” recommendation on International Oil Gas and
asks Lynn to take over coverage of that equity. He tells Lynn that under no circumstances should
the prevailing buy recommendation be changed.
Which of the following actions by Lynn is least likely a violation of the Code and
Standards? (2 points)
A. Lynn may be independent and objective in her analysis of International Oil Gas.
B. If Lynn believes that her boss’s instructions have compromised her, then she does not have
any options but to follow through with his demands.
C. Lynn must only issue recommendations that reflect her independent and objective opinion.
D. Lynn does not have to make recommendations that reflect her independent and objective
opinion.
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1B. Robert Farber, CMT, recently left his job as a research technical analyst for a large investment
advisor. While looking for a new position, he was hired by an investor-relations firm to write
a technical research report on one of its clients, a small educational software company. The
investor-relations firm hopes to generate investor interest in the technology company. The firm
will pay Robert a flat fee plus a bonus if any new investors buy stock in the company as a result
of Robert’s report.
Given this information, which of the following statements is most accurate? (2 points)
A. If Robert accepts this payment arrangement, he will not be in violation of Standard I(B)
because the compensation arrangement cannot be expected to compromise his independence
and objectivity.
B. If Robert accepts this payment arrangement, he will be in violation of Standard I(B) because
the compensation arrangement can be expected to compromise his independence and
objectivity.
C. Issuer-paid research that is objective and unbiased cannot be performed under the right
circumstances.
D. Issuer-paid research that is subjective and biased may be performed under the right
circumstances.

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1C. Charles Verdon, CMT, an analyst with Foster and Gibbons Incorporated, is assisting his firm
with a secondary offering for Brilliant Insight Technology Company. Charles participates, via
telephone conference call, in a meeting with Foster and Gibbons’ investment banking employees
and Brilliant Insight’s CEO. Charles is advised that the company’s earnings projections for the
next year have significantly dropped. Throughout the telephone conference call, several Foster
and Gibbons salespeople and portfolio managers walk in and out of Charles’s office, where
the telephone call is taking place. As a result, they are aware of the drop in projected earnings
for Brilliant Insight. Before the conference call is concluded, the salespeople trade the stock of
the company on behalf of the firm’s clients and other firm personnel trade the stock in a firm
proprietary account and in employees’ personal accounts.
Has Charles violated Standard II(A) regarding his failure to prevent the transfer and misuse of
material nonpublic information to others in his firm? (2 points)
A. Charles’s firm did not have to adopt information barriers to prevent the communication of
nonpublic information between departments of the firm.
B. The salespeople and portfolio managers who traded on the information have not violated any
applicable standard.
C. Charles violated Standard II(A) in failing to prevent the transfer and misuse of material
nonpublic information to others in his firm.
D. Charles did not violate Standard II(A).
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1D. Alyssa Newmark, CMT, is an investment advisor and technical analyst for high-net-worth clients.
A client with an aggressive risk profile in his investment policy statement asks about investing in
the Top Shelf hedge fund. This fund, based in Greenwich, Connecticut, has reported 20% returns
for the first three years. The fund prospectus states that its strategy involves long and short positions
in the energy sector using extensive leverage with options. Based on her overall fusion analysis
using a fundamental and technical examination of the fund’s financial holdings, track record, the
principals involved in managing the fund, the fees charged, and the fund’s risk profile, Alyssa
recommends the fund to the client and secures a position in it. The next week, the fund announces
that it has suffered a loss of 65% of its value and is suspending operations and redemptions until
after a regulatory review. Alyssa’s client calls her in a panic and asks for an explanation.
Given this information, which of the following statements is most correct? (2 points)
A. Alyssa’s actions were consistent with Standard V(A) as her analysis of an investment that
results in a reasonable basis for her recommendation does not guarantee that the investment
has no downside risk.
B. Alyssa’s actions were not legitimate as her analysis of this investment is unfavorably biased
due to a lack of fundamental and technical analysis.
C. Alyssa’s actions were legitimate as she did not have to discuss the matter with her client as
there was limited risk with this investment.
D. Alyssa’s actions were inconsistent with Standard V(A).

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1E. Roanna Maxwell, CMT, works for a regional brokerage firm. She estimates that Runnington
Industries will increase its dividend by US$1.75 a share during the next year. She realizes that
this increase is contingent on pending legislation that would, if enacted, give Runnington a
substantial tax break. The U.S. representative for Runnington’s home district has told Roanna
that, although she is lobbying hard for the bill and prospects for its passage are favorable,
concern of the U.S. Congress over the federal deficit could cause the tax bill to be voted down.
Runnington Industries has not made any statements about a change in dividend policy. Roanna
writes in her research report, “We expect Runnington’s stock price to rise by at least US$10.00
a share by the end of the year because the dividend will increase by US$1.75 as the trend is
technically up on weekly and monthly timeframes. Investors buying the stock at the current
time should expect to realize a total return of at least 20% on the stock.” According to the
Standards: (2 Points)
A. Roanna violated the Standards because she used material inside information.
B. Roanna violated the Standards because she failed to separate opinion from fact.
C. Roanna violated the Standards by basing her research on uncertain predictions of future
government action and mere speculation.
D. Roanna did not violate the Standards because she did not use material inside information.
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1F. Jordan Trump, CMT, is a portfolio manager. One of his firm’s clients has told Jordan that he
will compensate him beyond the compensation provided by his firm on the basis of the capital
appreciation of his portfolio each year. Jordan should: (2 Points)
A. Turn down the additional compensation because it will result in conflicts with the interests of
other clients’ accounts.
B. Turn down the additional compensation because it will create undue pressure on him to
achieve strong short-term performance.
C. Obtain permission from his employer prior to accepting the compensation arrangement.
D. Accept the additional compensation because it will result in conflicts with the interests of
other clients’ accounts.

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Section 2: System Development, Volatility (30 points)
This question combines Classical Methods, Volatility, and Portfolio Management. It is indicative of
the style of questions asked, but actual exam questions will vary in their content and complexity.
Use the following information to answer questions 2A through 2E.
You work as an analyst for Space27, a private equity firm that specializes in leveraged buyouts. You
are tasked with evaluating market conditions and recommending liquid strategies for protecting against
periods of market shock. You are evaluating the performance of four managed futures funds strategies
for your firm’s consideration. Your task is to write an opinion on which fund would be best for your firm
to invest in over the next 3 to 12 months. Your inputs are a 1-year chart of SPY, a short-term chart of the
VIX compared to the VIX futures, a short-term chart of SPY for comparison, and some performance data
from the four funds you are choosing among.
Chart 2-1

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Chart 2-2: 30-min, 10 day
Chart 2-3: 30-min, 10 day (for comparison to VIX charts)

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2A. How would you describe your observation of the SP 500’s overall trend as
shown in Chart 2-1? (3 points)
A. Trend is rising, RSI is not oversold, recent price drop is just a dip worth buying.
B. Trend has changed from upward to downward.
C. Trend is likely to fail because a head-and-shoulders is forming.
D. Trend is weakening as shown by the RSI, but has not failed yet.
Chart 2-4
Fund A Fund B Fund C Fund D
Average # of Trades Annually 52 21 250 450
Percent Profitable 57.5% 79.6% 58.5% 42.4%
Previous Year’s Rate of Return –5.2% 63.1% 29.1% 23.1%
10-year Average Annual Return 8.7% 12.2% 11.6% 12.5%
Std. Deviation of Annual Return 4.8% 14.7% 5.2% 10.8%
Rate of Return for 2008 46.2% 2.3% –11.8% –35.7%
Std. Deviation of 2008 Return 16.5% 12.2% 7.5% 20.5%
Percent of Time in the Market 16.3% 25.8% 33.4% 73.6%
Correlation to SPX –.05 +.20 +.24 +.76
Max. Drawdown (Trade Close to Trade Close)
as % of Initial Capital 3.8% 11.9% 1.6% 10.7%
Net Return as % of Drawdown 297.6% 181.4% 617.7% 124.3%
Average Beta of Stocks in Fund –.10 2.2 1.4 1.1
Information Ratio
Based on 10-Year Average Return 1.81 .82 2.23 1.16
Information Ratio Based on 2008 Performance 2.8 .18 –1.57 –1.74

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2B. What observation is noteworthy about the VIX and VIX futures patterns? (4 points)
A. The VIX moves show lower peaks while the VIX futures show higher peaks, suggesting that
VIX futures imply a continued rise in implied volatility.
B. The VIX moves are greater than the VIX futures moves, showing that the VIX futures imply
the market has yet to price in bullish sentiment.
C. The VIX moves are extreme and the VIX futures are not, implying that the futures market is
in contango and likely to stay that way.
D. The VIX moves were overdone for a few days but then got back into sync with the VIX
futures, showing that the extreme move was anomalous.
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2C. What would be the best interpretation of a comparison of the SP 500’s intraday trend for the
past two weeks with the VIX and VIX futures patterns? (4 points)
A. The SP mirrors the VIX; in general terms, everything is ordinary. This implies more bearish
moves ahead.
B. The VIX shows a current trend of lower highs and lower lows. This implies more bullish
moves ahead.
C. The VIX moves were exaggerated, but the VIX futures still trend higher, diverging from the
SP 500 price action. This implies more bearish moves ahead.
D. The VIX moves mirrored the SP and the VIX futures lagged because of a quick drop in price,
but all lines are converging back into equilibrium. This implies more bullish moves ahead.
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2D. Why would the Treynor ratio be less helpful for this selection process than the information
ratio? (4 points)
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2E. Select a fund based on the data you have from Charts 2-1, 2-2, 2-3, and 2-4 and specify three
reasons to support your choice. (15 points)

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Section 3: Asset Relationships (40 points)
Use Chart 3-1 to answer question 3A.
Chart 3-1
Use Chart 3-2 to answer questions 3B through 3E
Chart 3-2

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3A. You publish an advisory newsletter that alerts readers to opportunities in the Asian markets. As part
of your research you observe the Relative Rotation Graph (Chart 3-1) to determine which currencies
may provide evidence of a strengthening economy. Two currencies stand out on the chart, the
Philippines peso (PHPUSD, light blue line) and the Thai baht (THBUSD, darker blue line).
Which statement gives the most accurate interpretation of Chart 3-1? (8 points)
A. PHPUSD is likely to move into the “Leading” quadrant very soon.
B. THBUSD and PHPUSD are equally likely to outperform all other currencies shown in this chart.
C. The currencies in the “Improving” quadrant have outperformed all others over the past
10 weeks; this implies that they are poised to continue doing so.
D. The Malaysian ringgit (MYRUSD) will likely remain in the “Lagging” quadrant over the
next 10 weeks.
In addition to Chart 3-1, suppose you had other research that helped you to conclude that the Philippines
peso was showing evidence of economic opportunity in the Philippines.You therefore look to see if it is
appropriate to recommend a trade on EPHE, the ETF that tracks companies within that country. But this
requires that the chart show evidence of a bullish trade. Review Chart 3-2 of EPHE and its comparison to
EEM (a general, emerging-markets ETF), and identify the following.
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3B. Explain how the evidence of Chart 3-2 confirms or contradicts a bullish trade. (8 points)
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3C. List three points of evidence in Chart 3-2 for either a bullish or bearish trade. (12 points)
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3D. The time interval for calculating the correlation in Chart 3-2 was 20 periods, which equates
to about 1 month of trading days. The ending value of the correlation graph is +.76. The
interpretation of this correlation coefficient is best described by which of the following
statements? (6 points)
A. Over the past month the correlation to price comparison is strong and the correlation to
percentage changes is very strong.
B. Over the past month the correlation to price comparison is medium and the correlation to
percentage changes is strong.
C. Over the past month the correlation to price comparison is weak and the correlation to
percentage changes is very weak.
D. Over the past month the correlation to price comparison is very strong and the correlation to
percentage changes is medium.

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3E. Identify what candlestick pattern can be found in the lowest bar of Chart 3-2 and the two bars on
either side of it. (6 points)
A. Bullish engulfing with a high-wave candle following
B. Three outside up or spring with hammer candle
C. Above the stomach or piercing
D. Three-line strike or upthrust

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Section 4: Portfolio Management, Asset Relationships (34 points)
Use Chart 4-1 and the following information to answer questions 4A through 4C.
Chart 4-1: Position of U.S. economic status relative to business cycle
You are an analyst for Orange Valley Asset Management LLC, and your firm just updated their business
cycle model and designated where they believe the U.S. economy is currently positioned along the
business cycle (shown as the blue circle in Chart 4-1). The current reading shows that the U.S. is
positioned at the top of the full expansion phase. As the head of technical analysis, you are asked to
supply opinions on the following questions.
017-L3MEA017
4A. Select two of the following economic sectors that you would recommend the portfolio team
should overweight (6 points), and explain your answers. (8 points)
Industrials
Consumer Staples
Technology
Utilities
Financials

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4B. Which two of the following economic sectors would you recommend the portfolio team
underweight based on Chart 4-1? (8 points)
Materials
Technology
Utilities
Industrials
Financials
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4C. One month after you made your allocation decisions, the performance data for various sectors
appeared as follows:
SECTORS 1 Month 3 Month 1 Year 3 Year 5 Year
Energy +0.26% –7.90% –3.24% +10.71% +37.79%
Telecommunication Services +1.79% –2.95% +4.72% +24.16% +47.66%
Materials +0.91% +1.38% +10.99% +30.51% +62.48%
Consumer Discretionary +0.56% +5.89% +14.70% +74.66% +144.34%
Financials –3.92% –0.26% +12.91% +65.82% +63.32%
Industrials –0.56% +1.73% +11.82% +52.99% +94.62%
Information Technology –1.76% +1.18% +19.01% +52.11% +95.54%
Consumer Staples +1.23% +4.80% +20.23% +51.23% +82.22%
Health Care +2.06% +4.19% +25.25% +95.02% +117.92%
Utilities +2.64% +7.34% +24.71% +40.55% +62.77%
SP 500 Index –0.40% +1.58% +15.00% +54.66% +85.81%
Chart 4-2: Sector performance dashboard
After reviewing the latest SP sector performance dashboard in Chart 4-2, what observations can
you make about whether the 3-month and 1-year sector performances confirm or conflict with the
allocations that you chose in the previous two questions? (12 points)

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Section 5: Classical Methods (30 points)
Use Chart 5-1 and the following information to answer questions 5A through 5C.
Chart 5-1: Growth stock breaking out
You work as a trader for a large investment bank. The management has disclosed to you that they believe
that this stock (shown in Chart 5-1) has significant potential for growth based on the information about
who was hired as the new CEO. The chart shown above reflects the recent jump in price based on the
news. Your management has asked you to identify whether attempting to purchase in the next two trading
sessions is likely to be favorable timing.

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5A. Explain 5 points of evidence you can see on this chart that support the possibility of a continuing
upward trend. (15 points)
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5B. Assume your management wants to initiate and maintain a position of around 100,000 shares in
this stock. They want your opinion on whether a stop-loss could be implemented for this trade
without creating too much slippage. (5 points)
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5C. Name a logical place for a stop-loss and specify a reason for your choice. (10 points)

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Section 6: Classical Methods (30 points)
Use Chart 6-1 and the following information to answer questions 6A through 6F.
Chart 6-1: Jakarta Composite Index, before session opening
You work for a hedge fund that specializes in global opportunities. You run a portfolio based on Southeast
Asian equities and you see opportunities building in Indonesia. The Jakarta Composite Index looks
promising to you, but given the recent volatility in the global markets, your fund is currently employing
very short-term trading strategies, with the ability to enter either LONG or SHORT positions.

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6A. Based on the majority of evidence in the chart of the index, which direction recommendation
would you expect to start a trade: LONG or SHORT? (3 points)
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6B. Give the name of the two most recent multiday candlestick patterns and describe how each
supports your conclusion (i.e., continuation, reversal, etc.). (5 points)
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6C. Name one additional point of evidence, such as support, resistance, or other price/candle
patterns (not oscillators or trend indicators), found in the chart that helps to strengthen your
conclusion. (4 points)
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6D. Examine the three provided indicators in Chart 6-1: Jakarta Composite Index. Note that Bollinger
bands, ATR, and RSI all use a 10-period calculation. Briefly note how each indicator works (the
concept is more important than the actual formula). (6 points)
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6E. Identify your short-term outlook for the index and explain how each of the 3 indicators applies to
it. Be very specific. (6 points)
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6F. Assume you decide to use an exchange-traded fund (ETF) that tracks the Jakarta Composite
Index. This ETF trades at 1/100 of the index’s actual value. So, for example, if the index is
currently trading at a level of 5225, the ETF would be priced at $52.25 per share in the market.
Using Chart 6-1, determine how many shares of this ETF can be traded (long or short), rounded
to the nearest 100 shares. Assume the following conditions, and demonstrate how you arrived at
your answer. (6 points)

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Section 7: Risk Management, System Development (24 Points)
Use Chart 7-1 to answer questions 7A and 7B.
Chart 7-1

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7A. You work as a proprietary trader and are examining Chart 7-1 for a possible short-term swing-
trade entry. Of the following choices, which one of these patterns would be the most significant
indicator of a reversal setup, if it occurred next on the Alerian MLP Index? (6 points)

A. B.
C. D.
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7B. Name the candlestick pattern at the most recent swing high price near $470
in Chart 7-1. (6 points)

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7C. Assume you saw a setup you wanted to trade for a bearish continuation swing trade. This trade
would enter the Alerian MLP Index $408 after breaking support. You need to determine a stop-
loss price close enough to your entry price to maximize the trade potential, but far enough away
to not be stopped out by normal movement of the stock. Which of the following strategies would
be most likely to help you identify the best stop-loss price? (6 points)
A. Position a stop just a few cents above the broken support price.
B. Position a stop at the sum of the last closing prices and the annual VIX expected move.
C. Position a stop at the sum of the last closing price and the Case Dev-Stop calculation (which
uses ATR and standard deviation).
D. Position a stop above the last swing high near $472.
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7D. Suppose you notice that volatility is increasing on the Alerian MLP Index as well as for the
market at large. You have a rule that requires you to reduce your position size for the trade when
these circumstances occur. What influence would this rule have on your trading? (6 points)
A. The rule helps limit the volatility of returns in your trading.
B. The rule helps you select a stop-loss that is more logical and less likely to be hit.
C. A smaller position size means you are taking on less risk.
D. You will be out of the market during volatile periods.

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Section 8: Behavioral Finance, Risk Management (40 Points)
Use Chart 8-1 and the following information to answer questions 8A through 8E.
Chart 8-1: Weekly commodity chart
You work as the portfolio manager and principal of a boutique investment firm. Your firm is about to be
acquired by a significantly larger investment company that has a few concerns about your investment
selection process and your currently opened positions.
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8A. You currently have a sizable short position in a commodity. Its weekly price chart
(Chart 8-1) shows that the position has recently moved strongly in your favor. When asked
how you anticipated such a move you explained that this was a trade designed to capture
the breaking of a classic bubble market. Name and briefly describe the last two stages of a
bubble. (14 points)

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8B. Your current selection process includes only you and the research you study. The investment
company that wants to acquire your firm would like for you to consider making your selection
decisions with a committee that would have a vote. Assuming you had to accept some form of
this change, which of the following scenarios would you consider most likely to produce the best
results? (6 points)
A. Making decisions that require all members vote unanimously on a decision before action can
be taken.
B. Committee will vote on decisions using a secret ballot.
C. Committee will meet each month to look over recent mistakes and discuss corrections.
D. Committee will discuss the best ideas screened by an analyst team.
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8C. The new company’s management has questions about your position size on the short commodity
trade. It has performed well so far, and they want to know your strategy for getting out. You
explain that you are using a reflective pyramid compounding structure. You will stop out of all
contracts if the price rises to 105.
For taking profits you will do so in three tiers. The first tier of contracts closes out profits if the
price breaks through the 4-week support price, and the second tier closes out if the price breaks
through the 20-week support price. The final tier will be taken off through a trailing stop.
You explain that you began your position with 25 contracts and you have now built it up to
43 contracts after adding to the position twice.
Based on the pattern of a reflective pyramid, how many contracts will you close out if the price
drops to 75? (10 points)
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8D. How many more contracts will you close out if the price drops to 62? (5 points)
037-L3BHMEA037
8E. How many more contracts will you close out if the price drops to 52? (5 points)

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Level 3 Mock Exam — Solutions
Section 1: Ethics
1A. Answer: C
Choice A is incorrect. CFA SOP: Research Independence and Prior Coverage
Choice B is incorrect. CFA SOP: Research Independence and Prior Coverage
Choice C is the correct answer. Lynn must be independent and objective in her analysis of
International Oil Gas. If she believes that her boss’s instructions have compromised her, she
has two options: She can tell her boss that she cannot cover the company under these constraints,
or she can take over coverage of the company, reach her own independent conclusions, and if
they conflict with her boss’s opinion, share the conclusions with her boss or other supervisors
in the firm so that they can make appropriate recommendations. Lynn must issue only
recommendations that reflect her independent and objective opinion.
Choice D is incorrect. CFA SOP: Research Independence and Prior Coverage
1B.
Answer: B
Choice A is incorrect. CFA SOP. Research Independence and Compensation Arrangements
Choice B is the correct answer. If Robert accepts this payment arrangement, he will be in
violation of Standard I(B) because the compensation arrangement can reasonably be expected
to compromise his independence and objectivity. Robert will receive a bonus for attracting
investors, which provides an incentive to draft a positive report regardless of the facts and to
ignore or play down any negative information about the company. Robert should accept only a
flat fee that is not tied to the conclusions or recommendations of the report. Issuer-paid research
that is objective and unbiased can be done under the right circumstances as long as the analyst
takes steps to maintain his or her objectivity and includes in the report proper disclosures
regarding potential conflicts of interest.
Choice C is incorrect. CFA SOP: Research Independence and Compensation Arrangements
Choice D is incorrect. CFA SOP: Research Independence and Compensation Arrangements

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1C.
Answer: C
Choice A is incorrect. CFA SOP: Controlling Nonpublic Information
Choice B is incorrect. CFA SOP: Controlling Nonpublic Information
Choice C is the correct answer. Charles has violated Standard II(A) because he failed to prevent
the transfer and misuse of material nonpublic information to others in his firm. Charles’s firm
should have adopted information barriers to prevent the communication of nonpublic information
between departments of the firm. The salespeople and portfolio managers who traded on the
information have also violated Standard II(A) by trading on inside information.
Choice D is incorrect. CFA SOP: Controlling Nonpublic Information
1D. Answer: A
Choice A is the correct answer. Alyssa’s actions were consistent with Standard V(A). Analysis of
an investment that results in a reasonable basis for recommendation does not guarantee that the
investment has no downside risk. Alyssa should discuss the analysis process with the client while
reminding him or her that past performance does not lead to guaranteed future gains and that
losses in an aggressive investment portfolio should be expected.
Choice B is incorrect. CFA SOP: Successful Due Diligence/Failed Investment
Choice C is incorrect. CFA SOP: Successful Due Diligence/Failed Investment
Choice D is incorrect. CFA SOP: Successful Due Diligence/Failed Investment

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1E.
Answer: B
Choice A is incorrect. CFA SOP: Standard V(B)—Communication with Clients and Prospective
Clients
Choice B is the correct answer. This question related to Standard V(B)—Communication with
Clients and Prospective Clients. Roanna has issued a research report stating that she expects
the price of Runnington Industries stock to rise by US$10 a share “because the dividend will
increase” by US$1.75 per share and that the trend should continue. She has made this statement
knowing that the dividend will increase only if Congress enacts certain legislation, an uncertain
prospect. By stating that the dividend will increase, Roanna failed to separate fact from opinion.
The information regarding passage of legislation is not material nonpublic information because
it is conjecture, and the question does not state whether the U.S. representative gave Roanna
her opinion on the passage of the legislation in confidence. She could have been offering her
opinion to anyone who asked; therefore, statement A is incorrect. It may be acceptable to base a
recommendation in part on an expectation of future events, even though they may be uncertain.
Choice C is incorrect. CFA SOP: Standard V(B)—Communication with Clients and Prospective
Clients
Choice D is incorrect. CFA SOP: Standard V(B)—Communication with Clients and Prospective
Clients
1F.
Answer: C
Choice A is incorrect. CFA SOP: Standard IV(B)—Additional Compensation Arrangements
Choice B is incorrect. CFA SOP: Standard IV(B)—Additional Compensation Arrangements
Choice C is the correct answer. This question involves Standard IV(B)—Additional
Compensation Arrangements. The arrangement described in the question—whereby Jordan
would be compensated beyond the compensation provided by his firm on the basis of an
account’s performance—is not a violation of the Standards as long as Jordan discloses the
arrangement in writing to his employer and obtains permission from his employer prior
to entering into the arrangement. Answers A, B, and D are incorrect; although the private
compensation arrangement could conflict with the interests of other clients and lead to short-term
performance pressures, members and candidates may enter into such agreements as long as they
have disclosed the arrangements to their employer and obtained permission for the arrangement
from their employer.
Choice D is incorrect. CFA SOP: Standard IV(B)—Additional Compensation Arrangements

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Section 2: System Development, Volatility
2A. Answer: D
Choice A is incorrect. Brown, Chapter 1; Kaufman, Chapter 23; CMT III
Text pages 272, 497
Choice B is incorrect. Brown, Chapter 1; Kaufman, Chapter 23; CMT III
Text pages 272, 497
Choice C is incorrect. Brown, Chapter 1; Kaufman, Chapter 23; CMT III
Text pages 272, 497
Choice D is the correct answer. Brown, Chapter 1; Kaufman, Chapter 23; CMT III
Text pages 272, 497
2B.
Answer: A
Choice A is the correct answer. Katsanos, Chapter 4; Kaufman, Chapter 20; CMT III Text
Chapter 31
Choice B is incorrect. Katsanos, Chapter 4; Kaufman, Chapter 20; CMT III Text Chapter 31
Choice C is incorrect. Katsanos, Chapter 4; Kaufman, Chapter 20; CMT III Text Chapter 31
Choice D is incorrect. Katsanos, Chapter 4; Kaufman, Chapter 20; CMT III Text Chapter 31
2C.
Answer: C
Choice A is incorrect. Katsanos, Chapter 4; Kaufman, Chapter 20; CMT III Text Chapter 31
Choice B is incorrect. Katsanos, Chapter 4; Kaufman, Chapter 20; CMT III Text Chapter 31
Choice C is the correct answer. Katsanos, Chapter 4; Kaufman, Chapter 20; CMT III Text Chapter 31
Choice D is incorrect. Katsanos, Chapter 4; Kaufman, Chapter 20; CMT III Text Chapter 31
2D. Answer:

Fund A has a negative score for the average beta of its stocks. The Treynor ratio is not applicable
if the stocks have a negative beta.

Weigand, Chapter 7; CMT III Text Chapter 22

28
2E.
Answer:

Fund A – Best against market shocks since I am expecting possible bear moves in the next three
months.
Any three of these reasons are acceptable:
1. Slight negative correlation to the markets may help against market shocks.
2. Highest information ratio.
3. Lowest percentage of time in market.
4. Lowest standard deviation of returns means consistency.
5. Best performance in 2008 (price shock environment).
Katsanos, Chapter 4; Kaufman, Chapter 20; Weigand, Chapter 7; CMT III Text Chapters 22, 31

29
Section 3: Asset Relationships
3A. Answer: C
Choice A is incorrect, Ciana, Chapter 2; CMT III Text Chapter 20
Choice B is incorrect, Ciana, Chapter 2; CMT III Text Chapter 20
Choice C is the correct answer, Ciana, Chapter 2; CMT III Text Chapter 20
Choice D is incorrect, Ciana, Chapter 2; CMT III Text Chapter 20
3B.
Answer:
If the peso is rising, then Philippine company stocks should also be rising. With EPHE in a
corresponding uptrend it confirms the expectation.
Katsanos, Chapter 9; CMT III Text Chapter 19
3C.
Answer:
Bullish Trade (any three of these are acceptable):
• Price shows a breakout, retest, and continuation.
• Price shows higher highs and higher lows (upward trend).
• Price is outperforming EEM (other emerging markets), showing relative strength during
“improving” phase.
• EPHE and EEM show a high correlation, and EEM has just created evidence of a new
upward trend by showing a pattern of higher highs and higher lows.
• EPHE shows two breakaway gap patterns in most recent 10 trading sessions.
Bearish Trade
Note:
This shouldn’t be a bearish trade, but if you select bearish, you could get partial credit for
mentioning this idea and maybe others if graders judge your reasoning to be sound.
Tip:
Most questions will not have this level of ambiguity where at least partial points can be given for
either direction, but some will. Better to focus on the side that has the most apparent evidence.
EEM (emerging markets ETF) may be leading EPHE lower. EPHE and EEM show a high correlation,
and EEM may abruptly turn down and resume its downward trend, thus creating a new lower high.
Ciana, Chapter 2; Elder, Chapter 39; Katsanos, 3; CMT III Text Chapters 1, 13, 20
3D. Answer: A
3E.
Answer: B

30
Section 4: Portfolio Management, Asset Relationships
4A. Answer:

Consumer Staples and Utilities sectors typically lead the market and all other sectors at the
beginning of a recession (late expansion–early recession) phase of the business cycle as investors
seek defensive positions and anticipate economic contraction.
4B.
Answer:

Both the Industrials and Information Technology sectors have underlying industries which often
have rallied in anticipation of economic recovery, but also lead a downtrend into a recession as
companies in these sectors begin to see sales and earnings shrink once full expansion is reached.
Expectations for consumer and corporate spending tend to wane as less and less evidence of these
activities can be found. During this late economic phase these two sectors have not performed
well until evidence of sustained and more predictable economic growth appears.
Weigand, Chapter 7, CMT III Text Chapter 21
4C.
Answer:

Consumer Staples, Health Care, and Utilities sectors have led the market and all other sectors
in this data. Usually, such combined outperformance in the Consumer Staples, Health Care,
and Utilities sectors occurs in the late expansion to early recession phases of the business cycle,
which confirms the firm’s model.

31
Section 5: Classical Methods
5A. Answer:

Any five of the following:
• Break of resistance with successful retest of the 16.40–16.50 range
• Bullish engulfing candle pattern as part of retest
• Gap (window) above the resistance range (likely based on earnings news)
• Gap (window) has not been filled.
• Higher highs and higher lows in last three months
• Recent Bollinger band widening
• Fib pullback from resistance held at 38.2%
• Stochastic bottoming inside 30–50 range consistent with new uptrend
• High volume on the breakout
Brown, Chapter 1; Nison, Chapter 12; Elder, Chapter 39; Kaufman, Chapter 4; CMT III Text
Chapters 1, 3, 4, 6, 8, 34
5B.
Answer:

Yes, it would be feasible because 100K shares would represent less than ½ percent of the average
daily volume. With a share price of $16 this would represent a trade size of 1.6 million dollars—
not a large size for institutional orders in a stock this liquid.
CMT III Text Chapter 12
5C.
Answer:

There are three possible answers; any of these three are acceptable. Choosing one of these three
prices is worth 3 points; the correct explanation for what price you choose is worth 5 points.
• Just below the resistance at 16.40, since breakout represents a change of sentiment; but if
resistance fails the test of support, then change of sentiment has disappeared.
• Just below the gap range (or trend line) at 15.70, since gap represents a change of
sentiment; but if gap fills (or trend line breaks) and continues to fall, then change of
sentiment has disappeared.
• Just below 14.60 since all previous lows are taken out and you can assume a new
downtrend may be underway.
Kaufman, Chapters 13, 14; CMT III Text Chapters 3, 4

32
Section 6: Classical Methods
6A. Answer:

LONG
Brown, Chapter 1; Nison, Chapters 10–17; Elder, Chapter 39; Kaufman, Chapter 4; CMT III Text
Chapters 1, 3, 4, 6, 7, 8, 34, 35
6B.
Answer:

Three that could work:
Three advancing white soldiers (or 3 white soldiers) is the most recent pattern. (1 point)
This is a bullish continuation pattern. (1 point)
A harami immediately precedes this pattern (the second candle of the harami is also a part of the
3-white-soldiers pattern). (1 point)
A harami is a reversal pattern, and in this case has reversed the past 4- to 5-day short-term
pullback. (1 point)
Brown, Chapter 1; Nison, Chapters 10–17, Elder, Chapter 39; Kaufman, Chapter 4; CMT III Text
Chapters 1, 3, 4, 6, 7, 8, 34, 35
6C.
Answer:

Any one of the following:
A bullish harami pattern which reversed a very short-term pullback.
The 3-white-soldiers pattern that showed increasing/larger white candles that have moved the
index above the previous highest high—showing that resistance has just been broken.
The index has been in an uptrend since June 2014.
Prior resistance around the 5140 level in July 2014 has also just become support. As discussed
earlier, the recent harami helps to secure that support line for the short term.
Chapters 1, 3, 4, 6, 7, 8, 34, 35

33
6D. Answer:
• Bollinger bands: These bands are formed by taking into account the standard deviation
around a moving average. (2 points)
• ATR (average true range) also displays volatility, but it differs from Bollinger bands in that
volatility is displayed on a range of prices. ATR measures the average range (high to low) of
the most recent prices (in this case 10 days). (2 points)
• RSI (Relative Strength Index) helps to measure momentum, and is often used as an
overbought/oversold indicator. (2 points)
Chapters 1, 3, 4, 6, 7, 8, 34, 35
6E.
Answer:

Generally bullish.
(Any of the following information may be usable to answer this question.)
One purpose of the Bollinger bands is to help visually display volatility. In looking at how the
current bands compare to other areas of the chart, currently they are at/near their narrowest level.
This can be a sign that volatility will increase again over the short term. (1 point)
Other uses of the bands are to help measure trend strength. If candles are riding the upper band,
like in this example, this can be a sign that the current trend is strong/will continue. The last
white candle has not yet penetrated the upper band, but is near the edge, suggesting that the JKSE
index may increase, and the bands may widen yet again to account for the move. (1 point)
ATR is not a directional indicator.A risingATR line doesn’t mean the security is in an uptrend. (1 point)
A rising ATR line merely states that the security’s volatility is increasing. Some technicians interpret
a very low ATR level as a sign that eventually volatility will increase again. But a technician needs
other evidence to help determine which way the trend might move. Since the ATR level here is
among the lowest on the whole chart, this could be an indication of higher volatility. (1 point)
The very recent level in RSI is now higher than the last peak, so RSI is not diverging from the
overall direction of the index. (1 point)
Currently it is still below what many use as an overbought level (70), and momentum indicators
can stay overbought for some time in an extended uptrend. (1 point)
Chapters 1, 3, 4, 6, 7, 8, 34, 35

34
6F.
Answer:
• Index will open at 5225 at the time of trade (for both long or short position).
• Position risk limited to $10,000.
• Use ATR as provided in Chart 6-1 to calculate your stop price.
• Assume the ATR reading at the time of the trade is 40.
• Use a factor of 2.0 when you do your ATR stop calculation.
1/100 of $40 = 40 cents. 2 times an ATR of 40 cents = 80 cents. (2 points)
The stop would be placed 80 cents below the long entry price of 52.25. = 51.45. (2 points for
correct discussion of stop price)
$10,000 position risk divided by 80 cents = 12,500 shares. (2 points for correct number of shares)
Brown, Chapter 1; Nison, Chapters 10, 17; Elder, Chapter 39; Kaufman, Chapter 4; CMT III Text
Chapters 1, 3, 4, 6, 7, 8, 34, 35

35
Section 7: Risk Management, System Development
7A. Answer: D
Nison, Chapter 15; CMT III Text Chapter 33
7B.
Answer:

Bearish engulfing
Nison, Chapter 10; CMT III Text Chapters 34, 35
7C.
Answer: C

Kaufman, Chapter 23; CMT III Text Chapter 12
7D. Answer: A

Kaufman, Chapter 23; CMT III Text Chapter 12

36
Section 8: Behavioral Finance, Risk Management
8A. Answer:

The fourth stage of the bubble process is labeled the critical stage or the financial distress stage.
The critical stage is the point where a set of insiders decide to take their profits and cash out. The
detection of fraud is often coincident with this stage.
The fifth stage is revulsion, and is the final stage of the bubble. Investors are so scarred by market
events that they don’t want to participate at all. Revulsion continues a bear-market trend and
usually ends with a collapse in volume.
Montier, Chapter 38; CMT III Text Chapter 29
8B.
Answer: B
Montier, Chapter 17; CMT III Text Chapter 28
8C.
Answer:

6
Kaufman, Chapter 23; CMT III Text Chapter 12, Compounding Structures, Reflecting Pyramid
8D. Answer:

None
8E.
Answer:

12

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