Sample Level III Item-Set Questions: Past Level 3 CFA exams: The official CFA® institution website has the Level 3 past exams for CFA 2023. There are two different kinds of questions in the CFA level 3 question bank: essay questions and item set questions. Each item set question consists of four to six multiple-choice questions. Two types of responses are required for essay-style questions: word-based responses and calculation-based responses. To adequately prepare for the exam and become familiar with the exam format, it is advised that you read through the CFA® level 3 curriculum and prior exams for the 2023 CFA level. Students can better comprehend the CFA® level 3 test format and scoring by completing CFA level 3 previous papers from 2023.
Sample Level III Item-Set Questions
- To best comply with the CFA Institute Standards of Professional Conduct (the Standards)
related to the performance presentation, Somer should modify the:
A. text regarding Somer’s investment returns.
B. presentation of the performance for Karibe’s representative composite.
C. content of the disclosure statement related to assumptions and calculations. - Does Somer’s social media post result in a violation of the Standards?
A. No
B. Yes, he violates the standard related to the preservation of confidentiality
C. Yes, he violates the standard related to communication with clients and prospective
clients - When preparing the marketing materials for the quantitative strategy, did Somer comply
with the standard related to communication with clients and prospective clients?
A. Yes
B. No, because he did not identify the risk of coding errors
C. No, because he did not describe the investment process in detail - If he fills the client’s order for shares of the technology firm, would Somer violate the
standard related to priority of transactions?
A. No
B. Yes, because the client would be disadvantaged by the trade
C. Yes, because he would benefit personally from a trade undertaken for a client - For which portfolio is the spread duration likely to be closest to the modified duration?
A. Portfolio 1
B. Portfolio 2
C. Portfolio 3 - The expected 6-month excess return for Bond A is closest to:
A. −0.05%.
B. 0.25%.
C. 0.65%. - Which high-yield credit market in Exhibit 2 would be expected to perform best in the near
term?
A. Market 1
B. Market 2
C. Market 3 - Which of the following structured financial instruments would best address the preferences
of Apollo’s client?
A. Covered bonds
B. Asset-backed securities
C. Collateralized debt obligations
Answers to Sample Level III Item-Set Questions
- To best comply with the CFA Institute Standards of Professional Conduct (the Standards)
related to the performance presentation, Somer should modify the:
A. text regarding Somer’s investment returns.
B. presentation of the performance for Karibe’s representative composite.
C. content of the disclosure statement related to assumptions and calculations.
Answer: A
A is correct because Somer’s returns are not clearly explained as being generated at his prior
firm. If a firm is not claiming GIPS compliance, “Members and candidates can also meet their
obligations under Standard III(D) by including disclosures that fully explain the performance
being reported.”
B is incorrect because the marketing materials present the performance of a composite of
similar portfolios.
C is incorrect because the materials direct prospective clients to the website where a full
disclosure of the assumptions and calculations are available - Does Somer’s social media post result in a violation of the Standards?
A. No
B. Yes, he violates the standard related to preservation of confidentiality
C. Yes, he violates the standard related to communication with clients and prospective
clients
Answer: A
A is correct because Somer did not reveal the identity of his client (Standard III(E)). The context
of the comment (he helped his client avoid penalties) contradicts the mistaken conclusion of
the readers of the social media post (the athlete in question had to pay penalties so obviously
was not his client). He also does not violate the standard related to communication (Standard
V(B)) because it applies to 1) disclosure of the format and general principles of the investment
process; 2) significant limitations and risks of the investment process; 3) identifying important
factors for their analysis and recommendations; and 4) distinguishing between fact and opinion
in investment analyses and recommendations. His post did not relate to any of these and thus
is not a potential violation of the standard.
B is incorrect because Somer does not violate the standard related to confidentiality because
the athlete in the news story is not his client, and the information that he helped his own client avoid tax penalties by keeping good records does not provide enough information to disclose the client’s identity. C is incorrect because Somer does not violate the standard related to communication (Standard V(B)) because it applies to 1) disclosure of the format and general principles of the investment process; 2) significant limitations and risks of the investment process; 3) identifying important factors for their analysis and recommendations; and 4) distinguishing between fact and opinion in investment analyses and recommendations. His post did not relate to any of these and thus is not a potential violation of the standard, but certain candidates and/or exam team writers who think that communications with clients includes a duty to correct everyone who misunderstands you may choose this answer. - When preparing the marketing materials for the quantitative strategy, did Somer comply
with the standard related to communication with clients and prospective clients?
A. Yes
B. No, because he did not identify the risk of coding errors
C. No, because he did not describe the investment process in detail
Answer: A
A is correct because he did not violate Standard V(B). With respect to informing clients of the
investment process, the guidance stipulates that when explaining the process one “need not
describe the investment system in detail… but must inform clients of (the) basic process and
logic.” The explanation of Somer’s process as factor-based with weights dynamically allocated
meets this criterion. Regarding risk identification, “members and candidates cannot be
expected to disclose risks they are unaware of at the time…. Having no knowledge of a risk or
limitation that subsequently triggers a loss may reveal a deficiency in the diligence and
reasonable basis… but may not reveal a breach of Standard V(B).”
B is incorrect because “members and candidates cannot be expected to disclose risks they are
unaware of at the time…. Having no knowledge of a risk or limitation that subsequently triggers
a loss may reveal a deficiency in the diligence and reasonable basis… but may not reveal a
breach of Standard V(B).”
C is incorrect because when explaining the process one “need not describe the investment
system in detail… but must inform clients of (the) basic process and logic.” (Example 1 p. 141)
The explanation of Somer’s process as factor-based with weights dynamically allocated meets
this criterion. - If he fills the client’s order for shares of the technology firm, would Somer violate the
standard related to priority of transactions?
A. No B. Yes, because the client would be disadvantaged by trade C. Yes, because he would benefit personally from a trade undertaken for a client, Answer: C, C is correct because the guidance for Standard VI(B) specifies that “nothing is inherently unethical about… making money from personal investments as long as (1) the client is not trades undertaken for clients, and (3) the investment professional complies with applicable regulatory requirements.” In this case, Somer would personally benefit from a trade undertaken for a client by realizing a large gain and reducing the portfolio risk arising from his large position, which results in several potential conflicts of interest. At a minimum, he would need to disclose to the client that he was filling the order from his own account and seek permission from Karibe to do so. A is incorrect because Somer would personally benefit from a trade undertaken for a client by realizing a large gain and reducing the portfolio risk arising from his large position, which results in several potential conflicts of interest. At a minimum, he would need to disclose to the client that he was filling the order from his own account and seek permission from Karibe to do so. B is incorrect because the client is not disadvantaged by the trade (and in fact gets the order filled at a discount to the prevailing market price). - For which portfolio is the spread duration likely to be closest to the modified duration?
A. Portfolio 1
B. Portfolio 2
C. Portfolio 3
Answer: A
A is correct because interest rate changes and credit spread changes have almost identical
effects on non-callable, fixed-rate corporate bonds. For non-callable, fixed-rate corporate
bonds, the spread duration is generally very close to the modified duration.
B is incorrect because Portfolio 2 contains floating-rate bonds. “For floating-rate bonds (also
called floaters) and some other types of bonds, however, the spread duration can differ
substantially from the modified duration.”
C is incorrect because Portfolio 3 has a diversified set of callability and coupon features which
includes callable and floating rate bonds with lower sensitivity to interest rate changes. The
much higher credit loss rate experienced on high-yield bonds compared with investment-grade bonds results in higher credit spread changes. - The expected 6-month excess return for Bond A is closest to:
A. −0.05%.
B. 0.25%.
C. 0.65%.
Answer: B
B is correct based on the calculations below
EXR ≈ (s × t) – (Δs × SD) – (t × p × L)
EXR = expected excess return
s = spread at the beginning of the holding period
t = the holding period expressed in fractions of a year
Δs = the change in the credit spread during the holding period determined by expected OAS in 6
months minus current OAS in bps
SD = the spread duration of the bond
p × L = expected annual credit loss where p = the annualized expected probability of default and
L = the expected loss severity
(1.2% × 0.5) – ((1.3% – 1.2%) × 2) – (0.5 × 0.3%) = 0.25%
A is incorrect because the calculation swaps the spread duration and holding period in the 2nd
and 3rd parts of the equation.
C is incorrect because the calculation reverses expected OAS and current OAS in change in
credit spread calculation. - Which high-yield credit market in Exhibit 2 would be expected to perform best in the near
term?
A. Market 1
B. Market 2
C. Market 3
Answer: C
C is correct because Market 3 has a high concentration in lower-rated HY bonds, as well as a
lower expected supply of HY Bonds. Markets with a higher concentration in lower-rated bonds
and/or lower bond supply would likely outperform in an expected bullish global environment.
A is incorrect because Market 1 has a high expected supply of HY bonds. Markets with a higher
concentration in lower-rated bonds and/or lower bond supply would likely outperform in an
expected bullish global environment.
B is incorrect because Market 2 has a high concentration in higher-rated HY bonds. Markets with
a higher concentration in lower-rated bonds and/or lower bond supply would likely
outperform in an expected bullish global environment. - Which of the following structured financial instruments would best address the preferences
of Apollo’s client?
A. Covered bonds
B. Asset-backed securities
C. Collateralized debt obligations
Answer: A
A is correct because covered bonds provide more than one source of credit protection. “In the
event of default, bondholders have recourse against both the financial institution and the
assets in the cover pool. Because of this dual protection for creditors, covered bonds usually
carry lower credit risks and offer lower yields than otherwise similar corporate bonds or ABS.”
B is incorrect because asset-backed securities do not provide more than one source of credit
protection.
C is incorrect because collateralized debt obligations do not offer more than one source of credit
protection. Also, CDOs do not offer exposure to the financial sector, “CDOs do not provide much
diversification benefit compared with corporate bonds, and they do not offer unique exposure
to a sector or market factor.