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CFA Level III Updated
What's the right investment approach for a client in the Foundation phase?
The Foundation phase (22-35) has high human capital, low financial capital, long horizon. Example: Sienna Castellanos-Wu, 27, data scientist. Priorities: emergency fund first, high-interest debt, tax-advantaged accounts (401k match, Roth IRA, HSA), 85-90% equity allocation, human capital protection via disability insurance, automation...
What are the GIPS Advertising Guidelines?
GIPS Advertising Guidelines provide a condensed format for marketing materials with required disclosures and a pointer to the full GIPS report.
How does GIPS handle wrap fee and separately managed accounts (SMAs)?
Wrap fee accounts require separate composite, clear disclosure of pure gross (supplemental) vs. net returns, and full wrap fee deduction.
What is the significant cash flow policy under GIPS?
The SCF policy allows temporary exclusion of portfolios from composites during disruptive cash flows. Threshold and policy must be disclosed.
How is Monte Carlo used in asset allocation analysis?
Monte Carlo runs 10k-50k random paths using CMAs to estimate goal-achievement probability, sequence risk, and shortfall distributions. Key pitfalls: input uncertainty, normality, correlation instability.
What is the behavioral coaching framework and how should advisors apply it?
The four-step behavioral coaching framework is diagnose, classify cognitive vs emotional, act (moderate cognitive, adapt to emotional), and reinforce via IPS. Vanguard estimates ~150 bps/yr of advisor alpha.
What is the backdoor Roth strategy and who should use it?
High earners phased out of direct Roth contributions can use the backdoor: non-deductible traditional IRA contribution plus immediate Roth conversion...
How do I construct a liability hedging portfolio to match pension KRDs?
Match liability KRDs with STRIPS and swaps. For Ashmont Ridgedale with $5B liability, solve the KRD linear system: approximately $727M across 5y/10y/20y/30y STRIPS to match duration at each tenor. Layer in long corporate bonds for spread carry.
How do you implement a liability-driven investing (LDI) strategy?
LDI implementation: decompose liability KRDs, design hedging portfolio with bonds and swaps, build RS sleeve for excess return, set hedge ratio (70-100%), govern with daily monitoring. For Mereford Cardinal, use STRIPS plus receive-fixed swaps. Mind convexity and liquidity buffers.
Why does gamma trading profitability depend on volatility clustering?
Long gamma profits from realized vol exceeding implied vol; vol clustering creates asymmetric profits concentrated in high-vol regimes.
How do I decompose P&L from a delta-hedged options position?
Daily delta-hedged P&L decomposes into Gamma, Theta, Vega, Vomma, and Vanna components via Taylor expansion—the foundation of options P&L attribution.
What are vanna, vomma, and charm, and why do dealers care about them?
Vanna, vomma, and charm are second-order Greeks measuring cross-partial sensitivities that drift under skew, vol-of-vol, and time effects.
How do rainbow options on max/min of multiple assets price?
Rainbow options on max/min of multiple assets use Stulz-Johnson bivariate formulas; max options decrease in correlation, min options increase in correlation.
What variance reduction techniques work best for Asian options?
Geometric Asian closed-form as control variate yields 500x+ variance reduction for arithmetic Asians—the highest-impact Monte Carlo technique in exotic pricing.
How does discretization error affect path-dependent option pricing?
Path-dependent options suffer discretization bias because discrete sampling misses continuous-time extrema; Broadie-Glasserman correction eliminates most bias.
How is the policy portfolio (SAA) constructed from the IPS?
SAA construction: translate objectives to frontier target, define asset classes, gather CMAs, optimize with constraints, stress-test. Each IPS constraint maps to an allocation feature.
How do I construct an inflation-linked bond portfolio for real return objectives?
Ladder TIPS across 5-30Y for real duration ~11 years. Buy when expected inflation > breakeven. Diversify globally; watch liquidity in stress.
How do long-short equity strategies work and what are the key performance metrics?
Long-short equity takes both long positions in undervalued stocks and short positions in overvalued ones. Returns decompose into long alpha, short alpha, market beta exposure, and short rebate income. Key metrics include net exposure, gross exposure, and information ratio.
How is maximum drawdown incorporated as a portfolio constraint?
Maximum drawdown is path-dependent, incorporated via CDaR optimization, volatility scaling, options overlays, stochastic optimization, or drawdown-aware Kelly fractions.
How does a three-year moving-average smoothing rule stabilize endowment spending?
A three-year moving-average spending rule smooths volatility but introduces lag that can create spending overhang or undershoot.
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