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CFA Level III Updated
What are the main equity hedge fund strategy categories and how do they differ?
Five categories: long/short, market-neutral, event-driven, activist, sector specialist. Blend across three to reduce correlation in drawdowns.
What does GIPS verification actually involve and is it mandatory?
GIPS verification is indeed voluntary — no regulatory body mandates it. However, most firms that claim compliance choose to be verified because it provides significant credibility with institutional clients and consultants.
How are program-related investments (PRIs) structured and taxed?
PRIs are below-market loans/equity made primarily for charitable purpose; count toward 5% payout when made, with repayments added to next year's required distribution.
How do foundations implement mission-related investing (MRI) in the endowment?
MRIs are market-rate endowment investments aligned with mission. Scale from 5% to 20% over 3 years, match traditional risk-adjusted return bar, report impact separately. Not counted toward 5% payout.
How do you actually construct sub-portfolios in goals-based asset allocation?
Goals-based allocation assigns each goal a priority, time horizon, and required success probability, then matches it to a pre-built sub-portfolio module. The overall portfolio is the aggregation of all sub-portfolios, making trade-offs between goals transparent.
How is alpha-beta separation implemented in practice?
Implementation: identify beta targets, source alpha separately, combine via overlay/swaps/completion; monitor hidden beta and leverage...
What is portable alpha and how does it separate alpha from beta?
Portable alpha: invest cash in market-neutral alpha source + derivative for beta = alpha ported onto any beta...
How does a range accrual swap work and why use one?
In a range accrual swap, the coupon accrues only on days when a reference index stays inside a pre-defined range. Days outside contribute zero...
When should I use a jump-diffusion model like Bates instead of pure stochastic vol?
Heston can't generate enough short-dated skew. Implied vol smiles for 1-week options are dramatically steeper than any diffusion-only model can produce. Jumps are the cure...
How do foundation spending rules work and how do they differ from endowments?
US private foundations must distribute at least 5% of net investment assets annually (IRC §4942). This legal floor forces liquidity planning and a ~7.5-8.5% real-return target.
How is an endowment's governance structured and how does that affect its IPS?
Endowments have tiered governance (Trustees, Investment Committee, CIO), perpetual horizons, and smoothed spending policies — enabling heavy illiquid-asset tilts vs. pension plans.
How do equity market-neutral strategies actually achieve zero beta?
Market-neutral requires dollar, beta, and factor neutrality via optimizer with sector/factor constraints. Monitor rolling 60-day realized beta.
What is foundation impact investing and how does it differ from grants?
Impact investing generates financial return plus measurable impact. PRIs (below-market, count toward 5% payout) and MRIs (market-rate, sit in endowment) are the two foundation vehicles.
What is the income yield spending approach and why has it fallen out of favor?
Income-only spending biases the portfolio toward high-yield assets, causes volatile program spending, and erodes real purchasing power when yields are low. UPMIFA made total return standard.
How does a Charitable Remainder Trust (CRT) work and when is it appropriate?
A CRT converts appreciated assets into lifetime income plus charitable deduction, with tax-free sale inside the trust and remainder to charity.
What is the q-factor model and how does it differ from Fama-French five-factor?
The q-factor model derives investment and profitability factors from q-theory rather than empirics and has four factors total.
What restrictions and risks come with closed architecture platforms?
Closed architecture restricts to in-house products: conflicts, higher fees, performance drag, fiduciary risk...
What is open architecture in manager selection?
Open architecture = select any manager regardless of affiliation; closed = use in-house. Open better aligned with fiduciary duty...
Why is SABR the standard for swaption volatility?
SABR is a parametric stochastic volatility model designed for parsimonious smile fitting at a single maturity. Its four parameters are intuitive and stable...
How is a defined contribution plan different from a DB plan from an IPS perspective?
DC plans put risk on the participant. The IPS governs menu design and defaults (typically a QDIA target-date fund), with fiduciary focus on prudent selection and fees.
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