2003 Sample Level III Questions

These sample questions were developed in 2003 to give candidates an indication of the question
formats that would be experienced on the actual examination.

These questions were not intended to represent the actual exam with respect to topic coverage, level of
difficulty, or time requirement. These questions were not intended to provide any indication of
candidates’ performance on the actual exam. Candidates should also note that these questions were
based on old curriculum and/or learning outcome statements that may no longer be assigned. Also,
format and writing style conventions used for questions have changed over time in keeping with “best
practices”.

Item Set #1 (Ethics):

Emily Cassella is an investment manager in a bank trust department. She provides investment advice
to high-net-worth clients and has developed a computer model that successfully identifies emerging
market companies with the potential for earnings growth. Cassella is planning to leave the bank to
start her own investment advisory firm that will provide the same level of services as the bank but at
lower fees. After business hours, in a social context, she casually informs several of the bank’s clients
of her plans and suggests that they switch their accounts to her firm once it is established. Cassella
also contacts a number of potential clients that she had been actively soliciting for the bank to inform
them that she is planning to start her new firm. She then contacts prospective clients that the bank has
rejected as being too small. Several of the bank’s current clients, potential clients, and rejected
prospects agree to transfer their accounts to Cassella’s firm once it is established.
Two weeks prior to announcing her resignation, Cassella applies to the appropriate regulatory
authorities to ensure that she can complete and file the necessary registration documents so she can
begin operating her business on the day she announces her resignation. She informs both of her
research assistants at the bank that she will be resigning and asks them to help her start her new firm.
Neither agrees to follow Cassella to her new firm.
Just prior to announcing her resignation, Cassella takes home some of her work that she believes
will help her establish her new firm. This material includes sample marketing presentations that she
designed; research material on several companies that Cassella has been following; investment ideas
that were rejected by Cassella’s superiors at the bank; a list of her clients; a copy of the firm’s
compliance procedures; and her clients’ records, including their investment objectives and constraints.
1. Cassella is planning to start her own firm while still employed by the bank. According to the
AIMR Standards of Professional Conduct, which of the following best describes Cassella’s
obligations in this situation? She:
A. must disclose the potential change in her employment to the bank’s clients and prospects.
B. must disclose the potential change in her employment to her direct supervisor at the bank.
C. may not breach her duty of loyalty to the bank in preparing to leave her current position.
D. may not seek alternative employment that could place her in direct competition with the bank.
2. With regard to Cassella’s solicitation of the bank’s current clients, which of the following
statements is most accurate? Cassella:
A. has not violated the AIMR Standards if the solicited clients do not follow Cassella when she
resigns.
B. has not violated the AIMR Standards because the solicitation was made after business hours
and in a social setting.
C. has not violated the AIMR Standards because Cassella’s duty to inform the clients about the
potential for reduced fees takes priority over her duty of loyalty to her employer.
D. has violated the AIMR Standards by soliciting the bank’s investment clients.
3. With regard to the bank’s potential clients and rejected prospects, which of the following
statements is most accurate? Cassella:
A. has not violated the AIMR Standards if the potential clients are later rejected by the bank.
B. has not violated the AIMR Standards if potential clients’ fees are substantially lower at
Cassella’s new firm.
C. may solicit the rejected prospects while she is employed by the bank and the potential clients
after she starts her new firm.
D. may not solicit either group because both the potential clients and the rejected prospects
represent potential business opportunities for the bank.
4. With regard to Cassella’s removal of the sample marketing presentations and the research
materials, which of the following statements is most accurate? Cassella:
A. has violated the AIMR Standards because the research materials may include nonpublic
information.
B. has violated the AIMR Standards even if Cassella never uses either of them for the benefit of
her new firm.
C. may remove the sample marketing presentations if they do not include confidential
information about the bank or its clients.
D. may remove the research material if it is factual information published by recognized
financial and statistical reporting services.
5. With regard to Cassella taking the computer model and the rejected investment ideas from the
bank, which of the following statements is most accurate? Cassella:
A. may take the computer model solely for her personal use and the rejected investment ideas for
use by her new firm.
B. may not take the rejected investment ideas or the computer model because they remain the
property of the bank.
C. may take the rejected investment ideas, because the bank is not using them, but she may not
take the computer model because it is proprietary information.
D. may take both the computer model and the rejected investment ideas because she personally
developed both and they are her property.
6. With regard to Cassella’s removal of the compliance procedures from the bank, which of the
following statements is most accurate? Cassella:
A. has violated the AIMR Standards because Cassella developed them for use by the bank.
B. has not violated the AIMR Standards because AIMR requires adequate compliance
procedures at all member firms.
C. has not violated the AIMR Standards if they are copied directly from the AIMR Standards of
Professional Conduct.
D. has not violated the AIMR Standards if they are used solely to promote adherence to the
AIMR Code and Standards by Cassella and her new firm.

Guideline Answers:
1. C is correct. Cassella is not allowed to breach her duty of loyalty to the bank in preparing to leave.
However, she does not need to notify anyone of her pending departure and she is free to seek
other employment.
2. D is correct. Cassella may not solicit current or potential clients of the bank prior to her leaving
the bank whether in a social setting or any other setting. The reduced fee potential is not a
criterion for allowing her to solicit them. It does not matter whether the clients leave or not; the
act of soliciting them would be a violation.
3. C is correct. Cassella may solicit rejected prospects while she is still employed by the bank
because they do not represent competition with the bank. She must do this on her own time
however, so that she fullfills her duty to her current employer. Prior to leaving the bank, she may
not solicit potential clients, but once she leaves she is free to contact them. The reduced fee
 potential is not a criterion for allowing her to solicit the potential clients as long as she works for
the bank. It does not matter whether the bank eventually rejects the potential clients; the act of
soliciting them would be a violation as long as they have not been rejected.
4. B is correct. Cassella may not remove the sample marketing presentations and research materials
from the bank. The fact that the materials are never used to benefit her new firm does not change
the fact that they are the property of the bank and may not be removed. If Cassella had written
permission, she could remove the materials without violation of the Standards. It does not matter
whether the materials contain confidential or nonpublic information or not; the act of removing
them would be a violation. It does not matter whether the materials are factual information or not;
they are the property of the bank because they were gathered on the bank’s time.
5. B is correct. Cassella may not remove the computer model and the rejected investment ideas from
the bank. The fact that she developed them does not change the fact that they are the property of
the bank and may not be removed. They are not her property and she may not use them.
6. A is correct. Cassella may not remove the compliance procedures from the bank. They are the
property of the bank and may not be removed. Their source and use do not change the situation.
Item Set #2 (Derivatives)
Joel Franklin is a portfolio manager responsible for derivatives. Franklin observes European-style put
options and call options on Abaco Ltd. common stock with the same strike price and time to
expiration. Selected information relevant to Abaco Ltd. stock and options is shown in Exhibit 1.

Exhibit 1
Abaco Ltd. Securities Selected Data
Closing price of Abaco common stock $43.00
Put and call option exercise price $45.00
Time to expiration One year
Price of the European-style put option $4.00
Price of the European-style call option
One-year risk-free rate, compounded
5.50%
continuously
Samantha Crowe, a colleague of Franklin, believes that Abaco stock is overpriced and she decides to
sell short the stock. However, her broker informs her that an adequate inventory of the stock may not
be available to sell short.
1. Based on a put-call parity, the value of the European-style call option is closest to:
A. $0.00.
B. $2.00.
C. $4.35.
D. $4.41.
2. If the volatility of Abaco’s stock price decreases, what is most likely to happen to the values of
the related call and put?
A. Both the call and the put will decrease in value.
B. Both the call and the put will increase in value.
C. The value of the call will increase while the value of the put will decrease.
D. The value of the call will decrease while the value of the put will increase.

3. Franklin considers buying a European-style put option with an exercise price of $40.00 and one
year to expiration. Based on the information provided in Exhibit 1 about the options with an
exercise price of $45.00, what should be the price of a put option with an exercise price of
$40.00?
A. Less than or equal to $1.00.
B. Greater than $1.00 but less than or equal to $3.00.
 C. Greater than $3.00 but less than or equal to $9.00.
D. Greater than $9.00.
4. Which of the following actions, if executed by Crowe at the correct exercise prices, times to
expiration, and face values, will accomplish the same payoff as the original short sale strategy?
A. Buy a pure discount risk-free bond, buy a put option, buy a call option.
B. Short a pure discount risk-free bond, buy a put option, buy a call option.
C. Buy a pure discount risk-free bond, sell a put option, buy a call option.
D. Short a pure discount risk-free bond, buy a put option, sell a call option.
5. The Chief Economist at Franklin’s firm is forecasting a substantial decline in interest rates. To
help gain from this forecast while assuming limited risk, Franklin should take which of the
following actions with regard to the European-style options in Exhibit 1?
A. Buy the call option.
B. Buy the put option.
C. Sell the call option.
D. Sell the put option.
6. Franklin considers selling the European-style put option described in Exhibit 1. Ignoring time
value of money and given current prices, the maximum possible loss from this strategy is:
A. $39.00.
B. $41.00.
C. $45.00.
D. Unlimited.
Item Set #2 Guideline Answers
1. D is correct. c = S + p – Xe–r(T– t)
$4.408 = $43 + 4.00 – 45.00e–0.055×1
2. A is correct. The volatility of the stock is directly related to the price of the call option and the put
option. So a decrease in volatility will cause the price of both the call and the put to decrease.
3. B is correct. The price of the put option is its time value plus intrinsic value. The time value
should be about $2.00 (from the $45.00 exercise price) and the intrinsic value will be $0.00. This
will place the price of the put at about $2.00, depending upon the volatility of Abaco stock. Both
the options (exercise price of $40 and $45) have the same time to expiration and similar time
values, and both options are European.
4. D is correct. The put-call parity can be written as c = S + p – Xe–r(T– t)
This equation can be re-written as –S = – Xe–r(T– t) + p – c
The left-hand side can be stated as shorting a stock, and the right hand side of the equation can be
stated shorting a pure discount risk free bond, buying a put, and shorting a call.
5. B is correct. According to the Black-Scholes Option Pricing Model, the change in risk-free
interest rate (‘rho’) is directly related to the value of a call option and inversely related to the
value of a put option. A decrease in interest rates should cause the price of the call to fall and the
price of the put to increase. Buying a put and selling a call will both result in gains, but selling a
naked call is an unlimited risk strategy. Therefore, buying a put will be the most appropriate
choice.
6. B is correct because the upper boundary for a put option price is when the stock is worthless (S =
0). Here, the put holder will have the right to sell the stock for $45, when it is worth nothing in the
market. The put writer will lose ($45–$4) = $41.