CFA Program Level III Examination Practice Test
Level III study emphasizes portfolio management decisions: setting and implementing investment policy, assessing portfolio risk relative to a benchmark, and selecting strategies for investors with distinct objectives. Practice-bank examples address tracking error, bond convexity, rebalancing bands, foreign-currency obligations, private-market fees, and commodity futures roll returns.
Exam overview
About the CFA Program Level III Examination Exam
Portfolio problems call for connecting an investor’s circumstances to an appropriate allocation, implementation choice, and risk-control process. Relevant analytical tasks include interpreting active-return statistics, measuring currency sensitivity, and distinguishing benchmark-relative risk from total portfolio risk. Fixed-income decisions may require accounting for convexity when yields change, while asset-allocation policies can use tolerance bands to trigger rebalancing. Other scenarios involve hedging a known foreign-currency payment, evaluating incentive fees, phasing exposure when market timing is uncertain, and choosing a retirement-plan default that reflects participants’ time horizons. Futures-based commodity exposure also requires understanding how persistent curve conditions can affect returns as contracts roll. These questions reward clear calculations and careful interpretation of how a proposed action affects portfolio objectives, exposures, and constraints.
Sample Practice Questions
Review a selection from this exam's published US Practice Tests practice bank.
An investor wants exposure to a broad commodity market but does not want to store physical commodities. The investor uses a futures-based fund. When futures prices are below spot prices and the curve remains in that condition, what may support returns as contracts are replaced?
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Correct answer: AWhen futures are below spot and the curve is in backwardation, selling a nearer contract and buying a cheaper deferred contract can create positive roll yield, all else equal. Actual fund returns also depend on spot-price movements, collateral returns, fees, and implementation.
A manager expects a portfolio’s currency exposure to remain unhedged and wants to estimate the sensitivity of its home-currency value to a small change in the exchange rate. Which measure is most directly relevant?
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Correct answer: BCurrency delta measures the change in portfolio value associated with a change in an exchange rate, typically for a small move around the current rate. Duration and spread duration describe interest-rate and credit-spread sensitivities, respectively.
A manager estimates a portfolio’s tracking error as the standard deviation of the differences between portfolio and benchmark returns. If those return differences become more variable, what happens to tracking error, all else equal?
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Correct answer: ATracking error is the volatility of active returns, where active return is portfolio return minus benchmark return. Greater variability in those differences produces higher tracking error, all else equal.
A defined-contribution plan sponsor is reviewing its default investment option for participants who do not select their own investments. Which design feature most directly helps align the default portfolio’s risk level with participants’ expected time to retirement?
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Correct answer: BA target-date structure generally reduces growth-asset exposure and shifts toward a more conservative mix as the target retirement date approaches. The changing allocation is intended to reflect a shorter investment horizon and changing capacity for risk.
A portfolio manager believes an equity market is likely to outperform but is uncertain about the timing. The manager wants to establish exposure gradually while limiting the risk of committing the full amount immediately. Which approach best matches this objective?
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Correct answer: AA prespecified staged-investment plan spreads entry points over time and reduces the consequences of investing the full amount at an unfavorable single date. It does not guarantee higher returns and may underperform immediate investment in a rising market.
An investor is comparing two private-market funds with similar stated returns but different fee arrangements. Which fee feature most directly links the manager’s compensation to investment gains above a specified threshold?
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Correct answer: AA performance-based incentive allocation, often subject to terms such as a hurdle rate or high-water mark, makes some manager compensation depend on investment performance. The other listed fees are not directly contingent on exceeding a performance threshold.
A portfolio has a contractual obligation to pay a fixed amount in a foreign currency on a known date. Which approach most directly reduces uncertainty about the home-currency cost of that payment?
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Correct answer: AA forward contract fixes the exchange rate for a future currency purchase, making the home-currency cost of the known obligation more predictable. The other choices do not lock in the exchange rate and may introduce unrelated investment risk.
How to use this practice test
The free practice bank contains 50 questions. Each session presents up to 20 random questions, then shows results so you can review performance across portfolio analysis and implementation scenarios. Use missed or uncertain answers to identify concepts that need closer review.
Preparation tips
- Calculate tracking error from active-return variability, and distinguish it from correlation between portfolio and benchmark returns.
- Sketch the bond price-yield curve to explain why convexity matters when estimating price changes for larger yield moves.
- Work through rebalancing-band scenarios by comparing each allocation with its permitted range and identifying the required trade.
- For foreign-currency liabilities, compare the exposure before and after a hedge; for commodity futures, trace how contango or backwardation affects roll returns.
- Evaluate investment choices against the stated objective: compare incentive-fee structures, staged market exposure, and target-date default risk as separate decisions.