Case Scenario: Chapters 1 – 3.
Read the scenario below before answering the following questions and keep practising until you get the correct answer.
Based in Toronto, Ontario, Marie Drouin is age 45 and has been the lead manager of the $500 million XYZ North American Large Capitalization Equity pooled fund for the past 15 years. Also based in Toronto, Pierre Bouchard is age 50 and has been the lead manager of the $1 billion XYZ US High Yield Bond pooled fund for the past 20 years. David Chan, age 60, has been a senior executive at various fund companies over the past 30 years.
Marie and Pierre have decided to leave XYZ Investment Management and along with David will start their own investment management firm which they have named DEF Investment Management. DEF Investment Management will be based in Toronto, Ontario and will offer similar types of funds as those previously managed by Marie and Pierre.
Marie is considering hiring a portfolio manager she knows who, over a decade ago, was involved in market timing of client accounts. Pierre has met with Marie and David to consider hiring an experienced Chief Compliance Officer named Daniel Bisson, who earned a Chartered Accountant designation in Canada, based on a recommendation from one of his industry contacts.
The firm’s founders want to establish an effective code of ethics that is similar to the majority of institutional investment management firms.
Finally, the firm’s founders also want to grow their business by providing investment management services to small-to medium-sized pension funds.
Q1. What other educational requirements would Daniel Bisson need to have successfully completed in order to be registered with the Ontario Securities Commission solely for the position he is being considered for?
The Canadian Securities Course and the Options Licensing Course.
The CFA designation and the Canadian Securities Course.
The Chief Compliance Officers qualifying exam and the Technical Analysis Course.
The Partners, Directors and Senior Officers course and the CFA designation.
To fulfill the educational requirements to be registered as the firm’s chief compliance officer, since Daniel Bisson is already a Chartered Accountant in Canada then he would need to also have successfully completed the Partners, Directors and Senior Officers (PDO) course or the Chief Compliance Officers qualifying exam and, if he has not earned the CFA designation, the Canadian Securities Course.
Q2. For the potential hiring of the portfolio manager being considered, what is the best approach to consider when deciding if she should be hired?
Hire the portfolio manager but ensure she is made aware that the practice of market timing will be deterred by the firm.
Do not hire the portfolio manager as she would only qualify to be registered as an assistant portfolio manager due to market timing.
Do not hire the portfolio manager as she was likely banned from the industry.
Hire the portfolio manager and ensure she continues the practice of market timing to enhance client returns.
Market timing is not illegal. Therefore the potential portfolio manager would not be disqualified from registration based on having done something illegally in relation to market timing. However, prior to hiring, the firm must inform the portfolio manager that the practice of market timing is discouraged and will be deterred by the firm. Fund company prospectuses must clearly state that the firm does not practice market timing.
Q3. What should DEF Investment Management use as their code of ethics?
A Code of Ethics created by a management consultant.
The Federal Government’s Code of Ethics.
CFA Institute’s Code of Ethics.
The Ontario Securities Commission’s Code of Ethics.
DEF’s founders want to use a code of ethics that is similar to the majority of institutional investment management firms. The majority of institutional investment management firms have adopted the CFA Institute’s Code of Ethics.
Q4. Which entity would be responsible for the regulation of DEF Investment Management and those individuals employed by DEF?
CFA Institute.
Ontario Securities Commission.
Office of the Superintendent of Financial Institutions.
Investment Industry Association of Canada.
The Ontario Securities Commission is responsible for establishing and enforcing regulations and operational standards associated with the creation, management, sale and distribution of securities that are either managed in Ontario or sold to Ontario residents.
Q5. If DEF Investment Management is successful in its target growth area, who will have responsibility for monitoring and performance evaluation for this type of investor?
Insurance company, consultants.
Household, rating agencies.
Investors, rating agencies.
Trustees, consultants.
For pension funds, both defined benefit and defined contribution, the trustees and consultants have responsibility for monitoring and performance evaluation.
Read the scenario below before answering the following questions and keep practicing until you get the correct answer.
David Chan, Marie Drouin and Pierre Bouchard have set up their investment management firm as a private corporation. David will be the Chief Investment Officer and President of the firm. Marie will be the equities portfolio manager for the firm. Pierre will be the fixed income portfolio manager for the firm. With Daniel Bisson now hired as the firm’s Chief Compliance Officer, the roles and responsibilities of everyone in the firm are being determined.
The firm has hired Chris Chong as an assistant portfolio manager for equities and Lisa Park as an assistant portfolio manager for fixed income. Lisa Park currently lives with her mother and her father.
The firm is developing a clearly written policy regarding the personal investing activities that will incorporate best practices and cover all of their staff.
Q1. Based on best practice and to be consistent with the separation of duties principle, who should be the firm’s ultimate designation person?
Marie Drouin.
Lisa Park.
David Chan.
Pierre Bouchard.
It is considered a best practice — and consistent with the separation of duties principle — that different individuals should hold the ultimate designated person and chief compliance officer positions. David Chan, the president of the firm, should be the firm’s ultimate designated person.
Q2. What is the typical range of target cash bonus amounts for Chris Chong’s current position as a percentage of his base salary?
20% to 50%.
50% to 100%.
100% to 150%.
100% to 200%.
Chris Chong was hired as an assistant portfolio manager. An assistant portfolio manager role has a typical range of target cash bonus amounts, as a percentage of the base salary, of 50% to 100%.
Q3. Who will be responsible for making the day-to-day investment decisions for the firm’s investment in equities?
Lisa Park.
Daniel Bisson.
Pierre Bouchard.
Marie Drouin.
Marie Drouin is the equities portfolio manager for the firm. As such, she will be responsible for making the day-to-day investment management decisions that affect the equities portfolios. Portfolio managers make all of the security selection and trading decisions for their portfolios.
Q4. Regarding Lisa Park, who will require written pre-clearance to do a trade in their personal account?
Lisa Park only.
Lisa Park and Lisa’s mother only.
Lisa Park and Lisa’s father only.
Lisa Park, Lisa’s mother and Lisa’s father.
Employee personal trading best practice requires that pre-trade permission be obtained not only for the employee, but also for all family currently living with them. As Lisa Park lives with her mother and her father then all three of them must obtain written pre-clearance to do a trade in their personal account.
Q5. To whom would Daniel Bisson report directly to?
David Chan.
Marie Drouin.
Pierre Bouchard.
The chief legal officer.
The head of the compliance function, Daniel Bisson, must be the individual designated with the securities regulators as the firm’s chief compliance officer. In turn, the chief compliance officer should report directly to the person designated with the securities regulators as the firm’s ultimate designated person (the firm’s president), David Chan.
Read the scenario below before answering the following questions and keep practising until you get the correct answer.
DEF Investment Management will offer a North American Large Capitalization Equity pooled fund with Marie Drouin leading the management of the fund. Similar to the previous XYZ fund that Marie managed, the DEF North American Large Capitalization Equity pooled fund will focus on attempting to find equities with a low price-earnings ratio that are trading at a discount to book value. Marie’s investment philosophy has been largely influenced by Benjamin Graham’s method for selecting stocks. The fund’s net asset value per share will be priced in Canadian dollars. The DEF North American Equity fund’s benchmark will consist of 70% S&P 500 Index and 30% TSX Composite Index.
DEF Investment Management will offer a US High Yield Bond pooled fund with Pierre Bouchard leading the management of the fund. Similar to the previous XYZ fund that Pierre managed, the DEF US High Yield Bond pooled fund will restrict their investments to the higher-quality portion of the high yield bond market. Pierre will consider investing in bonds that have coupon rates set below market value for the first few years after bond issuance and then above-market rates for the remainder of the bond’s term. The fund’s net asset value per share will be priced in Canadian dollars.
Q1. What approach to investment is Marie using?
A growth-oriented, bottom up approach.
A value-oriented, bottom up approach.
A top-down approach.
A sector rotator approach.
A portfolio manager who uses the value-oriented approach looks for undervalued securities with little focus on overall economic and market conditions. The manager attempts to find stocks with a low price-earnings ratio that are trading at a discount to book value.
Q2. Marie is considering investment in ABC Company. ABC Company’s current stock price is $10 per share and this company has 20 million shares outstanding. ABC Company’s total current assets are $400 million and its total liabilities are $120 million. Based on the investment philosophy that has largely influenced Marie, what is the most Marie would be willing to pay for the stock?
$9.33 per share.
$10 per share.
$13.33 per share.
$14 per share.
First, we subtract the total liabilities from the current assets ($400 million - $120 million) to get a net current asset value of $280 million. Next, we divide $280 million by the number of shares outstanding (20 million) which gives a net current asset value of $14 per share. Graham’s strategy says the stock price cannot exceed 66.67% of the net current asset value – in this case $9.33 per share (calculated as $14 x 0.6667).
Q3. The high-yield bond market index selected for the fund managed by Pierre would likely limit its exposure to only what rating of securities?
AA-rated and A-rated securities.
BB-rated and B-rated securities.
CC-rated and C-rated securities.
DD-rated and D-rated securities.
Some investors may wish to direct or restrict their high-yield investment allocation funds to the higher-quality portion of the high-yield bond market. These investors will likely select a high-yield bond market index that limits its exposure to only BB-rated and B-rated securities.
Q4. What type of bond is Pierre considering for the bond fund?
Extendible reset bond.
Payment-in-kind bond.
First-half bond.
Step-up bond.
A step-up bond, which is underwritten with pre-defined (varying) coupon rates for each year until maturity would fit a type of bond that Pierre would consider investing in. The coupon rate of a step-up bond is set below market for the first few years, but then crosses to above-market rates for the remainder of the bond’s term.
Q5. Why might Marie consider using derivatives in the equity fund she is managing?
The equity fund is attempting to gain access to markets that would otherwise be difficult to enter.
The equity fund is attempting to replicate an index.
The equity fund is priced in Canadian dollars and holds some U.S. securities.
Her investment strategy involves frequent trading.
Marie is managing a North American large capitalization fund that has a benchmark of 70% U.S. stocks and the fund’s net asset value is priced in Canadian dollars. As such, DEF may consider the use of derivatives to reduce exchange rate exposure resulting from holding foreign currency-denominated securities.
Read the scenario below before answering the following questions and keep practising until you get the correct answer.
DEF Investment Management’s two funds have now been in existence for 6 years. Their assets under management for the two funds is now $700 million. This consists of $400 million in the North American Large Capitalization Equity fund and $300 million in the US High Yield Bond fund. The DEF Large Capitalization Equity fund has been using derivatives to reduce exchange rate exposure resulting from holding foreign currency-denominated securities. DEF Investment Management would like to be compliant with the GIPS standards. A potential investor wants to do a style analysis for the DEF Large Capitalization Equity fund.
Now, the management team is exploring opportunities to expand their product offerings and launch new funds over the next year. After being repeatedly asked by investors in their current funds, DEF is considering the creation of a Canadian equity hedge fund for exempt investors. Marie Drouin, Pierre Bouchard and their team do not have experience with managing a fund that invests this way.
Q1. Identify the term used to explain how the potential new DEF fund was identified for consideration?
Pulled to market.
Pushed to market.
Pooled to market.
Punched to market.
A product market “pull” occurs when a new investment fund or product idea originates from within the investment fund or product market. Typically, current investors or product distributors are the sources of new fund ideas as is the case with the idea for DEF’s potential new fund. In other words, the investment management firm is being “pulled” towards a potential new investment fund or product opportunity.
Q2. Based on the type of new fund being considered, what type of offering document is generally distributed to investors?
Prospectus.
Fund facts.
Offering memorandum.
Trading expense report.
In Canada, investment products such as hedge funds that are only designed for and distributed to exempt investors do not require an approved prospectus. These products are generally distributed with an offering memorandum or a partnership agreement, or both.
Q3. Based on the type of new fund being considered, if Marie will be the portfolio manager, then what type of additional analysis will need to be completed?
High and low testing.
Future return testing.
Distress testing.
Backtesting.
To determine whether DEF’s team has the requisite skills to manage this new hedge fund, it will perform a backtest. Because an internally managed fund does not exist, and DEF is not hiring another investment manager with an appropriate track record on a sub-advisory basis to manage the new hedge fund, then backtesting will form an integral part of the analysis.
Q4. What minimum performance records would DEF Investment Management’s two funds currently need to present to be compliant with GIPS?
One-year and four-year performance records.
Two-year and three-year performance records.
Five-year and six-year performance records.
Six-year and seven-year performance records.
As DEF Investment Management’s two funds have been in existence for six years, DEF would need a minimum of five-year and six-year performance records.
Q5. What is the best method to use for the potential investor to do a style analysis for the DEF Large Capitalization Equity fund?
Holdings-based analysis.
Returns-based analysis.
Residual factor-based analysis.
Sector/quality effect-based analysis.
Returns-based analysis is the easiest to use, as it only requires monthly returns. Holdings-based analysis requires detailed portfolio data that is neither easy nor inexpensive to obtain. In addition, the holdings-based method has no way to account for any derivatives that may be in a portfolio.