Chartered Financial Analyst (CFA®) Level III Exam
Questions and Correct Answers (Verified Answers)
Plus Rationales 2026 Q&A | Instant Download Pdf
1. An investor with a liability-driven investment (LDI) strategy is
most concerned with:
A) Matching asset duration with liability duration
B) Maximizing equity exposure
C) Minimizing transaction costs
D) Diversifying across international markets
Rationale: In an LDI strategy, the goal is to ensure assets generate cash
flows that match future liabilities, reducing interest rate risk.
2. Which of the following is most consistent with a behavioral
finance perspective on investor decisions?
A) Overconfidence in personal forecasts
B) Efficient market hypothesis
C) Mean-variance optimization
D) Arbitrage pricing theory
Rationale: Behavioral finance emphasizes psychological biases, such as
overconfidence, that deviate from purely rational behavior.
3. A pension fund seeks to immunize its liabilities. Which of the
following actions is most appropriate?
A) Invest in bonds with duration equal to liabilities
B) Increase equity allocation
C) Invest in short-term treasury bills only
D) Use a market-timing strategy
,Rationale: Matching the duration of assets and liabilities reduces the
risk that interest rate changes will affect the funding status of the
pension.
4. Which of the following best describes the use of contingent
immunization?
A) Active management until a minimum return requirement is
threatened, then passive immunization
B) Passive management regardless of market conditions
C) Purely active management
D) Rebalancing only quarterly
Rationale: Contingent immunization combines active and passive
strategies, shifting to passive if the risk of not meeting liabilities
increases.
5. In a forward-rate agreement (FRA), the buyer benefits when:
A) Interest rates rise above the contracted rate
B) Interest rates fall below the contracted rate
C) Interest rates rise above the contracted rate, locking in
borrowing costs
D) Interest rates remain unchanged
Rationale: The FRA allows locking in a future interest rate. The buyer
gains if market rates increase above the agreed rate for borrowing.
6. An active manager uses a replication strategy to minimize tracking
error. Which of the following is true?
A) Portfolio weights closely match benchmark weights
B) Portfolio is heavily tilted toward high-alpha stocks
C) The portfolio ignores risk exposures
D) The manager trades frequently based on market timing
, Rationale: Replication aims to minimize differences from the
benchmark, keeping tracking error low.
7. Which of the following is the most appropriate metric for
evaluating the performance of a liability-driven portfolio?
A) Sharpe ratio
B) Surplus at risk
C) Treynor ratio
D) Jensen’s alpha
Rationale: Liability-driven portfolios focus on the risk of not meeting
obligations, making surplus at risk more relevant than traditional
performance ratios.
8. When using Monte Carlo simulation in retirement planning, the
primary benefit is:
A) Reducing portfolio volatility
B) Guaranteeing investment returns
C) Estimating a range of potential outcomes under uncertainty
D) Simplifying asset allocation
Rationale: Monte Carlo simulation provides probabilistic projections of
retirement outcomes, accounting for variability in returns, inflation, and
withdrawals.
9. Which of the following is a key advantage of using a constant
proportion portfolio insurance (CPPI) strategy?
A) Guarantees maximum returns
B) Eliminates downside risk
C) Provides a dynamic exposure to risky assets while maintaining
a floor
D) Requires no monitoring
Questions and Correct Answers (Verified Answers)
Plus Rationales 2026 Q&A | Instant Download Pdf
1. An investor with a liability-driven investment (LDI) strategy is
most concerned with:
A) Matching asset duration with liability duration
B) Maximizing equity exposure
C) Minimizing transaction costs
D) Diversifying across international markets
Rationale: In an LDI strategy, the goal is to ensure assets generate cash
flows that match future liabilities, reducing interest rate risk.
2. Which of the following is most consistent with a behavioral
finance perspective on investor decisions?
A) Overconfidence in personal forecasts
B) Efficient market hypothesis
C) Mean-variance optimization
D) Arbitrage pricing theory
Rationale: Behavioral finance emphasizes psychological biases, such as
overconfidence, that deviate from purely rational behavior.
3. A pension fund seeks to immunize its liabilities. Which of the
following actions is most appropriate?
A) Invest in bonds with duration equal to liabilities
B) Increase equity allocation
C) Invest in short-term treasury bills only
D) Use a market-timing strategy
,Rationale: Matching the duration of assets and liabilities reduces the
risk that interest rate changes will affect the funding status of the
pension.
4. Which of the following best describes the use of contingent
immunization?
A) Active management until a minimum return requirement is
threatened, then passive immunization
B) Passive management regardless of market conditions
C) Purely active management
D) Rebalancing only quarterly
Rationale: Contingent immunization combines active and passive
strategies, shifting to passive if the risk of not meeting liabilities
increases.
5. In a forward-rate agreement (FRA), the buyer benefits when:
A) Interest rates rise above the contracted rate
B) Interest rates fall below the contracted rate
C) Interest rates rise above the contracted rate, locking in
borrowing costs
D) Interest rates remain unchanged
Rationale: The FRA allows locking in a future interest rate. The buyer
gains if market rates increase above the agreed rate for borrowing.
6. An active manager uses a replication strategy to minimize tracking
error. Which of the following is true?
A) Portfolio weights closely match benchmark weights
B) Portfolio is heavily tilted toward high-alpha stocks
C) The portfolio ignores risk exposures
D) The manager trades frequently based on market timing
, Rationale: Replication aims to minimize differences from the
benchmark, keeping tracking error low.
7. Which of the following is the most appropriate metric for
evaluating the performance of a liability-driven portfolio?
A) Sharpe ratio
B) Surplus at risk
C) Treynor ratio
D) Jensen’s alpha
Rationale: Liability-driven portfolios focus on the risk of not meeting
obligations, making surplus at risk more relevant than traditional
performance ratios.
8. When using Monte Carlo simulation in retirement planning, the
primary benefit is:
A) Reducing portfolio volatility
B) Guaranteeing investment returns
C) Estimating a range of potential outcomes under uncertainty
D) Simplifying asset allocation
Rationale: Monte Carlo simulation provides probabilistic projections of
retirement outcomes, accounting for variability in returns, inflation, and
withdrawals.
9. Which of the following is a key advantage of using a constant
proportion portfolio insurance (CPPI) strategy?
A) Guarantees maximum returns
B) Eliminates downside risk
C) Provides a dynamic exposure to risky assets while maintaining
a floor
D) Requires no monitoring
