How much granularity in AM answers

CFA Level III
#1

Is the below answer the level of detail that the CFAI is looking for in the AM answers? The below answer describes how a covered call works in a yield enhancement strategy. I mean, is the assumption that the candidate knows absolutely nothing and f.ex if he doesn’t explain what happens if stock price finishes above strike, the grader assumes that he doesn’t know ?

Keller is most likely recommending writing covered calls against 10% of Morrison’s shares in MBI. Morrison would sell call options with a strike price that is above the current price of MBI and in return receive premium income (yield enhancement) from the sale of the call options. The strategy effectively allows the investor to establish a liquidation value (the strike price) for the shares he/she writes call options against. If the stock price increases above the strike price at maturity, the calls will be exercised and Morrison will deliver his long shares. He would receive a total sum equal to the strike price of the calls and the premium from the initial sale of the calls. If MBI closes at or below the strike price at expiration, the calls will expire worthless and Morrison will retain the option premium and the long shares. One of the most significant benefits of implementing a covered call writing program is that it can psychologically prepare the owner to dispose of his/her shares.

#2

The more you write, the more likely you will get things WRONG or backwards!

#3

That’s way, way too much to write for an answer that’s worth a couple of points.

I’d write that writing covered calls will generate a premium, and that if the share price exceeds the strike price at expiration the portfolio will lose money, potentially more than offsetting the premium received.

#4

Once you start doing AM essays for practice, it becomes pretty clear based on the guideline answers.

#5

Less is more. Look at the minutes and draft accordingly. Bullet points and no unneeded words. You just don’t have the time for loads of explaining.

I was shocked with the Kaplan’s tutors model answers when I started L3. 3 minute question could be 2 or 3 very short sentences.

#6

You guys dont know how happy I am reading this. Now Im doing end of chapters questions, and some of them are so vague and have so big answers that I was getting nervous about how much I would have to write just to score a point.

#7

The gains will be limited by strike price, how will portfolio (stock + option) lose money?

#8

They’ll have to sell off assets at less than market value.

#9

That’s way too verbose. The best way on actual exam questions is to use the allocated number of points for the question to guide the length & structure of your answer. Let me know if you want more clarification.

Best,

Alex

#10

I have another question regarding guideline answers. This is an issue which I’ve encountered a few times doing the EOCs. For example: one question asked to name two limitations to using Tobins q. I wrote 1) asset valuation can cause problems and inaccurate estimations… and couldn’t come up with a second limitation. The guideline answer was 1) valuation of the company’s illiquid assets is difficult 2) valuing company’s intangible assets is difficult.

The thing is that I knew the correct answer but didn’t know that that was what they were looking for. I assumed that ‘‘asset valuation problems’’ constitutes an umbrella term and there’s got to be some other limitation that I don’t know of. Would my answer get all points or would the grader only give partial points?

#11

So at the limit zero words means MAX points! YAY!!!

#12

Brilliant :+1:

#13

Thank you good sir. I try. Happy Friday.

#14

I’m just doing the 2015 AM paper.

CFAI guideline answer is 15 times longer than mine. BUT:

What would you say is missing from my answer? Is it necessary to repeat what each figure in the equation represents? Or in such a case explain the definition of the Taylor rule? (which was not asked by the question??) Or what?

My answer:

2.5 + 0.5(1.2-1) + 0.5(1.5-2) =2.35%. CB should loosen monetary policy, decrease interest rate as there is a negative output gap.

CFAI guideline answer:

The central bank, assuming it follows the Taylor rule, should loosen monetary policy. The

Taylor rule links a central bank’s target short-term interest rate to economic growth and inflation.

If the optimal short-term interest rate derived from the equation differs from the neutral rate, this

suggests that the central bank should change its monetary policy to be more or less

accommodative…

Taylor rule: Roptimal = Rneutral + [0.5(GDPgforecast – GDPgtrend) + 0.5(Iforecast – Itarget)]

Where:

Roptimal = the target for the short-term interest rate

Rneutral = the short-term interest rate that would be targeted if GDP growth were on trend and

inflation on target

GDPgforecast = the GDP forecast growth rate

GDPgtrend = the observed GDP trend growth rate

Iforecast = the forecast inflation rate

Itarget = the target inflation rate.

Roptimal = 2.50% + [0.5

(1.50% – 2.00%) + 0.5

(1.20% – 1.00%)] = 2.35%

Since the optimal short-term rate of 2.35% is 15 bps lower than the current short-term interest

Since the optimal short-term rate of 2.35% is 15 bps lower than the current short-term interest

rate target of 2.50%, the central bank should loosen its monetary policy.

The central bank, assuming it follows the Taylor rule, should loosen monetary policy. The

Taylor rule links a central bank’s target short-term interest rate to economic growth and inflation.

If the optimal short-term interest rate derived from the equation differs from the neutral rate, this

suggests that the central bank should change its monetary policy to be more or less

accommodative…

Taylor rule: Roptimal = Rneutral + [0.5(GDPgforecast – GDPgtrend) + 0.5(Iforecast – Itarget)]

Where:

Roptimal = the target for the short-term interest rate

Rneutral = the short-term interest rate that would be targeted if GDP growth were on trend and

inflation on target

GDPgforecast = the GDP forecast growth rate

GDPgtrend = the observed GDP trend growth rate

Iforecast = the forecast inflation rate

Itarget = the target inflation rate.

Roptimal = 2.50% + [0.5

(1.50% – 2.00%) + 0.5

(1.20% – 1.00%)] = 2.35%

Since the optimal short-term rate of 2.35% is 15 bps lower than the current short-term interest

Since the optimal short-term rate of 2.35% is 15 bps lower than the current short-term interest

rate target of 2.50%, the central bank should loosen its monetary policy.

#15

This is absurd.

Surely the guideline answer didn’t have the phrase, “Since the optimal short-term rate of 2.35% is 15 bps lower than the current short-term interest” _ four _ times.

#16

I took the guideline answers to be lessons, and not actual answers that graders expected to see. CFAI knows you’re using the old L3 AM sections to study and learn, and from that perspective a complete explanation makes total sense.

So that said, I think you absolutely can have a much shorter answer than the guideline answers. And in fact I’d say you SHOULD have much shorter answers. So when grading yourself, I’d probably say that if your answer touches all the key points brought up in the guideline answer, it would probably award that full credit (unless the question asked for explanation and you didn’t give one).

I would also add that while I’ve never graded a L3 AM section (and likely never will), I have done University exam grading before and I can tell you that the graders will see so many wrong answers that it will make them very happy to see a right answer come across. I don’t expect they would be in the mood to decide partial credit for your answer not being as clean as the CFAI solutions. Just my 2c.

#17

Due to rushing in copying I copied parts multiple times, sorry for that. Still CFAI answer was significantly more wordy than what I would call succint, bullet point like answer.

#18

As Mr. pck pointed out, the guideline answers aren’t intended to be model answers; they’re intended for teaching as much as for answering the question.

I think that you original answer needs to say that the target rate is lower than the current rate, but other than that, it’s fine.

(Well, it also needs those fancy script _ x _s for multiplication signs, of course.)

#19

Well keep in mind that all they’ve asked is to name, or identify, two limitations. They haven’t asked you to justify or explain your answer. If they did (which they always do), then I would elaborate as briefly as possible, but in a very specific way. You need to explain why these are limitations, or how they affect the portfolio being discussed.