How To Answer CFA® Level III Constructed Response (Essay) Questions for MAXIMUM Points

Crucial Advice for Level 3 Candidates: Avoid This Common Mistake

Hello everyone, Nathan Ronen, CFA here with another update specifically for CFA Level III (“Level 3”) candidates gearing up for their exam. I've been receiving a multitude of calls, texts, emails, WhatsApp messages, and website inquiries, all with a recurring theme of a common mistake. As I'm currently grading numerous CFA mock exam essays, I want to share this insight to help you avoid this error on exam day. With my extensive experience grading exams and providing feedback, I believe this advice will be invaluable for your success.

Understanding How CFA Exams Are Graded

Let's spend some time rectifying a critical aspect of how exams are graded and how you should answer the questions to align with the answer key the graders use. I'll use a hypothetical scenario to illustrate this.

Example Scenario: Fixed Income

Fixed income is a topic that often troubles CFA candidates at Level 3, and it accounts for approximately 20% of your exam points. Many candidates struggle due to weak foundations in fixed income at Level 1 and Level 2, primarily from relying on prep notes instead of engaging with the CFA curriculum.

Imagine you are given the following scenario:

  • Smith is assisting Jones in updating the forecasted yields for bonds in their portfolio.
  • Smith presents three strategies for a duration-neutral portfolio: a bullet portfolio, a barbell portfolio, and a laddered portfolio.
  • The bullet portfolio invests in 10-year US Treasury bonds, the barbell portfolio in 2-year and 30-year bonds, and the laddered portfolio equally in 2-year, 5-year, 10-year, and 30-year bonds.
  • You are given an exhibit showing the starting yields for these maturities and the forecasted changes, with a positively sloped yield curve.

Forecasted Yield Changes:

  • 2-year: +30 basis points
  • 5-year: +50 basis points
  • 10-year: +40 basis points
  • 30-year: -90 basis points

Exam Question:

"State which strategy the portfolio should implement for the year ahead given Smith's yield curve expectations and justify your recommendation."

Correct Answer and Justification:

  1. State the Strategy: Barbell Portfolio

    • Simply state "barbell portfolio." Avoid unnecessary elaboration on this initial point.

  2. Justify the Recommendation:

    • Explain why the barbell portfolio is the best choice based on the yield curve expectations.
    • Example: "The barbell portfolio, consisting of long positions in 2-year and 30-year bonds, is expected to perform the best. Despite the expected increase in the 2-year rate, its short duration results in minimal price impact. Conversely, the 30-year yield is forecasted to decrease, resulting in a significant positive price impact due to the longer duration, which will drive overall performance."

Avoid explaining why other strategies are wrong, as this does not directly answer the question. Focus on why the barbell portfolio is the best given the provided information.

Common Mistakes to Avoid:

  • Incorrectly stating the strategy (e.g., laddered or bullet) results in zero points.
  • Misunderstanding the barbell strategy by suggesting short positions instead of long positions.
  • Failing to justify the recommendation with clear, cohesive rationales.

Practice with Mock Exams

Practicing with mock exams is crucial to mastering this approach. At Chalk & Board, we offer high-quality mock exams with detailed feedback to help you correct mistakes before the exam. Self-grading has limited benefits, so getting professional feedback is essential.

I hope this advice helps you prepare effectively for your CFA Level III exam.

Good luck, and feel free to reach out for more Level 3 guidance.