IS SMITH’S ASSERTION ABOUT CASH FLOW MATCHING MOST LIKELY CORRECT

54. Is Smith’s assertion about cash flow matching most likely correct?

A. Yes.

B. No, he is incorrect regarding cash balances.

C. No, he is incorrect regarding the interest rate assumption.

Anton Case Scenario

Beatriz Anton, CFA, is the chief compliance officer at Long Pond Advisors, an asset management firm

catering to institutional investors. Long Pond is not currently GIPS compliant, but Anton would like to

market the firm as being compliant as soon as possible. To assist Anton in achieving compliance, she

hires Ana Basco, CFA, from Nantucket Advisors to provide guidance on achieving compliance.

At their initial meeting to discuss a framework for the implementation of GIPS standards, Anton asks

Basco what she believes the fundamentals of GIPS compliance encompass. Basco responds, “A good

starting point is input data because the Standards rely on the integrity of input data to accurately

calculate results. Portfolios must be valued in accordance with the definition of fair value, not cost or

book values. In fact, fair value supersedes market value. Transactions are reflected in the portfolio at

settlement when the exchange of cash, securities, and paperwork involved in a transaction is

completed. Accrual accounting is used for fixed income securities and all other assets that accrue

interest income; dividend-paying equities accrue dividends on the ex-dividend date.”

Basco then asks Anton about Long Pond’s policies for return calculation methodologies. Anton responds

that she has recently implemented the following polices:

Policy 1: Total return is calculated for portfolios using time-weighted rates of return computed by

geometrically linking the periodic returns. Both realized and unrealized gains and losses are

used in the calculation.

Policy 2: Large- and mid-cap equity portfolios are revalued on the date when capital equal to 10

percent or more of current market value is contributed or withdrawn. Small-cap and fixed

income portfolios use a 5 percent threshold.

Policy 3: Cash and cash equivalents are excluded in total return calculations. Custody fees are not

considered direct transaction costs. Returns are calculated after deduction of trading

expenses.

Their conversation turns to the construction of composites and composite return calculations. Anton

tells Basco,

Long Pond calculates composite returns by asset-weighting the individual portfolio returns using

beginning-of-period values. For periods beginning 1 January 2010, we calculate composite

returns by asset weighting the individual portfolio returns quarterly. All actual, fee-paying,

discretionary portfolios are included in at least one composite. Non-fee-paying discretionary

portfolios are also included in a composite, and appropriate disclosures are provided. Client

portfolios that restrict the purchase of certain securities are excluded if this restriction hinders

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to

the portfolio manager’s ability to execute the investment strategy. We consider a hierarchical

structure of criteria for composite definition that promotes primary and secondary strategy

characteristics, such as asset classes, style, benchmarks, and risk/return characteristics. The

composites are not always defined according to each level of the hierarchy.

Anton then provides Basco a recent presentation to a prospective client for Long Pond’s mid-

capitalization composite. Details of this presentation are found in Exhibit 1.

Exhibit 1 – Mid-Capitalization Equity Composite

Benchmark: Russell Midcap Index

Column > 1 2 3 4 5 6 7

Total Assets ($m)

Net-of-

Gross-of-

Fees

Internal

Return

Benchmark

Dispersion

Number of

Composite Firm

(%)

Portfolios

Return (%)

Year

2007 4.4 3.4 3.6 5 3.1 125 1,000

2008 2.7 1.7 6.2 8 4.0 220 1,150

2009 –1.5 –2.5 –4.3 7 1.9 345 910

2010 8.3 7.3 11.1 11 2.6 430 1,020

1Q11 6.6 5.6 –2.9 13 4.1 600 1,100

Notes: