Free CFA Level III: Private Markets Private Investments & Structures Practice Questions
Private investment structures on CFA Level III cover limited partnership fund structures, management fee and carried interest arrangements, co-investment vehicles, secondary market transactions, and the GP-LP relationship.
Sample Questions
Question 1
Easy
The denominator effect in a private equity portfolio refers to:
Solution
C is correct.
The denominator effect occurs when the total portfolio value (the denominator in the allocation percentage calculation) declines due to public market losses, while private market NAVs are based on lagged appraisals and adjust more slowly. This causes the PE allocation percentage to rise above the target, even though the PE portfolio value may have also declined in economic terms. This can force investors to reduce new commitments or sell PE positions on the secondary market.
The denominator effect occurs when the total portfolio value (the denominator in the allocation percentage calculation) declines due to public market losses, while private market NAVs are based on lagged appraisals and adjust more slowly. This causes the PE allocation percentage to rise above the target, even though the PE portfolio value may have also declined in economic terms. This can force investors to reduce new commitments or sell PE positions on the secondary market.
Question 2
Medium
Based on Exhibit 2, the pension plan's DPI on its Larkspur IV commitment at the end of year 5 is closest to:
Solution
A is correct. DPI (Distributed-to-Paid-In) equals cumulative distributions divided by cumulative contributions (paid-in capital). From Exhibit 2, cumulative distributions equal $45.0 million and cumulative contributions equal $75.0 million, so DPI captures realized cash returned relative to capital drawn and is independent of the unrealized NAV.
Question 3
Hard
Considering Northstar's allocation status, vintage diversification, and CV-1's revised economics, which option from Exhibit 3 is most appropriate for Halverson to recommend?
Solution
C is correct. The decision must integrate three signals. (1) Allocation: Northstar is at 18% vs a 20% target — Options 2 and 3 reduce PE exposure further, worsening the underweight; Option 1 maintains it. (2) Pacing: redeploying secondary proceeds into new primaries (Option 2) introduces multi-year J-curve drag, whereas the rollover keeps capital invested in marked-up assets with a projected 4-year gross IRR of ~22%. (3) Economics: CV-1's 1.25%-on-invested fee and 12.5% carry are materially lower than Fund IV's, and the stapled $5M co-invest at zero fee / zero carry further compresses blended cost. Option 3 is strictly worse than Option 2 (it accepts a 5% discount AND re-incurs primary fees on a third-party fund). Option 2 forfeits the lower-cost economics and creates redeployment risk. Option 1 best aligns with all three considerations.