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CFA Level II Updated
What is a credit barbell strategy, and when does it outperform a bullet credit allocation?
A credit barbell combines high-grade (AA) and high-yield (BB) bonds while avoiding intermediate BBB credits. It can outperform a BBB bullet allocation by eliminating fallen angel risk, capturing convexity in credit returns, and harvesting liquidity premiums at both ends of the spectrum.
How do you calculate the breakeven spread widening for a corporate bond, and what does it tell you about the risk-reward of holding credit?
Breakeven spread widening equals the credit spread divided by spread duration, indicating how much the OAS can widen before the price loss offsets the carry advantage over Treasuries. A wider breakeven provides a larger margin of safety for credit positioning.
How do you calculate the roll-down return for a bond, and what assumptions does it require?
Roll-down return is the price appreciation from a bond aging along an unchanged, positively sloped yield curve. It is calculated as the price change when the bond's yield falls from its current maturity point to the shorter maturity point on the same curve.
How do you derive a justified price-to-sales (P/S) ratio from fundamentals, and when is P/S more useful than P/E?
The justified P/S ratio equals the net profit margin times the payout ratio times (1+g), all divided by (r - g). It is most useful when earnings are negative or volatile, making P/E unreliable, though it must be interpreted alongside profitability analysis.
How do you adjust WACC for country risk when valuing a company operating primarily in emerging markets?
The most common approach adds a country risk premium to the standard CAPM, estimated as the sovereign default spread multiplied by the ratio of equity market volatility to bond volatility. This captures political, currency, and institutional risks not reflected in a global beta.
How sensitive is a FCFF model to the terminal growth rate assumption, and how do I select an appropriate perpetuity growth rate?
Terminal value is highly sensitive to the perpetuity growth rate because the denominator (WACC minus g) shrinks as g increases. The growth rate should not exceed long-run nominal GDP growth and must be validated against implied exit multiples and sustainable reinvestment rates.
How is a brand or trade name valued in a purchase price allocation using the relief-from-royalty method?
Brands acquired in a business combination are valued using the relief-from-royalty method, which estimates fair value as the present value of hypothetical after-tax royalty payments the acquirer saves by owning the brand. The royalty rate is derived from comparable licensing transactions in the same industry.
How is a favorable lease recognized and measured as an intangible asset in a business combination?
A favorable lease in a business combination is measured as the present value of rent savings over the remaining lease term. Under IFRS 16, this value is embedded as an upward adjustment to the right-of-use asset rather than recognized as a separate intangible line item.
Why can't an assembled workforce be recognized as a separate intangible asset in a purchase price allocation?
An assembled workforce cannot be recognized separately in a PPA because it fails both the separability and contractual/legal rights criteria for identifiable intangible assets. Instead, its value is subsumed within goodwill, though it is still estimated using the replacement cost method for use as a contributory asset charge.
How are non-compete agreements valued and amortized as intangible assets in an acquisition?
Non-compete agreements are valued using the with-and-without method, comparing enterprise value with the agreement in place versus a scenario where the individual could compete. The resulting intangible is amortized over the contractual term, typically on a straight-line basis.
Does the convergence hypothesis hold in practice — do poor countries actually grow faster than rich countries?
Absolute convergence (all countries converging to the same income level) is not supported by data. However, conditional convergence — where countries converge to their own steady states based on institutional quality, education, and savings — finds strong empirical support.
What is a ratio call spread, and why does it have unlimited upside risk?
A ratio call spread buys fewer calls at a lower strike and sells more calls at a higher strike, typically 1:2. Maximum profit occurs at the higher strike, but the uncovered short call creates unlimited upside risk above the upper breakeven point.
What are the key differences between IFRS 2 and ASC 718 for share-based compensation accounting?
IFRS 2 and ASC 718 both require grant-date fair value measurement for equity-settled awards, but they diverge on classification when employees choose settlement method, forfeiture estimation requirements, and treatment of compound instruments.
How do you derive the minimum variance hedge ratio, and when does it differ from a naive 1:1 hedge?
The minimum variance hedge ratio h* = rho x (sigma_S / sigma_F) minimizes the variance of the hedged portfolio. A naive 1:1 hedge only works when the hedging instrument perfectly mirrors the exposure, which rarely occurs in cross-hedging situations.
How are intercompany leases eliminated in consolidation under IFRS 16 / ASC 842?
Intercompany leases require elimination of the lessee's ROU asset and lease liability, the lessor's lease revenue, and all related depreciation and interest. The consolidated entity shows only the underlying physical asset at historical cost with normal depreciation.
How are intercompany management fees eliminated in consolidation, and why do analysts watch for them?
Intercompany management fees are eliminated in consolidation by reversing the parent's fee revenue against the subsidiary's fee expense. Analysts watch these fees closely because they can be used for profit shifting, minority interest extraction, and segment profitability distortion.
How is goodwill impairment allocated between the parent and non-controlling interest (NCI)?
Under the full goodwill method, impairment is allocated between parent and NCI in proportion to ownership. Under the partial goodwill method, the entire impairment is allocated to the parent since NCI was never assigned goodwill. IFRS requires grossing up for testing under partial goodwill.
What is push-down accounting, and when can a subsidiary elect to apply it?
Push-down accounting allows an acquired subsidiary to elect to adjust its own separate financial statements to reflect the acquirer's fair value adjustments and goodwill. Under US GAAP it is an irrevocable election available when an acquirer obtains control.
What was proportionate consolidation for joint ventures, and why did IFRS eliminate it?
Proportionate consolidation included the venturer's proportionate share of each joint venture line item in its own financial statements. IFRS 11 eliminated this option in favor of the equity method because the venturer does not individually control the JV's assets and liabilities. While net income is identical under both methods, revenue, assets, liabilities, and most ratios differ significantly.
How does a private equity fund structure work? I'm confused by the GP/LP relationship and the fee waterfall.
Private equity funds use a limited partnership structure where the GP manages investments and LPs provide most of the capital. The fee structure includes a management fee, hurdle rate, and carried interest distributed through either European or American waterfall methods.
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