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CFA Level II Updated
Do TIPS have reinvestment risk, and if so, how does it differ from nominal bonds?
TIPS have reinvestment risk in the REAL yield component. Coupons paid on indexed principal must be reinvested at prevailing real yields. TIPS eliminate inflation risk on principal and coupons but NOT real rate risk on reinvested cash flows or price risk before maturity...
What is stacking and how does it differ from other ensemble methods?
Stacking combines heterogeneous base learners using a meta-learner that learns optimal weights from out-of-fold predictions, often outperforming any single model...
What is a unitranche loan, and why has it become the dominant structure in middle-market private credit?
A unitranche loan combines senior and subordinated debt into one facility with a blended rate. It dominates middle-market lending because it simplifies execution, reduces closing timelines, and eliminates intercreditor complexity — despite costing slightly more than a traditional split.
How does ensemble stacking combine multiple models, and why does it outperform individual learners in financial prediction?
Stacking trains a meta-learner to optimally combine diverse base model predictions. Unlike simple averaging, it discovers conditional strengths — weighting models differently based on market conditions — and uses out-of-fold predictions to prevent overfitting.
Under IAS 28, how does an investor account for an associate's losses when the losses exceed the carrying amount of the investment?
When an associate's losses exceed the investor's carrying amount under IAS 28, the investor first reduces the equity investment to zero, then applies remaining losses against long-term interests forming part of the net investment, and recognizes a liability only if legal or constructive obligations exist. Subsequent profits must first recover cumulative unrecognized losses before the investor resumes profit recognition.
How does a parent company consolidate a subsidiary that has a different reporting date, and what adjustments are required under IFRS 10?
IFRS 10 permits consolidation using a subsidiary's statements prepared at a different date, provided the gap does not exceed three months and is consistent between periods. The parent must adjust for significant transactions occurring in the gap — including major asset sales, dividends, equity changes, and exchange rate movements.
What were Brady bonds, how were they structured, and what is their historical significance for the emerging market debt asset class?
Brady bonds were created in 1989 to resolve the Latin American debt crisis by converting non-performing bank loans into tradeable securities enhanced with US Treasury zero-coupon collateral. They came in par and discount varieties and effectively created the modern emerging market sovereign bond market.
How do IFRS and US GAAP differ in accounting for crypto assets like Bitcoin on a company's balance sheet?
Under IFRS, crypto assets are typically classified as indefinite-life intangible assets measured at cost less impairment, while US GAAP (ASU 2023-08) now requires fair value measurement through net income. This divergence creates material comparability challenges when analyzing cross-border companies holding cryptocurrency.
How do you evaluate PE fund performance using IRR, TVPI, and DPI — and which metric matters most?
Private equity fund performance measurement requires specialized metrics because of irregular cash flows and the J-curve effect. The four key metrics are IRR, TVPI (total value multiple), DPI (cash-on-cash return), and RVPI (unrealized value). DPI is the most reliable metric for mature funds.
How does a tender offer fund provide liquidity in alternative investments, and how does it differ from an interval fund?
Tender offer funds provide discretionary periodic liquidity where the board decides whether to offer redemptions, while interval funds are legally required to make periodic repurchase offers at predetermined intervals. Tender offer funds give managers more flexibility but provide investors less certainty about redemption access.
When do you switch from the equity method to the acquisition method for intercorporate investments?
Great question — this is one of the most frequently tested areas in CFA Level II FRA. The ownership thresholds are guidelines: below 20% uses fair value, 20-50% uses the equity method, and above 50% requires full consolidation under the acquisition method.
What is the clientele effect in dividend policy, and how do different investor groups sort themselves by payout preference?
The clientele effect describes how investors self-select into stocks matching their payout preferences based on tax brackets and income needs. In equilibrium, every payout level has its natural clientele, but changing policy causes transitional disruption.
How does the quantitative goodwill impairment test work under IFRS versus US GAAP, and what happens to the impairment loss?
IFRS tests goodwill at the CGU level by comparing the unit's carrying amount to its recoverable amount, with excess losses allocated to other assets. US GAAP compares reporting unit fair value to carrying value, capping the loss at the goodwill balance.
Why does WACC calculation sometimes require an iterative approach, and how do you handle the circularity?
WACC is circular because it depends on market value weights which depend on the firm value which depends on WACC. The iterative approach starts with initial weight estimates, computes WACC, re-derives market values, and repeats until convergence.
How do AIC, BIC, and HQC differ in penalizing model complexity, and which should I use?
AIC, BIC, and HQC all penalize model complexity but differ in severity. AIC uses a fixed penalty of 2k, BIC penalizes with k x ln(n) which grows with sample size, and HQC falls in between. BIC favors simpler models, while AIC optimizes prediction accuracy.
How does a carry trade work in fixed income, and how is it different from a yield pickup trade?
A fixed income carry trade borrows at short-term rates and invests in longer-duration bonds to earn the term premium. Total return includes carry plus roll-down return, but the strategy fails when the yield curve flattens, inverts, or when funding costs spike unexpectedly.
What is a yield pickup trade in fixed income, and what risks does the investor accept in exchange for the additional yield?
A yield pickup trade captures additional spread by swapping into a higher-yielding bond, typically accepting credit, liquidity, or complexity risk in exchange. The trade is profitable only if spreads remain stable or tighten — the breakeven spread widening equals the yield pickup divided by duration.
How do share buybacks affect FCFE, and should I adjust my valuation model when a company repurchases its own stock?
Share buybacks do not affect FCFE — they represent a distribution choice, not a cash flow component. The recommended approach is to discount total FCFE to arrive at aggregate equity value, then divide by current shares outstanding, avoiding the circularity of modeling per-share buyback effects.
What does a negative FCFE mean, and how do you handle it in a dividend discount or FCFE valuation model?
Negative FCFE means the company consumes more cash than it generates, requiring external financing. In a DCF model, negative near-term cash flows are discounted normally, with most equity value coming from the terminal value once the firm reaches profitability.
How is a customer relationship intangible asset identified and valued in a purchase price allocation?
Customer relationship intangibles are valued using the multi-period excess earnings method (MPEEM), which isolates cash flows specifically attributable to existing customer relationships by deducting contributory asset charges — returns required on all other assets used to generate those cash flows.
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