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CFA Level II Updated
What are measurement period adjustments in acquisition accounting?
The measurement period allows up to one year after an acquisition for the acquirer to refine provisional fair values of acquired assets and liabilities. Adjustments are made retrospectively, affecting goodwill and requiring restatement of comparative information. Only information about conditions existing at the acquisition date qualifies.
How do I reconcile FCFE and FCFF — what is the bridge between them?
The bridge from FCFF to FCFE is: FCFE = FCFF - Interest x (1 - tax rate) + Net Borrowing. FCFF represents cash available to all capital providers, while FCFE removes debt-related flows to isolate cash available to equity holders only.
When and how do you impair an equity method investment, and is the write-down reversible?
Equity method investments are impaired when fair value drops below carrying amount and the decline is other-than-temporary. The key IFRS vs. US GAAP difference is that IFRS allows reversal of impairment losses while US GAAP does not.
How do you derive the sustainable growth rate from the DuPont identity, and how does it connect to valuation?
The sustainable growth rate g = b x ROE can be decomposed using DuPont into g = retention ratio x net profit margin x asset turnover x equity multiplier. This full decomposition reveals which operational levers drive growth and directly feeds into dividend discount model valuations.
What are the pros and cons of direct vs. indirect real estate investment? When should I use each?
Direct real estate offers control, tax benefits, and leverage but requires high capital and is illiquid. Indirect investment through REITs and funds provides liquidity and diversification but sacrifices control and may have higher market correlation.
What's the difference between supervised and unsupervised learning, and how are they used in finance?
Supervised learning uses labeled data to predict outcomes like defaults or returns. Unsupervised learning finds hidden patterns in unlabeled data, useful for clustering stocks or detecting market regimes. Finance uses both extensively.
How does pecking order theory differ from trade-off theory in explaining how firms actually raise capital?
Trade-off theory says firms target an optimal debt ratio balancing tax shields against distress costs. Pecking order theory says firms follow a financing hierarchy — internal funds first, then debt, then equity — driven by information asymmetry rather than a target ratio.
What is a swaption and how does the payer vs. receiver distinction work in practice?
A swaption is an option on an interest rate swap. The holder has the right, but not the obligation, to enter into a swap at a predetermined fixed rate on a future date. Payer swaptions benefit from rising rates while receiver swaptions benefit from falling rates.
Can someone explain pension accounting -- PBO, plan assets, and funded status?
Pension accounting involves tracking the PBO (present value of earned benefits), plan assets (investments to pay benefits), and funded status (plan assets minus PBO). Pension expense components are split between the income statement and OCI depending on the reporting standard.
What is active share and how does it help detect closet indexing?
Active share measures the percentage of holdings that differ from the benchmark, calculated as half the sum of absolute weight differences. Values below 40% suggest closet indexing; above 60% indicates truly active management. It complements tracking error in evaluating manager style.
How is Natural Language Processing (NLP) applied in finance?
NLP in finance involves analyzing unstructured text (earnings calls, news, filings) using techniques like sentiment analysis, topic modeling, and named entity recognition to generate investment signals. Key preprocessing steps include tokenization, stop word removal, and TF-IDF feature extraction.
How do you conduct a DCF sensitivity analysis and which inputs matter most?
DCF sensitivity analysis tests how valuation changes when key inputs vary. WACC and terminal growth rate are typically the most impactful — a 1% change in WACC can shift value by 15-25%. Two-way tables and scenario analysis provide ranges rather than point estimates.
When must a company consolidate a Special Purpose Entity (SPE) or Variable Interest Entity (VIE)?
Companies must consolidate SPEs/VIEs when they are the primary beneficiary — having power to direct the entity's significant activities AND obligation to absorb losses or right to receive benefits. This applies even without majority ownership.
What makes farmland an attractive alternative investment, and how do returns compare to traditional assets?
Farmland returns come from operating income and land appreciation, driven by crop prices, population growth, and arable land scarcity. It offers strong inflation hedging and low correlation with traditional assets, but carries weather, water, and illiquidity risks.
How does ESG integration affect corporate valuation and the cost of capital?
ESG affects valuation through two channels: the cost of capital (risk premiums) and cash flows (revenues, costs, risk events). Analysts can incorporate ESG by adjusting the discount rate, modifying cash flow projections, or using scenario analysis.
How does the Mundell-Fleming model predict the effect of monetary and fiscal policy on exchange rates?
The Mundell-Fleming model shows that under floating exchange rates with high capital mobility, monetary policy is effective while fiscal policy is crowded out through currency appreciation. Under fixed rates, the opposite holds.
What does the Carhart 4-factor model add beyond Fama-French, and how does momentum factor work?
The Carhart 4-factor model adds WML (Winners Minus Losers) to capture momentum — the tendency of recent winners to keep winning. It was designed to strip out momentum-driven returns when evaluating fund manager skill.
How does vega work and why does implied volatility matter more than historical volatility for options pricing?
Vega measures an option's sensitivity to changes in implied volatility, not historical volatility. It is highest for at-the-money, longer-dated options and is always positive for long positions. Portfolio vega determines P&L impact from volatility changes.
How do you price a currency forward using covered interest rate parity?
Currency forwards are priced using covered interest rate parity: F = S₀ × (1 + r_domestic) / (1 + r_foreign). The currency with the higher interest rate trades at a forward discount. Always check whether the quote is DC/FC or FC/DC before calculating.
How do securitization structures work — can someone walk through the waterfall with an example?
Securitization involves pooling assets in a bankruptcy-remote SPE, then issuing tranches with different priorities. Cash flows follow a strict waterfall: senior tranches receive payments first, while the equity tranche absorbs initial losses.
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