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CFA Level II Updated
How does the mosaic theory let analysts use non-public information legitimately?
Mosaic theory permits an analyst to combine public information and non-material non-public information to reach a material conclusion, then trade or publish on that conclusion...
What is a random walk and how does it relate to a unit root?
Random walk: x_t = x_{t-1} + epsilon_t, an AR(1) with phi=1 (unit root). Non-stationary with growing variance and permanent shocks. Differencing yields stationary returns.
What is an ARMA model and when is it appropriate?
ARMA(p,q) combines autoregressive and moving average terms. Use Box-Jenkins methodology: check stationarity, examine ACF/PACF, estimate, and select via AIC/BIC.
What does a bull flattener signal about the economy?
A bull flattener features long-end yields falling faster than short-end yields...
What are the macro implications of a bear steepener?
A bear steepener occurs when long-end yields rise sharply while short-end yields rise modestly...
How should flotation costs affect project NPV?
Flotation costs should be subtracted from initial cash flows (not added to WACC)—discount future CF at unadjusted WACC, treating issuance fees as a one-time upfront outflow.
How do taxes correctly enter capital budgeting cash flow analysis?
After-tax capital budgeting requires depreciation tax shields, working capital changes, and terminal value with tax on gain—critical for accurate NPV.
How is wealth inequality measured and why do estimates differ?
Wealth inequality estimates differ based on coverage of ultra-wealthy, pension inclusion, offshore holdings, and capitalization assumptions—top 1% share ranges 32-40%.
What is a real option and how does it differ from DCF?
A real option is managerial flexibility embedded in a physical investment that can be valued using option-pricing techniques...
How do concurrent PIPE investments work in SPAC mergers, and what terms do institutional investors typically negotiate?
PIPE investors commit capital after seeing the identified SPAC target — a major informational advantage. They typically buy at $10 per share but cannot redeem. Their participation quality signals deal merit: oversubscribed vanilla PIPEs from top institutions predict outperformance.
What is the curse of dimensionality and why is it particularly problematic for financial models with many features?
The curse of dimensionality means data requirements grow exponentially with feature count. Financial models are especially vulnerable because time series are short while potential predictors are numerous. PCA, feature selection, and regularization help mitigate the problem.
How does TIPS accretion create a 'phantom income' tax problem, and what are the tax implications for different types of investors?
TIPS accretion creates phantom income because the annual CPI-based principal increase is taxed as ordinary income in the year it accrues, even though no cash is received until maturity. At high tax rates, the tax owed can exceed the coupon cash received, making tax-deferred accounts the optimal location for TIPS holdings.
How is the conversion premium on convertible preferred stock calculated and interpreted in equity valuation?
The conversion premium on convertible preferred stock measures the excess paid over conversion value, reflecting the value of the preferred dividend advantage, liquidation preference, and downside protection. Analysts calculate the payback period using the dividend yield advantage and evaluate dilution impact using the if-converted method.
What are the key bondholder-stockholder agency conflicts, and how do bond covenants mitigate them?
The three core bondholder-stockholder conflicts are asset substitution (risk shifting to riskier projects), underinvestment (rejecting positive-NPV projects due to debt overhang), and claim dilution (issuing senior debt or paying excessive dividends). Bond covenants including investment restrictions, negative pledge clauses, and dividend limitations are designed to mitigate each conflict.
How do you approach NFT valuation from an investment analysis perspective, and what frameworks apply?
NFT valuation draws on comparable sales analysis, cost-based approaches, income capitalization for revenue-generating tokens, and hedonic pricing models. The fundamental challenge is that most NFTs lack cash flows, making them more akin to collectibles where value depends on rarity, artist reputation, and community sentiment.
How do multifactor models connect to active risk and the information ratio in portfolio management?
Multifactor models decompose portfolio returns into factor exposures (market, size, value, momentum) plus alpha. Active return equals portfolio return minus benchmark return, and can be split into factor tilts and security selection. The information ratio measures active return per unit of active risk.
What is pin risk at options expiration, and why does it create problems for market makers who are delta-hedging?
Pin risk occurs when a stock trades near a strike at expiration, causing option delta to oscillate between 0 and 1 with tiny price movements. Market makers face whipsaw hedging costs as gamma approaches infinity, making accurate delta-hedging impossible in the final trading hours.
How does a DRIP work mechanically, and what is the compounding effect on long-term wealth accumulation?
A DRIP automatically reinvests dividends into additional shares, creating compound growth as new shares generate their own dividends. Company-sponsored DRIPs often offer a 2-5% discount. Over long horizons, DRIP compounding significantly outperforms cash dividend collection.
How are transfers into and out of investment property accounted for under IAS 40, and what triggers a transfer?
Under IAS 40, property transfers are triggered by a change in use. When owner-occupied property transfers to investment property under the fair value model, the gain is treated like a revaluation (OCI), while inventory-to-IP transfers produce P&L gains.
What is a credit spread option, and how is it used to hedge or speculate on credit risk?
A credit spread option pays off based on credit spread movements relative to a strike spread, using duration to convert spread changes into dollar payoffs. Unlike CDS which protects against default, CSOs hedge mark-to-market spread widening risk.
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