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CFA Level II Updated
How does credit migration interact with embedded options in bond valuation?
Credit migration widens Z-spread and reduces call likelihood because distressed issuers cannot refinance cheaply. Default dominates with recovery value. Use rating transition matrices to weight credit-state cash flows...
How does the yield curve shape affect binomial tree outputs?
Curve shape drives future rate distribution. Steep upward curves reduce call option value (fewer paths below coupon). Flat curves produce larger option values. Inverted curves make callable options very valuable and putable options less so...
How does logistic regression work and what's the intuition behind the logit link?
Logistic regression predicts binary outcomes using a logit link that transforms bounded probabilities into unbounded log-odds, allowing linear modeling...
What is the one-fund theorem and the tangency portfolio?
The one-fund theorem: with a risk-free asset, all investors hold combinations of the risk-free asset and the tangency portfolio (maximum Sharpe ratio). Risk tolerance dictates the cash mix only...
How do information barriers (Chinese walls) work at investment firms?
Information barriers separate firm functions that handle MNPI from those that don't. The goal: prevent private-side information from influencing public-side decisions...
What is a moving average (MA) model and how does it differ from AR?
MA(q) models express current value via current and past q error terms. ACF cuts off at lag q; PACF decays. Short memory contrasts with AR's persistent feedback.
What is an autoregressive (AR) model in time series analysis?
AR(p) models express current value as a linear function of past p lags plus error. AR(1) is the simplest; requires covariance stationarity (phi magnitude less than 1) to be valid.
How is a curve flattener trade structured?
A flattener profits when the spread between long and short yields narrows...
How do I construct a curve steepener trade?
A curve steepener profits when long rates rise more (or fall less) than short rates...
Why has productivity growth slowed since 2005?
Productivity slowdown explanations include measurement error, diminishing returns to R&D, declining business dynamism, weak investment, and incomplete IT diffusion.
What causes revisions to potential GDP estimates?
Potential GDP revisions come from labor force and productivity updates; lower potential growth worsens fiscal sustainability and lowers r-star.
Why is output gap measurement so uncertain?
Output gap uncertainty arises from unobserved potential GDP, data revisions, end-point issues, and NAIRU uncertainty—practitioners triangulate using multiple methods.
Why has the Phillips curve flattened in recent decades?
The Phillips curve flattened due to anchored expectations, globalization, weakened labor bargaining, and measurement changes—but 2021-2023 reflation shows it can steepen under shocks.
How do I use a decision tree to value a staged capital project?
Decision trees are essential when projects have sequential decisions and information arrives in stages...
What is the mosaic theory in CFA ethics, and how does it differ from trading on material nonpublic information?
The mosaic theory permits analysts to form material investment conclusions by combining public information with individually non-material nonpublic information. The critical distinction is whether any single piece of nonpublic information is material on its own — if it is, trading on it violates Standard II(A).
How are environmental liabilities recognized and measured under IFRS and US GAAP, and what should analysts look for in the disclosures?
Environmental liabilities are recognized when probable and estimable, but IFRS uses expected value measurement while US GAAP uses the range minimum when no single estimate is best. This creates significant cross-framework differences in reported liabilities for identical environmental obligations.
How do you value an interest rate swap after initiation? I can't figure out which leg to discount at which rate.
Swap valuation is really bond math in disguise. A plain vanilla swap for the fixed-rate payer equals a long floating-rate bond minus a short fixed-rate bond. After rates change, you discount remaining fixed payments at new spot rates and compare to the floating leg, which resets to par on each coupon date.
What is contingent immunization, and how does the cushion spread determine the manager's freedom to actively manage?
Contingent immunization allows active bond management while the portfolio maintains a surplus over the immunization floor. The cushion spread — the difference between the immunized rate and minimum acceptable return — determines the manager's freedom, and when the cushion is exhausted, the manager must lock in pure immunization.
Why are bearer plants excluded from IAS 41 and treated under IAS 16, and how does this affect measurement?
Bearer plants were excluded from IAS 41 and placed under IAS 16 because they function like productive equipment rather than consumable biological assets. They are measured at cost or revalued amount with depreciation, while their produce remains under IAS 41 at harvest.
How do traders interpolate across the volatility surface when there's no quoted option at the exact strike and maturity they need?
Volatility surface interpolation fills gaps between observed option implied volatilities across strike and maturity dimensions. Strike interpolation is typically done in delta space; time interpolation must be done in variance space to prevent calendar arbitrage.
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