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CFA Level II Updated
How does a clawback provision protect LPs in a private equity fund?
A clawback provision requires the GP to return previously distributed carry to LPs if the GP has received more than its contractual share of profits by fund end.
What does Modigliani-Miller say about capital structure irrelevance?
MM Proposition I: in frictionless markets, firm value is independent of capital structure via homemade leverage arbitrage. Real-world deviations (taxes, bankruptcy, agency, asymmetry) are where CFOs create value.
How do I compute individual node values in a binomial bond tree?
V_t = [0.5*(V_up + C) + 0.5*(V_down + C)] / (1 + r_t). Compute backward value, then apply call/put rules. If backward value exceeds call price, cap at call price. Careful with coupon timing conventions — CFA assumes end-of-period coupons...
How is effective convexity computed for a putable bond and why is it positive and higher than straight?
EffConv = (V_plus + V_minus - 2*V_0) / (V_0 * delta_y^2). Putable bond has high positive convexity because the put floors downside while upside participates fully. Callable can have negative convexity. Useful for hedging MBS negative convexity...
What are generalized linear models (GLMs) and when are they used in finance?
GLMs extend OLS regression to handle non-normal response distributions using a random component, linear predictor, and link function...
What is the two-fund theorem in portfolio theory?
The two-fund theorem states any efficient portfolio can be built from a linear combination of two other efficient portfolios. All mean-variance investors hold combinations of these two funds...
What is the difference between parallel and non-parallel yield curve shifts?
A parallel shift moves every point on the yield curve by the same number of basis points...
How do I use key rate durations to position for yield curve twists?
Key rate duration measures a portfolio's price sensitivity to a change in yield at a specific maturity...
How do I compute after-tax yield and compare municipal bonds to taxables?
After-tax yield = pre-tax × (1 − marginal rate). Taxable-equivalent yield of muni = muni yield / (1 − marginal rate). Include state taxes, AMT, and surtaxes for the effective marginal rate.
What's the difference between nominal yield and real yield, and how do I convert?
Nominal yield includes expected inflation; real yield is purchasing-power return. Fisher: (1 + nominal) = (1 + real)(1 + inflation). Breakeven = market-priced inflation. Match real with real, nominal with nominal.
What is the synthetic control method for causal analysis?
Synthetic control constructs a weighted combination of donor units to match pre-treatment trajectories, with post-treatment divergence attributed to the intervention.
How does regression discontinuity identify causal effects?
RDD exploits treatment assignment based on a cutoff in a continuous running variable, estimating local causal effects from the jump at the threshold.
How does difference-in-differences identify causal effects?
DiD compares outcome changes between treated and control groups before and after intervention, identifying causal effects under the parallel trends assumption.
How does two-stage least squares solve endogeneity?
2SLS solves endogeneity by predicting the endogenous regressor from exogenous instruments in stage 1, then using predictions in stage 2—requires relevance and exclusion.
How do I set up a Monte Carlo simulation for a capital project?
Monte Carlo simulation draws input variables from assumed distributions, recomputes NPV thousands of times, and delivers a full output distribution...
How does accretion expense work for asset retirement obligations, and how should analysts adjust for changes in ARO estimates?
Asset retirement obligation accretion expense is the periodic increase in the ARO liability as the present value discount unwinds over time. Combined with depreciation of the ARO asset component, it creates a dual charge pattern. Estimate revisions are treated prospectively under US GAAP, adjusting both the asset and liability.
What is regularization in machine learning, and why should CFA candidates care about LASSO vs. Ridge?
Regularization adds a penalty term to OLS regression that discourages large coefficient values, addressing overfitting and multicollinearity — two critical problems in financial modeling. Ridge regression shrinks coefficients toward zero, while LASSO can force them to exactly zero, performing automatic variable selection.
How do you assess whether a company's dividend growth rate is sustainable?
Dividend growth sustainability requires checking the sustainable growth rate (b x ROE), ensuring dividend growth does not exceed earnings growth, and verifying free cash flow coverage. Rising payout ratios and declining FCF coverage are major red flags.
What is a credit spread option, and how does it differ from a credit default swap for hedging credit risk?
Credit spread options pay based on spread widening beyond a strike level, providing mark-to-market protection that CDS cannot. While CDS only triggers on actual default events, credit spread options compensate for any spread movement, making them ideal for active portfolio management.
How does the repo rate imply a financing cost for bond positions, and when does an arbitrage opportunity exist?
The repo rate represents the financing cost for leveraged bond positions. Carry equals bond yield minus repo rate. Arbitrage opportunities arise when bonds trade 'special' in repo (below the general collateral rate) or when the futures-implied repo rate diverges from the actual repo rate.
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