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CFA Level II Updated
How do you determine the primary beneficiary of a Variable Interest Entity?
The primary beneficiary of a VIE must consolidate it. Determination requires meeting both prongs: the power to direct the VIE's most significant activities AND the obligation to absorb significant losses or receive significant benefits.
What is the financial reporting quality framework and how does it differ from earnings quality?
Financial reporting quality measures how faithfully statements represent economic reality under GAAP/IFRS. Earnings quality measures the sustainability and cash backing of reported earnings. The quality spectrum ranges from high-quality compliant reporting to fraudulent misstatement.
What causes deferred tax liabilities and can they ever reverse?
Deferred tax liabilities arise when tax depreciation exceeds book depreciation, from installment sales, or from undistributed foreign earnings. While they theoretically reverse, growing companies may see DTLs act as quasi-permanent obligations, and analysts often reclassify them as equity.
How does deep reinforcement learning apply to portfolio management?
DRL trains an agent via states, actions, rewards. Algos: DQN, A2C, PPO, SAC. Applied to allocation but faces non-stationarity and sample inefficiency.
How does dividend signaling theory work in practice?
Signaling theory: management with private info uses dividends to communicate future prospects. Paying/raising dividends is a costly, credible commitment. Cuts produce sharp negative returns (-4% to -9%) due to negative information inference, lost confidence, and clientele disruption...
What is integrated reporting and how does the IR framework work?
Integrated Reporting combines financial and non-financial info into a single value-creation narrative via six capitals and seven content elements.
How does the CLO equity tranche actually make money?
CLO equity earns the arbitrage spread between the weighted average interest earned on the loan pool and the weighted average cost of the CLO debt tranches.
What's the difference between an American and European waterfall in private equity?
American ('deal-by-deal') and European ('whole-fund') waterfalls differ in when the GP can start earning carry. European is much more LP-friendly.
What is carried interest in private equity and how is it different from a hedge fund incentive fee?
Carried interest is the GP's share of profits in a private equity fund — usually 20% — but it works on a fund-level deal-by-deal or aggregate basis with waterfall mechanics.
How do I evaluate business risk in corporate credit analysis?
Business risk = competitive position + diversification + operating efficiency + profitability stability. For Kenwood Office Products: #2 market share, 90% single category, below-peer margins → BRP 'Fair' (score 4), which combined with intermediate leverage yields BB anchor rating...
What is partial correlation and why does it matter in financial analysis?
Partial correlation isolates the relationship between two variables after removing the influence of a third, exposing spurious correlations from confounders.
How do I forecast dividends in a multi-stage DDM?
Forecast dividends from fundamentals (EPS x payout, tied to ROE and retention) in three stages: explicit forecast, transition, and terminal. Anchor terminal growth to long-run nominal GDP and verify feasibility.
How is a binomial interest rate tree calibrated?
Calibration ensures the tree prices on-the-run Treasury zeros correctly. Use ratio r_up/r_down = e^(2*sigma). Solve backward: find rates at each horizon that, when used in the tree, reproduce observed zero-coupon prices. Iterate outward...
How do I calculate option-adjusted spread (OAS) step by step?
OAS is the constant spread added to every node rate in the binomial tree that makes the model price equal the market price. Iterate by adjusting z and re-running backward induction with call rules. OAS isolates credit/liquidity from option cost...
What were the 2009 CDS Big Bang and Small Bang conventions and why did they matter?
The 2009 Big Bang (North America) and Small Bang (Europe) standardized CDS with fixed coupons, Determinations Committees, and hardwired auction settlement...
How do I construct a global minimum variance portfolio (GMVP)?
The GMVP is the portfolio with lowest variance subject to weights summing to one. Closed form: weights proportional to inverse covariance times vector of ones. Depends only on covariance, not expected returns...
How does the standard of care differ for retail vs institutional clients?
The duty of care is the same — prudent, skilled, diligent action. What differs is application: how the standard translates into practice depends on client sophistication...
What are clean-surplus violations and how do they affect residual income valuation?
Clean surplus requires all equity changes flow through NI; OCI items (AFS gains, FX, pensions) violate it. For Zephyr, use Comprehensive Income — $180M OCI difference turns RI from $4M to $184M. Alternatively, use Penman's operating-RI framework.
What is the difference between arithmetic and geometric Asian options?
Arithmetic Asian options average prices normally; geometric uses nth root of products. Geometric has closed-form pricing; arithmetic requires Monte Carlo.
How is the exit multiple method applied in M&A valuation?
The exit multiple method calculates terminal value as Terminal-Year Financial Metric × Exit Multiple...
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