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CFA Level II Updated
What are industrial revenue bonds (IRBs)?
IRBs: muni issues debt for private company (Ridgeline Plastics $9.5M). Corporate credit is obligor; bonds are AMT private-activity, priced off BB+ rating (4.8%).
How do I aggregate convexity across a bond portfolio with multiple holdings?
Portfolio convexity is the market-value-weighted sum of bond convexities — same approach as duration, useful for estimating P&L on large parallel yield shifts.
How does litigation finance work as an alternative investment?
Litigation finance provides non-recourse capital to plaintiffs in exchange for a share of any eventual recovery. If the case loses, the funder loses its investment.
What are blue bonds and how do they work?
Blue bonds are a subset of green bonds financing ocean and marine projects. Often use blended finance with DFI guarantees and debt-for-nature swaps.
How does the variance ratio test detect mean reversion or momentum?
Under a random walk, the variance of k-period returns equals k times the variance of one-period returns. The variance ratio is VR(k) = Var(r_t(k)) / (k * Var(r_t))...
How does a TAC (Targeted Amortization Class) tranche differ from a PAC tranche?
A TAC tranche provides one-sided prepayment protection, shielding against faster-than-expected prepayments but not against extension risk from slower prepayments. It offers higher yield than a PAC tranche in exchange for accepting extension risk.
What is the difference between going concern value and liquidation value, and when does each matter?
Going concern value assumes continued operations and is based on future cash flows, while liquidation value assumes all assets are sold and liabilities paid. Liquidation value serves as a floor valuation and is relevant for distressed companies or asset-heavy businesses.
What are the basics of hedge accounting, and how do fair value hedges differ from cash flow hedges?
Fair value hedges protect against changes in the fair value of recognized items, with both the hedged item and hedge instrument gains/losses in P&L. Cash flow hedges protect against variability in future cash flows, with the effective portion of hedge gains/losses in OCI until the hedged transaction affects P&L. Net investment hedges protect foreign currency exposure on foreign operations, with effective portions in OCI.
How does a change in the discount rate affect both the PBO and pension expense, and why is sensitivity analysis important?
A decrease in the discount rate increases the PBO, typically increases service cost, and deteriorates funded status. The relationship is convex, meaning rate decreases have a larger impact than equivalent increases. Sensitivity disclosures help analysts stress-test pension risk.
What techniques do companies use to manipulate cash flow statements and how can analysts detect them?
Companies manipulate CFO by stretching payables, selling receivables, capitalizing operating costs, and using supply chain financing. Analysts detect manipulation by tracking CFO/NI ratios, DPO trends, capex-to-depreciation ratios, and reviewing footnotes for factoring and securitization programs.
How does an LSTM cell solve the vanishing gradient problem?
LSTM adds forget, input, output gates and a cell state that preserves info via additive updates. Solves vanishing gradient, handles long sequences.
How is contingent consideration (earnouts) accounted for in business combinations?
Contingent consideration (earnouts) is measured at fair value at acquisition date and included in total consideration. Subsequently, liability-classified earnouts are remeasured to fair value through P&L; equity-classified are not remeasured...
How is private company stock valued for fair value reporting?
Private stock valuation blends market, income, and cost approaches with calibration to recent financings. Always Level 3 due to significant unobservable inputs requiring full disclosure.
How does shareholder activism affect target company valuations?
Shareholder activism typically generates a 5-10% initial pop and 10-15% two-year abnormal returns, but outcomes depend on activist quality and demand merit.
What are fallen angel bonds and why do they often outperform?
Fallen angels are bonds that were investment grade at issuance but have been downgraded to high yield. They outperform for technical and fundamental reasons.
When should I use polynomial regression to capture curvature in the data?
Polynomial regression is useful when you have clear evidence of nonlinearity and a theoretical reason for the curvature.
When should I add interaction terms to my regression in practice?
Add interactions when theory or domain knowledge predicts that the effect of one variable depends on another. Do not add them mechanically as a data-mining exercise.
What is the fundamental approach to credit analysis?
Fundamental credit analysis follows 8 steps: industry, competitive position, management, financials, leverage/coverage, liquidity, structure, scenarios. For Silvercrest Logistics: #5 trucking player, 3.2x leverage, clean structure → Ba2/BB rating...
When should I use a debit spread instead of buying a single option?
A debit spread caps both risk and reward, making it cheaper than a naked call when you have a specific price target and want to reduce vega.
What is a credit spread and how is it different from selling naked options?
A credit spread defines maximum loss with a protective long option, drastically reducing margin and tail risk versus selling naked options.
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