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CFA Level II Updated
Why is own credit risk on liabilities reported in OCI rather than P&L?
OCI treatment of own-credit avoids the paradox of P&L gains when credit deteriorates. Measure via residual method or CDS-based approximation; special exception exists if OCI creates new mismatch.
How does the resource-based view (RBV) identify sustainable competitive advantage?
VRIO tests whether a resource is Valuable, Rare, Inimitable, and Organizationally embedded. Inimitability comes from historical accident, causal ambiguity, social complexity, or legal protection...
What is Porter's 'stuck in the middle' problem and how do I spot it?
'Stuck in the middle' describes a firm that fails to commit to cost leadership or differentiation and underperforms both. Symptoms: gross margin below differentiators but costs above cost leaders, medium loyalty, weak ROIC...
What are the main methods for estimating a factor model?
Three main approaches: time-series regression (macro factors observable), cross-sectional regression (characteristics observable), and statistical factor models (PCA or ML)...
What is empirical duration and how does it differ from analytical duration?
Empirical duration is the negative slope from regressing bond returns on yield changes. Captures credit and liquidity effects that analytical duration misses.
Why does decomposing ROE into operating spread and financial spread matter?
Alpha (RNOA 16% + small leverage) vs Beta (RNOA 10% + heavy leverage) both yield 18% ROE but Alpha is sustainable and Beta is fragile — a 3pt RNOA drop cuts Beta's ROE by 4.8pts vs Alpha's 3pts. Decomposition reveals quality.
How do I identify derivatives embedded in host contracts?
An embedded derivative is a contractual provision that causes some or all of the cash flows of a host...
How is hedge ineffectiveness measured and reported?
Hedge ineffectiveness is the difference between the change in the derivative's fair value...
What are the main motivations for mergers and acquisitions?
M&A motivations fall into categories — synergy, growth, market power, capability acquisition, tax, unlocking hidden value, diversification.
What is the change of numeraire technique in derivatives pricing?
Change of numeraire is a Girsanov-powered technique that lets you price derivatives using any tradeable asset as reference.
What is the swap measure and how is it used for swaptions?
The swap measure uses the swap annuity A(t) as numeraire. Under this measure, the forward swap rate becomes a martingale.
What index construction choices do I need to understand for CFA?
Index construction combines target market, selection rules, weighting scheme, free-float adjustment, rebalancing cadence, and reconstitution rules. Each choice has distinct performance implications.
Quote-driven vs order-driven — which is better for execution?
Quote-driven markets have dealers posting two-sided quotes; order-driven markets match limit orders with price-time priority. Hybrid venues combine both for best execution.
What are special assessment bonds?
Special assessment bonds repaid by lien on benefiting parcels. Birchwood Grove's $4.8M utility-conversion issue assesses 247 parcels $19,430/parcel over 15 years.
Why do callable bonds and MBS exhibit negative convexity, and what's the cost to investors?
Negative convexity arises when embedded calls or prepayments cap price appreciation — investors are compensated via OAS, the option-cost component of yield spread.
How do classic cars perform as an investment asset?
Classic cars are a niche alternative that has produced strong headline returns but with enormous dispersion and hidden costs.
What is the ICMA Green Bond Framework?
ICMA GBP has four components: use of proceeds, project selection, proceeds management, reporting. Green bonds fund eligible environmental projects.
Why is the support (companion) tranche the riskiest part of a CMO, and who would buy it?
The support tranche absorbs all prepayment variability in a CMO, with average life swinging from under 2 years to over 24 years. It offers the highest yield (100-300+ bps above PAC tranches) and is purchased by hedge funds and sophisticated traders who can actively manage the prepayment risk.
What is an 'asset play' investment strategy and how do you identify hidden asset value?
An asset play targets companies whose market capitalization understates the realizable value of underlying assets — including real estate at historical cost, overlooked subsidiaries, NOL carryforwards, and LIFO reserves. Analysts compare adjusted NAV to market cap and identify potential catalysts.
What are embedded derivatives and when do they need to be separated from the host contract?
An embedded derivative modifies the cash flows of a host contract in a derivative-like way. Bifurcation is required when the embedded derivative is not closely related to the host, would qualify as a standalone derivative, and the hybrid is not already at fair value through P&L. Under IFRS 9, financial assets no longer require bifurcation but are instead classified entirely based on the SPPI test.
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