Community Q&A
Expert-verified answers to your financial certification questions. Ask, learn, and connect with fellow candidates.
CFA Updated
Can someone explain the main hedge fund strategies — long/short equity, event-driven, and relative value — with concrete examples?
The three major hedge fund strategies differ in their return sources: long/short equity profits from stock selection, event-driven strategies profit from corporate events like mergers and bankruptcies, and relative value strategies exploit pricing discrepancies between related securities.
How do you test for a unit root and what does the Dickey-Fuller test actually tell you?
The Dickey-Fuller test detects unit roots by testing whether the AR(1) coefficient equals 1. Crucially, it uses special critical values more negative than standard t-values because the test statistic follows a non-standard distribution under the null.
How does a firm find its optimal capital structure? The trade-off between tax shields and financial distress costs confuses me.
The static trade-off theory says every firm has an optimal debt-to-equity ratio where the marginal benefit of additional debt from tax shields exactly equals the marginal cost from increased financial distress risk.
What are the practical differences between futures and forwards beyond 'exchange-traded vs OTC'?
You're right that the exchange-vs-OTC distinction is just the surface. The real differences that matter for CFA Level II revolve around daily settlement, credit risk, and pricing divergence driven by the convexity adjustment.
How are intercompany transactions eliminated during consolidation?
Intercompany transactions must be fully eliminated during consolidation. For downstream sales (parent to subsidiary), unrealized profit is allocated entirely to the parent. For upstream sales (subsidiary to parent), unrealized profit is shared between parent and NCI proportionally.
How do FIFO, LIFO, and weighted average affect financial statements differently?
FIFO, LIFO, and weighted average are cost flow assumptions that affect COGS, gross profit, ending inventory, and taxes differently. In a rising-price environment, FIFO produces the highest net income and balance sheet inventory, while LIFO produces the lowest.
What is risk parity and how does it differ from traditional asset allocation?
Risk parity allocates portfolio weights so each asset class contributes equally to total portfolio risk. Unlike a traditional 60/40 portfolio (which derives ~90% of risk from equities), risk parity achieves true diversification across risk sources, often using leverage to reach target returns.
How do decision trees work for financial classification problems?
Decision trees recursively split data at each node using the variable that produces the most homogeneous child groups (measured by entropy or Gini impurity). They are interpretable but prone to overfitting, which is why ensemble methods like random forests are often preferred.
How do you estimate the appropriate discount for a private company valuation?
Private company discounts include DLOM (lack of marketability, typically 15-35%) and DLOC (lack of control, derived from control premiums). The key is knowing which discounts to apply based on your starting valuation basis.
How does goodwill impairment testing work under IFRS vs. US GAAP?
Under IFRS, goodwill impairment compares CGU carrying amount to recoverable amount (higher of fair value less costs to sell or value in use). US GAAP compares reporting unit carrying amount to fair value. Both test annually, and impairment is irreversible.
What is the J-curve effect in private equity fund returns?
The J-curve describes how private equity funds typically show negative returns in early years (due to management fees, slow deployment, and conservative valuations) before returns improve significantly in later years as portfolio companies are grown and exited.
How do you calculate WACC and why does each component matter?
WACC blends the after-tax cost of debt and cost of equity weighted by their market values: WACC = (E/V) × Re + (D/V) × Rd × (1 - T). The tax adjustment on debt reflects the deductibility of interest expense.
Can someone explain call and put option payoffs with diagrams?
A long call pays max(S - K, 0) with unlimited upside and loss limited to the premium. A long put pays max(K - S, 0) with gain capped at K minus premium. Payoff is the raw exercise value; profit subtracts the premium paid.
How do I calculate portfolio risk for a two-asset portfolio? I keep messing up the formula.
Portfolio variance for two assets uses the formula σ²_p = w₁²σ₁² + w₂²σ₂² + 2w₁w₂ρ₁₂σ₁σ₂. The key insight is that because correlation is typically less than 1, the portfolio's actual risk is lower than the weighted average of individual risks.
How should risk management for individuals consider human capital and financial capital together?
Risk management for individuals recognizes that total wealth includes both human capital and financial capital. The nature of a person's human capital — whether bond-like or equity-like — should drive financial portfolio allocation and insurance decisions.
What is the difference between IRR and MOIC in private equity, and why can IRR be misleading?
IRR measures time-weighted returns and rewards early exits, while MOIC measures total wealth creation regardless of timing. IRR can be misleading because it can be inflated through subscription credit lines, early exits, and timing of capital calls.
When and how should a company adjust its WACC for project-specific or country-specific risk?
The firm's WACC should be adjusted when project risk, capital structure, or country risk differs from the firm's profile. The pure-play method unlevers a comparable company's beta and re-levers it for the project. Country risk premiums are added for international projects.
How do hedge fund fee structures work, and what is the high-water mark provision?
Hedge funds typically charge 2% management fees plus 20% incentive fees. The high-water mark prevents charging performance fees on recovered losses — the fund must exceed its previous peak NAV before earning incentive fees again.
What are the three forms of the Efficient Market Hypothesis, and why do market anomalies seem to contradict them?
The three forms of EMH differ in which information is reflected in prices: weak (past prices), semi-strong (all public info), and strong (all info including insider). Anomalies may reflect risk premiums, data mining, or the joint hypothesis problem.
What drives long-term real exchange rate movements, and what is the Balassa-Samuelson effect?
Real exchange rates can trend persistently due to structural factors. The Balassa-Samuelson effect explains why currencies of fast-growing economies appreciate in real terms: rapid productivity growth in tradeable goods pushes up wages and service prices economy-wide.
Want unlimited access?
You've browsed several pages. Sign in to save your spot, bookmark questions, and unlock all 2,485 CFA community questions plus expert-verified study materials.
Have a Question? Ask Our Experts
Register to ask questions, get expert-verified answers, and connect with fellow certification candidates preparing for CFA, FRM, CIA, CPA, and EA exams.