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CFA Level II Updated
How are contingent liabilities recognized and measured in a business combination under IFRS 3?
Under IFRS 3, contingent liabilities assumed in a business combination are recognized if they represent a present obligation with a reliably measurable fair value — even when the probability of outflow is below the 'probable' threshold required by standalone IAS 37.
How is acquired inventory measured in a purchase price allocation, and what is the income statement effect when that inventory is later sold?
In a business combination, acquired inventory is measured at fair value on the acquisition date. Finished goods are valued at selling price less disposal costs and a reasonable profit margin on selling effort, creating a step-up above book value that compresses gross margins when sold post-acquisition.
What is the demographic dividend, and how does the age structure of a population drive economic growth?
The demographic dividend occurs when a falling dependency ratio increases the share of working-age adults, boosting labor supply, savings, and education investment. Historically, this effect contributed 1.5-2.0% annual growth in East Asia, but it requires quality institutions and education to be realized.
How does a call back spread work, and why is it considered a volatility play rather than a directional bet?
A call back spread sells fewer lower-strike calls and buys more higher-strike calls, creating unlimited upside potential with defined downside. It profits from large upward moves or from inaction (keeping the net credit), but loses in the dead zone between strikes.
What is gamma scalping, and how does a trader profit from it while maintaining delta neutrality?
Gamma scalping involves buying options for positive gamma and dynamically rebalancing delta to profit from large price swings. The strategy wins when realized volatility exceeds implied volatility, generating rebalancing profits that outpace theta decay.
How do you value the rights in a rights offering, and what determines whether shareholders should exercise or sell?
A rights offering gives existing shareholders the option to purchase new shares at a discounted subscription price. The theoretical value depends on whether shares trade cum-rights or ex-rights, and shareholders should analyze exercise versus sell economics carefully.
How does the expected return on plan assets assumption affect pension expense, and what should analysts watch for?
Under US GAAP, the expected return on plan assets directly reduces pension expense — a higher assumption increases reported income. Analysts should compare EROA to peer averages, historical actual returns, and plan asset allocations to detect aggressive assumptions.
How are pension plan amendments and the resulting past service cost recognized under IFRS vs. US GAAP?
Under IFRS, past service cost from pension plan amendments is recognized immediately in P&L. Under US GAAP, it goes to OCI and is amortized over the remaining service life of affected employees. The total impact is identical — only the timing differs.
How does a pension plan curtailment affect the projected benefit obligation (PBO) and the income statement?
A pension curtailment reduces the PBO when future benefit accruals are significantly reduced or eliminated. The curtailment gain or loss is recognized immediately in P&L, along with any unrecognized prior service cost related to the curtailed benefits.
What does the swap spread tell us about the market, and why can it sometimes go negative?
The swap spread (swap rate minus Treasury yield) reflects banking sector credit risk, liquidity conditions, and supply/demand dynamics. Negative swap spreads occur when heavy Treasury supply or regulatory demand for swaps pushes Treasury yields above swap rates.
How do clean surplus violations affect the residual income model, and how should I adjust?
Clean surplus violations occur when items bypass net income and go directly to Other Comprehensive Income, distorting the residual income model. Common violations include foreign currency translation adjustments, unrealized securities gains, and pension adjustments.
How is an arbitrage-free binomial interest rate tree calibrated to match market prices?
An arbitrage-free binomial tree is calibrated by adjusting interest rates at each node so that the tree correctly prices all on-the-run benchmark bonds at par. The process uses trial-and-error with a volatility assumption relating up and down rates.
How sensitive is the H-model to changes in the initial high-growth rate assumption?
The H-model approximates a linear decline in growth rate from an initial high rate to a sustainable rate. The growth premium is linear in the spread between high and stable growth, making the model moderately sensitive to the initial growth assumption.
How are joint ventures accounted for under IFRS 11 using the equity method?
Under IFRS 11, joint ventures use the equity method with several CFA Level II nuances: excess purchase price must be allocated to identifiable assets (amortized) and goodwill (not amortized), unrealized intercompany profits are eliminated proportionally, and the entire investment is tested for impairment as a single asset. Losses cannot reduce the investment below zero unless the investor has additional obligations.
How do I implement a three-stage DDM with declining growth in the middle period?
The three-stage DDM has a high-growth phase, a transition phase with linearly declining growth, and a stable mature phase. Calculate dividends in each phase using the declining growth rate, compute terminal value using the Gordon Growth Model at the stable rate, then discount all cash flows back to today.
How do fair value adjustments to PP&E affect the equity method income reported by the investor?
This is one of the most commonly tested equity method mechanics on CFA Level II. The investor must depreciate its share of the fair value adjustment to PP&E over the asset's remaining useful life, which reduces the equity income pickup each period.
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.
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