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CFA Level II Updated
What happens when the parent grants put options to non-controlling interest holders?
Written put options on non-controlling interests (NCI) create complex accounting because the parent may be forced to acq...
How do you consolidate subsidiaries with different fiscal year-ends?
Both IFRS 10 and US GAAP (ASC 810) address fiscal year-end mismatches in consolidation. The rules are similar but with k...
How do companies account for multi-employer pension plans and why is cost allocation tricky?
Multi-employer plans pool contributions from multiple unrelated employers, typically under a collective bargaining agree...
How are pension plan amendments handled retrospectively under IFRS and US GAAP?
When a defined benefit plan is amended, the change in the projected benefit obligation (PBO) is called **prior service c...
Where do remeasurement gains and losses appear under the temporal method?
Under the temporal method (used when the functional currency equals the parent's reporting currency), remeasurement gain...
How do multinationals manage translation exposure, and is it worth hedging?
Translation exposure (also called accounting exposure) is the risk that consolidated financial statements change due to ...
What factors determine functional currency and why does it matter for CFA Level II?
Functional currency is the currency of the primary economic environment in which a subsidiary operates. IAS 21 and ASC 8...
How do you restate financial statements under hyperinflationary conditions with a worked example?
Under IAS 29, non-monetary assets, equity, and income statement items are restated using a general price index before tr...
What is an asset swap spread, and how is it used as a credit risk measure compared to Z-spread and OAS?
The asset swap spread measures the credit premium an investor earns by buying a fixed-rate bond and swapping the coupons to floating rate. It strips out interest rate risk and expresses credit compensation relative to the swap curve. ASW differs from Z-spread for bonds trading away from par and is particularly useful for bank trading desks that fund at floating rates.
What is a CMBS interest-only (IO) strip, and why does it behave differently from an agency IO strip in terms of prepayment and extension risk?
CMBS IO strips receive excess spread between the loan pool's weighted average coupon and the pass-through rate to principal tranches. Unlike agency IOs, CMBS IOs face minimal prepayment risk due to lockout periods and yield maintenance but bear real credit risk from loan defaults. Extension risk at balloon maturity is the primary analytical concern.
How do non-agency RMBS differ from agency MBS in terms of credit risk, structure, and analysis?
Non-agency RMBS carry full credit risk (no government guarantee) backed by non-conforming mortgages. They rely on subordination, excess spread, and overcollateralization for credit enhancement. Analysis focuses on loan-level credit quality, loss severity assumptions, and structural waterfall modeling rather than just prepayment risk.
How does synthetic securitization work, and how does it differ from traditional (cash) securitization?
Synthetic securitization uses credit default swaps rather than asset sales to transfer credit risk. The underlying assets remain on the originator's balance sheet while investors sell protection on a reference portfolio in tranched form. Banks prefer synthetic structures for speed, confidentiality, undisrupted borrower relationships, and selective risk transfer.
How does the CLO equity tranche work, and what drives its returns compared to senior CLO tranches?
CLO equity receives residual cash flows after all debt tranches are paid. Returns are driven by the spread between the loan portfolio yield and the weighted average cost of the debt tranches, applied on approximately 9-10x leverage. Key risks include loan defaults triggering overcollateralization test failures, reinvestment risk, and manager quality.
What are covenant-lite loans, why have they become prevalent, and what risks do they pose for creditors?
Covenant-lite loans replace maintenance covenants (tested quarterly) with incurrence covenants (tested only when the borrower takes specific actions), removing the early warning system that traditional covenants provide. While this gives borrowers more flexibility, it delays creditor intervention during deterioration and typically leads to lower recovery rates.
What does a negative basis between CDS spreads and bond spreads mean, and how can investors exploit it?
A negative basis occurs when CDS spreads trade below bond spreads, creating a positive-carry opportunity by buying the bond and buying CDS protection simultaneously. While theoretically close to arbitrage, the trade carries real risks from funding costs, counterparty exposure, mark-to-market widening, and bond-CDS mismatches.
What is a credit box trade, and how does it isolate relative value between investment-grade and high-yield bonds across different maturities?
A credit box trade uses four positions across two credit qualities and two maturities to isolate the relative term premium between investment-grade and high-yield segments. By going long one diagonal and short the other, the trade neutralizes both directional credit risk and interest rate risk, focusing purely on cross-segment relative value.
What is a butterfly trade in fixed income, and how is it constructed to express a view on yield curve curvature?
A butterfly trade involves going long the wings (short-term and long-term bonds) and short the body (intermediate bond) to profit from a flattening of yield curve curvature. It is duration-neutral and isolates curvature from directional rate moves. The butterfly spread equals 2 times the body yield minus the two wing yields.
What is the segmented markets theory of the term structure, and how does it differ from the expectations theory and liquidity preference theory?
The segmented markets theory argues that yields at each maturity are determined by independent supply and demand forces, because institutional investors have strong maturity preferences driven by their liabilities. Unlike expectations theory, it does not assume investors freely substitute across maturities.
What does the academic evidence say about spin-off returns, and why do spun-off entities tend to outperform the market?
Academic evidence shows spin-offs generate 2-4% abnormal returns at announcement and 15-25% excess returns over the following 12 months. Value creation comes from eliminating conglomerate discounts, improving management focus, and temporary selling pressure from index funds forced to divest small-cap entities. Smaller spin-offs with insider buying tend to outperform most.
How do activist investors create value, and what determines whether an activist campaign will succeed?
Activist investors create value through capital returns, operational restructuring, strategic refocusing (spin-offs), governance reform, and M&A intervention. Success depends on measurable underperformance vs. peers, specificity of proposals, shareholder support, and the activist's track record. Conglomerate discount elimination is one of the most reliable value creation paths.
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