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CFA Level II Updated
How is the liquidity premium measured in corporate bonds?
Isolate liquidity premium via on-the-run vs off-the-run spreads, cash-CDS basis, bid-ask, and trade frequency. Typically 20-50 bps; widens in crisis.
How does an inverse floater work and why does it have leveraged exposure to interest rate changes?
An inverse floater has a coupon that moves opposite to rates (coupon = K - L x reference rate). The leverage factor L arises from the structural split of a fixed-rate bond, creating duration equal to (1 + L) times the underlying bond's duration — potentially 30+ years of effective duration.
How should the PEG ratio be adjusted for risk, and what are its critical limitations?
The raw PEG ratio ignores risk differences across companies. Analysts can adjust using beta-adjusted PEG, growth quality haircuts, or sector-normalized comparisons. Critical limitations include meaninglessness for negative earnings, explosion at low growth rates, and the assumption of linear P/E-to-growth relationship.
How are non-monetary items restated under IAS 29 for hyperinflationary economies, and what triggers hyperinflationary designation?
Under IAS 29, non-monetary items are restated to current purchasing power using the consumer price index ratio before translation. The restated financial statements are then translated entirely at the current exchange rate.
How do analysts assess whether a deferred tax asset is realizable?
DTA realizability depends on whether sufficient future taxable income will exist to use the deductions. Analysts evaluate positive evidence (history of profits, existing reversing DTLs, tax strategies) against negative evidence (cumulative losses, expiring carryforwards). Changes in the valuation allowance directly impact reported earnings and signal management's confidence in future profitability.
What is a feedforward neural network and how does it process inputs?
Feedforward NN: input -> hidden layers -> output. Each neuron computes weighted sum + activation (ReLU). Learns non-linear interactions automatically.
What recognition criteria must acquired assets and liabilities meet in a business combination?
In a business combination, IFRS 3 and ASC 805 apply modified recognition principles. Items recognized include internally-generated intangibles of target, IPR&D, contingent liabilities, and off-market lease terms. Assembled workforce and synergies are subsumed into goodwill...
How does the KPSS test differ from ADF in stationarity testing?
KPSS reverses ADF's null: null is stationarity, alternative is unit root. Running both provides confirmatory evidence given low power of unit-root tests.
How does the Augmented Dickey-Fuller test detect unit roots?
The Augmented Dickey-Fuller test examines unit roots with null of non-stationarity. Augmentation adds lagged differences to absorb residual autocorrelation.
When does a fair value measurement fall into Level 3?
Level 3 applies when fair value uses significant unobservable inputs. Classification goes to the lowest level of any significant input, so a single significant Level 3 input pushes the entire measurement to Level 3.
How do Level 2 inputs differ from Level 1 and Level 3?
Level 2 inputs are observable inputs other than Level 1 quoted prices — similar-asset quotes, non-active market quotes, observable yield curves, credit spreads, and market-corroborated inputs.
What qualifies as a Level 1 input under the fair value hierarchy?
Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities. Three conditions must all hold: active market, identical instrument, and entity access at measurement date.
How does one-class SVM work for outlier detection?
One-class SVM learns a boundary around normal data in kernel space, labeling points outside as outliers; best for moderate-size datasets with compact normal regions.
What are the core drivers of shareholder value I should track?
Rappaport's classic framework narrows shareholder value drivers to seven. In practice, four dominate 80% of value creation.
What is a non-deliverable forward (NDF) and why is it used for emerging market currencies?
An NDF is a cash-settled FX forward in which no physical exchange of the underlying currency occurs. It exists precisely because some emerging market currencies have capital controls.
What's the intuition behind covered interest rate parity and when does it break down?
Covered interest rate parity (CIP) says that a fully-hedged foreign investment must earn the same return as a domestic deposit.
How do I derive implied ERP directly from market prices?
Implied ERP: solve DCF of aggregate equity cash flows for the ke that matches current index. For S&P at 5,840 with 5-year growth 6% fading to 4.25%: ke ≈ 8.8%, ERP ≈ 4.55%. Sensitive to growth assumptions...
How do I identify the principal market for fair value measurement?
Principal market is the market with greatest volume and activity that the entity can access. If not identifiable, use the most advantageous market. Transaction costs inform selection but are excluded from fair value.
How do I distinguish a joint venture from a joint operation under IFRS 11?
IFRS 11 classifies joint arrangements by rights and obligations, not legal form. A joint venture gives rights to net assets, while a joint operation gives direct rights to assets and obligations for liabilities...
Why do the first three PCA components of yield curves represent level, slope, and curvature?
PCA of yield changes consistently produces three dominant components with recognizable level, slope, and curvature shapes. The first factor explains 70-80% of variance...
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