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CFA Level II Updated
Why do callable bonds and mortgage-backed securities exhibit negative convexity?
Callable bonds and MBS exhibit negative convexity because issuer or homeowner refinancing caps the upside while the downside remains fully open.
How does Bayesian estimation differ from frequentist?
Frequentist: parameters are fixed unknowns; data is random. Bayesian: parameters are random variables with probability distributions; data updates beliefs...
How do I interpret a deteriorating Days Inventory trend across sectors?
Industry-specific benchmarks matter: food 25-50 days, tools 80-120, apparel 95-150. Verdant's food inventory buildup signals spoilage risk; SilverLink's 53% DSI surge predicts 30-50% markdowns; Ironclad requires deeper demand analysis.
When does a contract have a significant financing component, and how does it affect revenue?
If payment timing provides significant financing benefit, adjust transaction price to cash selling price and recognize the difference as interest income or expense. Practical expedient for periods under one year.
Right-to-access vs right-to-use IP licenses — how do they differ for revenue timing?
Right-to-use licenses recognize revenue at a point in time (static IP). Right-to-access licenses recognize over time because the licensor undertakes activities significantly affecting the IP.
What is walk-forward testing and when should I use it?
Walk-forward re-estimates on rolling windows, producing concatenated OOS returns. Caldera Capital's sector rotation: OOS Sharpe 0.8 vs IS 1.4, realistic decay.
How do I normalize asset turnover for cyclical businesses, and why does it matter for DuPont?
Cyclical asset turnover swings with demand while assets stay fixed — normalize to mid-cycle using multi-year averages or peak-capacity adjustments.
How does farmland investing generate returns and what drives performance?
Farmland returns come from cash income from renting land or selling crops, and capital appreciation driven by land-value growth over time.
How is cost curve analysis used for commodity equities?
Cost curves show industry production sorted by cost. Marginal producer sets price; Q1 producers earn durable margins through cycles.
What is a range accrual note and how does its payoff depend on the reference rate staying within a band?
A range accrual note pays interest only for days when a reference rate stays within a specified band, offering an enhanced coupon in exchange for the risk of receiving zero on out-of-range days. The investor is implicitly selling volatility and expressing a low-volatility, range-bound rate view.
How is free cash flow yield calculated and why is it preferred over earnings yield for screening?
Free cash flow yield measures FCF per dollar of market value and is preferred over earnings yield because it is harder to manipulate, captures capital expenditure intensity, and is a stronger predictor of future stock returns. It is especially valuable for capital-intensive businesses.
Why do business combinations create deferred tax liabilities, and how does this affect goodwill?
Business combinations create DTLs when fair value step-ups exceed tax bases of acquired assets. These DTLs increase total liabilities, reduce net identifiable assets, and consequently increase goodwill. No deferred tax is recognized on goodwill itself.
How does a compound option work, and how are they priced?
Compound option = option on option. Call-on-call hedges only if a contingent event occurs. Cheaper than vanilla, used in M&A and real options.
How do I allocate purchase price across acquired assets and liabilities?
Purchase price allocation distributes consideration across identifiable assets and liabilities at fair value on acquisition date, with the residual becoming goodwill. Hierarchy: tangible assets, intangibles, liabilities, deferred tax, NCI, goodwill residual...
What are the steps in the Box-Jenkins methodology for ARIMA fitting?
Box-Jenkins methodology consists of three iterative stages: identification via ACF/PACF, coefficient estimation, and residual diagnostic checking.
How do ARIMA models forecast financial time series?
ARIMA(p,d,q) combines autoregression of order p, differencing of order d, and moving average of order q to forecast non-stationary time series.
What is the local outlier factor and when should I use it?
LOF scores anomalies by comparing a point's local density to its neighbors'; catches contextual outliers that global methods like isolation forest miss.
What is Cash Value Added (CVA) and when should I use it?
Cash Value Added (CVA) replaces accounting earnings with operating cash flow to strip out non-cash distortions.
How do I derive the no-arbitrage price of a currency forward?
The way to never forget which rate goes on top is to think of the forward as the outcome of two equivalent arbitrage portfolios.
How can I decompose a plain-vanilla interest rate swap into a series of FRAs?
The decomposition is elegant and worth understanding because it makes swap valuation intuitive. A plain-vanilla pay-fixed, receive-floating interest rate swap exchanges cash flows at multiple reset dates.
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