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What are the components of GDP under the expenditure approach and how do net exports work?
The expenditure approach is the most commonly tested GDP calculation method on the CFA Level I exam. GDP = C + I + G + (X - M), where C is consumption, I is gross private domestic investment (not financial investment), G is government spending on goods and services (excluding transfer payments), and X - M is net exports.
What's the difference between aggressive, conservative, and moderate working capital policies, and how do they affect profitability vs. risk?
Working capital policies range from conservative (high current assets, long-term financing, low risk) to aggressive (minimal current assets, heavy short-term financing, higher returns but greater liquidity risk). The moderate approach matches asset and liability maturities.
What must I disclose under Standard VI(A) — Disclosure of Conflicts, and how granular do I need to be?
Standard VI(A) requires full and fair disclosure of all matters that could impair independence and objectivity. You must disclose ownership of recommended securities, compensation conflicts, firm-level relationships, and board memberships, though exact dollar amounts are not required.
How does the Central Limit Theorem apply to portfolio return estimation, and what sample size is 'large enough'?
The Central Limit Theorem states that the sampling distribution of the sample mean approaches a normal distribution as n increases, regardless of the population shape. The conventional CFA Level I threshold is n ≥ 30, and the standard error shrinks as SE = σ/√n.
How does the 'riding the yield curve' strategy work, and when does it fail?
Riding the yield curve involves buying a bond with a longer maturity than your horizon and profiting as it rolls down to a lower yield over time. The strategy works when the yield curve is upward-sloping and remains unchanged, generating capital gains beyond coupon income. It fails if the curve flattens, shifts up, or if the expectations hypothesis holds.
Why is EV/EBITDA often preferred over P/E for comparing companies, and what are the major pitfalls?
EV/EBITDA is preferred over P/E because it is capital-structure-neutral, accounting-policy-neutral, and almost always produces a usable number. The biggest pitfall is that it ignores capex intensity, so two companies with the same EV/EBITDA can have vastly different free cash flow profiles.
What are the journal entries for the equity method of accounting for investments?
The equity method records the initial investment at cost, then adjusts the carrying value upward for the investor's share of income, downward for dividends received, and downward for amortization of excess purchase price allocated to identifiable assets. Goodwill embedded in the investment is not amortized but is tested for impairment.
Why do ESG ratings from different agencies diverge so much, and what does this mean for risk management?
ESG rating divergence stems from scope differences (what is measured), measurement differences (how it is measured), and weighting differences (what matters most). With correlations of only 0.38-0.71 between agencies, risk managers should use multiple sources and focus on sector-specific materiality.
What is entropic VaR, and how does it provide a tighter bound on tail risk than traditional VaR?
Entropic VaR is derived from the Chernoff bound and uses the moment-generating function to provide a tighter tail risk bound than VaR. It sits in the ordering VaR <= EVaR <= ES, offering a coherent risk measure connected to information theory and relative entropy.
How does cross-product netting reduce counterparty exposure, and what are the legal and operational prerequisites for it to work?
Cross-product netting extends close-out netting across different derivative types under a single ISDA Master Agreement, providing 20-40% additional exposure reduction beyond single-product netting. It requires consistent legal documentation and enforceability opinions across product types.
How does the funding spread adjustment work for uncollateralized derivatives, and why is FVA controversial?
FVA captures the cost of funding uncollateralized derivative positions at rates above the risk-free rate. It equals the dealer's funding spread multiplied by expected exposure over the trade's life. The controversy centers on whether FVA double-counts with DVA.
How is the G-SIB score calculated, and how does it determine the additional capital buffer a bank must hold?
The G-SIB score aggregates five equally-weighted indicator categories — size, interconnectedness, substitutability, complexity, and cross-jurisdictional activity — each scored relative to the banking system total. The resulting score places banks into buckets with CET1 surcharges from 1.0% to 3.5%.
How does the FAIR model quantify cyber risk in financial terms, and what makes it different from qualitative risk assessments?
The FAIR model quantifies cyber risk by decomposing it into loss event frequency (threat frequency times vulnerability) and loss magnitude (primary and secondary losses), then running Monte Carlo simulations to produce probabilistic dollar estimates. Unlike qualitative heat maps, FAIR enables cost-benefit analysis of security investments.
How does the countercyclical capital buffer work, and how do national regulators decide when to activate or release it?
The countercyclical capital buffer requires banks to hold 0-2.5% additional CET1 capital during excess credit growth, guided by the credit-to-GDP gap. It is built slowly during booms and released immediately during stress to support continued lending.
What is procyclicality in banking regulation, and how do risk-sensitive capital requirements amplify economic cycles?
Procyclicality means risk-sensitive capital requirements decrease during booms and increase during busts, amplifying economic cycles. Basel addresses this through countercyclical buffers, through-the-cycle PD calibration, stressed risk measures, and the leverage ratio backstop.
What is the Calmar ratio, and how does it compare to the Sharpe ratio for evaluating hedge fund performance?
The Calmar ratio relates annualized return to maximum drawdown, providing a risk-adjusted performance measure that is more relevant than the Sharpe ratio for hedge fund strategies where investors care about worst-case loss paths rather than volatility.
How is maximum drawdown calculated, and why do risk managers use it alongside VaR?
Maximum drawdown measures the largest cumulative loss from a peak to a subsequent trough before a new peak is established. Unlike VaR which measures single-period risk, MDD captures the worst path-dependent experience and is widely used in hedge fund due diligence.
What is the conditional coverage test in VaR backtesting and how does it improve on Kupiec's test?
The Christoffersen conditional coverage test checks both whether the correct number of VaR exceptions occurs and whether exceptions are independent over time. It improves on Kupiec's test by detecting dangerous clustering of exceptions.
How do embedded call and put options affect bond valuation and risk?
Bonds with embedded options have cash flows that depend on the path of interest rates. A callable bond equals a straight bond minus the call option value, while a putable bond equals a straight bond plus the put option value. OAS strips out the option effect to isolate credit spread.
What is P&L attribution (P&L explain) and how does it relate to the risk-theoretical P&L in FRTB?
P&L attribution (P&L explain) is a critical model validation tool under the FRTB. It tests whether the risk model used for IMA capital can actually explain the desk's real profits and losses.
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