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CFA Level II

Prepare for CFA Level II with CFA practice questions covering 106 topics. Build your knowledge, track your progress, and study effectively with PopCFA.

Questions
4,082
Units
13
Topics
106

What’s in it.

13 units

Sample questions

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A few questions from this module, with the answer and a full explanation. The complete bank is available when you start practising.

  1. A subsidiary in a hyperinflationary economy acquired PP&E at a historical cost of 1,000 local currency units (LCU) when the general price index was 100. At the current balance sheet date, the general price index is 300. What is the restated carrying amount of the PP&E under IAS 29 (ignoring depreciation) before translation?

    • Restated carrying amount = 1,000 × (300 / 100) – accumulated depreciation at the new index, so the net amount is 2,000 LCU after two years of straight-line depreciation.
    • Restated carrying amount = 3,000 LCU but is immediately impaired back to recoverable amount because hyperinflationary restatement triggers a mandatory impairment test.
    • Restated carrying amount = 1,000 × (300 / 100) = 3,000 LCU. The PP&E is restated to 3,000 LCU in terms of the measuring unit current at the balance sheet date.
      Correct answer
    • Restated carrying amount = 1,000 + (300 – 100) = 1,200 LCU. The increase in the price index (200 points) is added to the historical cost.
    Explanation

    Under IAS 29, non-monetary items such as PP&E carried at historical cost are restated by multiplying their historical cost by the ratio of the current general price index to the index at the date the item was acquired. Restatement = 1,000 × (300/100) = 3,000 LCU. This brings the cost to the measuring unit current at the balance sheet date, reflecting the loss of purchasing power over the period. Note that this is the pre-depreciation gross restated cost; depreciation would also be restated and deducted. The restated LCU financial statements would then be translated at the closing rate to the parent's presentation currency.

  2. A company has: EV = \$3,000m, Net Financial Debt (reported) = \$800m, Pension Deficit (PBO – Plan Assets) = \$400m, Minority Interest = \$200m. An analyst computes equity value as: \$3,000m – \$800m = \$2,200m. Identify and correct the errors.

    • The analyst's calculation is correct; pension deficit and minority interest are not deducted from EV when deriving equity value.
    • Corrected equity value = \$3,000m – \$800m + \$400m (pension deficit adds value) – \$200m = \$2,400m.
    • The analyst omitted the pension deficit (\$400m) and minority interest (\$200m) from the deduction. Corrected equity value = \$3,000m – \$800m – \$400m – \$200m = \$1,600m.
      Correct answer
    • Corrected equity value = \$3,000m – \$800m – \$400m = \$1,800m (minority interest is part of EV, not deducted separately).
    Explanation

    EV is the value of the entire enterprise to all claimants. To derive equity value attributable to ordinary shareholders: EV – Net Financial Debt – Pension Deficit – Minority Interest (which represents the portion of consolidated subsidiaries owned by outside shareholders) = \$3,000m – \$800m – \$400m – \$200m = \$1,600m. The analyst understated deductions by \$600m, overstating equity value by 37.5%. Minority interest is included in EV (the firm is valued on a consolidated basis) but must be deducted to derive equity attributable to the parent company's shareholders.

  3. A company has senior secured first-lien loans (expected recovery 70% in default) and senior unsecured bonds (expected recovery 40%). An LCDS on the first-lien loan trades at 180 bps and a bond CDS on the senior unsecured bonds trades at 350 bps. The implied hazard rate from each instrument is estimated as: λ_LCDS = 180 / (100 × 30%) = 6.0% and λ_bond = 350 / (100 × 60%) = 5.83%. These hazard rates should theoretically be equal for the same issuer. What explains the 0.17% difference and what does it imply about pricing?

    • The small hazard rate difference is consistent with the LCDS including a cancellability premium (the option for LCDS buyers to cancel when the loan prepays or is refinanced), which requires slightly higher spread per unit of LGD; it may also reflect basis differences in instrument-specific demand/supply, liquidity, and whether the LCDS more accurately reflects the secured class's credit quality vs the senior unsecured class; the two should converge as the market matures.
      Correct answer
    • The hazard rates should be equal for the same reference entity regardless of recovery rate, because the hazard rate is a property of the borrower's creditworthiness, not the specific instrument; the 0.17% gap is explained entirely by LCDS-specific technical factors.
    • The 0.17% difference confirms a significant arbitrage: buying the bond CDS at an implied λ of 5.83% and simultaneously selling the LCDS at an implied λ of 5.67% locks in a riskless 17 bps per year.
    • The hazard rate difference of 0.17% is too small to be economically meaningful and should be disregarded; any spread difference below 50 bps on CDS instruments reflects only bid-ask spreads and transaction costs.
    Explanation

    In theory, the hazard rate for a given reference entity should be the same whether estimated from LCDS or bond CDS, since both reference the same issuer and reflect the same probability of default event. The LGD difference should be captured entirely in the spread difference (lower spread for LCDS because lower LGD), not in different implied hazard rates. The small 0.17% discrepancy in hazard rates has several structural explanations: (1) the LCDS cancellability feature (when the loan is prepaid, the LCDS terminates, reducing expected tenor and requiring slightly higher spread per unit of remaining exposure); (2) instrument-specific supply/demand imbalances in the LCDS vs bond CDS markets; (3) different documentation (LCDS references a specific loan, bond CDS references all eligible bonds—making the effective reference pool different). This is not an arbitrage because the two instruments are not identical in their payoff profiles—they reference different obligations and have different optionality features—so a persistent small basis is expected and does not represent riskless profit.