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Most Recent CFA Institute CFA-Level-II Exam Questions & Answers


Prepare for the CFA Institute CFA Level II Chartered Financial Analyst exam with our extensive collection of questions and answers. These practice Q&A are updated according to the latest syllabus, providing you with the tools needed to review and test your knowledge.

QA4Exam focus on the latest syllabus and exam objectives, our practice Q&A are designed to help you identify key topics and solidify your understanding. By focusing on the core curriculum, These Questions & Answers helps you cover all the essential topics, ensuring you're well-prepared for every section of the exam. Each question comes with a detailed explanation, offering valuable insights and helping you to learn from your mistakes. Whether you're looking to assess your progress or dive deeper into complex topics, our updated Q&A will provide the support you need to confidently approach the CFA Institute CFA-Level-II exam and achieve success.

The questions for CFA-Level-II were last updated on Nov 6, 2024.
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Question No. 1

Mary Carr is 62 years old, in good health, and will retire in four years from her position as the CEO and chairman of the board of a large professional services firm, Appleton Professional Services, which is located in the midwestern United States. Carr has approached Tim Houlis, her financial planner, for help in preparing an investment policy statement and accompanying asset allocation. Jack Timmons is Houlis' assistant.

In a lunch meeting with Houlis and Timmons, Carr reveals that she is thinking of moving this year to be closer to Appleton's largest client. She is concerned about developing an investment plan now given that she will no longer have contact with Houlis if she does move. Houlis reassures her that this is not a problem. He states that a properly constructed investment policy statement can be readily implemented by her new financial advisor. Timmons states that the investment policy statement is a long-term document that should be changed only if the outlook for equities versus bonds and other assets changes.

Carr's parents were successful business people who owned a series of small firms. Their success, however, did not come without challenges. Twice they had to liquidate businesses in which they were the primary shareholders. As a child, Carr became accustomed to the uncertainties of the entrepreneurial world. When she graduated from college, her parents provided her with the funds to purchase Appleton Professional Services. Appleton was a small firm at that point, but Can-has grown it into one of the larger firms in its industry, even though the professional services industry is cyclical and is susceptible to economic recessions. Appleton went public eight years ago and Carr retained a majority shareholder position when it did. Over time she has sold some of the stock but still has a controlling position in the firm.

Despite the business difficulties Carr's parents experienced, they were able to amass a sizeable fortune in their later years. Including her inheritance and holdings in Appleton stock, Carr has a portfolio with a current value of $6,000,000, most of which is invested in Appleton and other domestic and international equities. Carr has instructed Houlis and Timmons to grow her portfolio over time, focusing on capital appreciation and achieving long-term return goals. She would like to leave her children a sizeable inheritance.

Carr is single with two children. Her oldest child, Mark, is 25 years old and financially independent. Her youngest son, John, is a junior in college at a prestigious liberal arts college in New England. The tuition payment for his last year of college of approximately $40,000 is due at the end of this year. She has no mortgage on her house. Carr is an avid bird watcher and gifts $50,000 a year to a local environmental group. She is concerned with the destruction of bird habitat, so she does not want to invest in highly-polluting industries or firms that are involved in real estate development.

When she retires, Carr will receive a lump-sum, after-tax distribution of approximately $500,000 from her firm. She will also begin collecting an annual pension payment equal to her current salary. The pension payment is indexed to inflation. She will be covered under Appleton's health insurance plan in retirement. Carr spends $ 170,000 a year on vacations and living expenses, which is about equal to her current salary at Appleton.

Houlis estimates that Carr is taxed at an effective marginal rate of 30% on capital gains and income. Houlis estimates an inflation rate of 3% for the rest of Carr's life expectancy, which he projects at 20 years or more, given her good health.

With regard to generating adequate liquidity for Carr's portfolio, Timmons states that she need not invest entirely in income-generating assets. Instead, Carr can generate income from stock dividends, bond coupons, and the sale of assets. By being willing to generate income through the sale of assets, Carr would be able to broaden the types of securities available to her for investment. Timmons states that the problem with most assets that produce income (e.g., dividend paying stocks) is that their expected return is usually lower. He states that the advantage of his approach is that Carr could pursue higher return assets, such as small company stocks.

Are Carr's liquidity constraint and unique circumstances constraint best characterized as significant or insignificant?

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Correct Answer: B

Her liquidity constraint is best characterized as insignificant compared to the size of her portfolio. Her current personal spending is covered by her salary. She requires $40,000 for her son's final tuition payment next year and $50,000 annually as a gift to the local environmental group. Her current portfolio value is $6,000,000, so her current liquidity needs are 1.5% ($90,000 / $6,000,000) of her portfolio value. Since she will receive an indexed pension upon retirement that approximates her current salary, liquidity needs can be expected to remain small relative to her total assets.

Her unique circumstances are best characterized as a significant constraint because she has specific social investing concerns. She states that does not want to invest in highly-polluting industries or firms that are involved in real estate development. Houlis and Timmons should respect her wishes and invest appropriately. This will have a significant affect on the set of potential investment opportunities for her portfolio. (Study Session 18, LOS68.c,f)


Question No. 2

Sara Robinson and Marvin Gardner are considering an opportunity to start their own money management firm. Their conversation leads them to a discussion on establishing a portfolio management process and investment policy statements. Robinson makes the following statements:

Statement 1;

Our only real objective as portfolio managers is to maximize the returns to our clients.

Statement 2:

If we are managing only a fraction of a client's total wealth, it is the client's responsibility, not ours, to determine how their investments are allocated among asset classes.

Statement 3: When developing a client's strategic asset allocation, portfolio managers have to consider capital market expectations. In response, Gardner makes the following statements:

Statement 4: While return maximization is important for a given level of risk, we also need to consider the client's tolerance for risk.

Statement 5: We'll let our clients worry about the tax implications of their investments; our time is better spent on finding undervalued assets.

Statement 6: Since we expect our investor's objectives to be constantly changing, we will need to evaluate their investment policy statements on an annual basis at a minimum.

Robinson wants to focus on younger clientele with the expectation that the new firm will be able to retain the clients for a long time and create long-term profitable relationships. While Gardner felt it was important to develop long-term relationships, he wants to go after older, high-net-worth clients.

Are Statements 1 and 4 consistent with the appropriate method of developing portfolio objectives?

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Correct Answer: C

1 he investment process requires consideration of risk and return concurrently. While maximization of returns is always preferable, an investors risk tolerance must also be determined and included in the investment decision. Recall that risk and return objectives are closely related to one another because of the trade-off between risk and return. Therefore, Statement 1 is incorrect, and Statement 4 is correct. (Study Session 18, LOS 68.c)


Question No. 3

Martha Garret, CFA, manages fixed income portfolios for Jones Brothers, Inc. (JBI). JBI has been in the portfolio management business for over 23 years and provides investors with access to actively managed equity and fixed-income portfolios. All of JBI's fixed-income portfolios are constructed using U .S . debt instruments. Garret's primary portfolio responsibilities are the Quasar Fund and the Nova Fund, both of which are long fixed-income portfolios consisting of Treasury securities in all maturity ranges. The Quasar Fund holdings as of March 15 are provided in Exhibit 1. A comparison of key rate durations for the Quasar Fund and Nova Fund is provided in Exhibit 2.

Of particular importance to Garret and her colleagues is the degree of interest rate risk exposure unique to each portfolio under JBI's management. Driving the increased awareness of the portfolios' interest rate exposure is the double digit growth in assets under management that JBI's fixed-income portfolios have experienced in the last five years. Interest in the company's fixed-income portfolios continues to grow and as a result, all portfolio managers are required to attend weekly meetings to discuss key portfolio risk factors. At the last meeting, Miranda Walsh, a principal at JBI, made the following comments:

"The variance of daily interest rate changes has been trending higher over the last three months leading us to believe that a period of high volatility is approaching in the next twelve to eighteen months. However, the reliability is questionable since the volatility estimates were derived using an option pricing model, which assumes constant interest rates."

"Also, the Treasury spot rate curve currently has a similar shape to the yield curve on Treasury coupon securities, which, according to the market segmentation theory of interest rate term structure, indicates a relatively high level of demand from investors for intermediate term securities. Overzealous trading by investors unwilling to move into other maturity ranges may create mispricing and opportunities for arbitrage."

After the meeting, Walsh and JBI's other principals met to discuss a new international portfolio opportunity. At Walsh's suggestion, the principals selected Garret as the lead portfolio manager for the new fund, which will be titled the Atlantic Fund. One of the other portfolio managers, Greg Terry, CFA, suggested to Garret that she utilize the LIBOR swap curve as a benchmark for the Atlantic fund rather than using local government yield curves. Terry justifies his suggestion by claiming that "the lack of government regulation in the swap market makes swap rates and curves directly comparable between different countries despite fewer maturity points with which to construct the curve as compared to a government yield curve. Furthermore, credit risk in the swap curves of various countries is similar, thus avoiding the complications associated with different levels of sovereign risk embedded in government yield curves.'' Intrigued by the idea of using the swap curve, Garret has her assistant begin gathering a range of current and forward LIBOR rates.

Which of the following best evaluates Terry's justification for using the swap curve as the benchmark for the Atlantic Fund? Terry's justification is:

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Correct Answer: B

Terry's justification is incorrect. There are actually more maturity points in the swap market from which a swap curve can be derived. The rest of Terry s statements are correct. (Study Session 14, LOS 53.d)


Question No. 4

James Walker is the Chief Financial Officer for Lothar Corporation, a U .S . mining company that specializes in worldwide exploration for and excavation of precious metals. Lothar Corporation generally tries to maintain a debt-to-capital ratio of approximately 45% and has successfully done so for the past seven years. Due to the time lag between the discovery of an extractable vein of metal and the eventual sale of the excavated material, the company frequently must issue short-term debt to fund its operations. Issuing these one to six month notes sometimes pushes Lothar's debt to capital ratio above their long-term target, but the cash provided from the short-term financing is necessary to complete the majority of the company's mining projects.

Walker has estimated that extraction of silver deposits in southern Australia has eight months until project completion. However, funding for the project will run out in approximately six months. In order to cover the funding gap. Walker will have to issue short-term notes with a principal value of $1,275,000 at an unknown future interest rate. To mitigate the interest rate uncertainty, Walker has decided to enter into a forward rate agreement (FRA) based on LIBOR which currently has a term structure as shown in Exhibit 1.

Three months after establishing the position in the forward rate agreement, LIBOR interest rates have shifted causing the value of Lothar's FRA . position to change as well. The new LIBOR term structure is shown in Exhibit 2.

While Walker is estimating the change in the value of the original FRA position, he receives a memo from the Chief Operating Officer of Lochar Corporation, Maria Steiner, informing him of a major delay in one of the company's South African mining projects. In the memo, Stciner states the following: "As usual, the project delay will require a short-term loan to cover funding shortage that will accompany the extra time until project completion. I have estimated that in 210 days, we will require a 90-day project loan in the amount of $2,350,000.1 would like you to establish another FRA position, this time with a contract rate of 6.95%."

Which of the following statements regarding the credit risk associated with Walker's original FRA contract three months after the inception of the contract is least accurate?

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Correct Answer: B

In forward markets, there is no clearinghouse. Forward contracts are between two private entities, and as such, rhe credit risk is borne by the part)* with a positive contract position. In Walker's case, since the contract has positive value three months after inception, he is exposed to the risk that the short position will be unable to make the required payment at the contract expiration. This problem could be alleviated through periodically marking the contract to market. Mark-to-market features are not common to ail forward contracts but can be included if so desired by the parties entering into the contract. (Study Session 16, LOS 58.d)


Question No. 5

MPT Associates (MPTA) is an investment advisory firm that makes asset allocation and stock selection recommendations for its clients. MPTA currently manages three portfolios: X, Y, and Z. Portfolio X is the mean-variance efficient market portfolio. Portfolio Y is the portfolio of risky assets with minimum variance. Portfolio Z consists exclusively of 90-day Treasury bills. The three portfolios have the following characteristics:

Expected return for Portfolio X =15%

Standard deviation of returns for Portfolio X = 20%

Expected return for Portfolio Y = 7%

Standard deviation of returns for Portfolio Y = 5%

Expected return on Portfolio Z = 5%

Recently, MPTA was contacted simultaneously by two clients: Danielle Burk and Derek Kitna. Burk and Kitna have known each other since college and are both currently working for the same company.

Burk currently owns a $100,000 portfolio which she is holding in her Roth IRA retirement account. Her investment strategy is a passive approach. Her retirement portfolio has the following risk-return characteristics:

Expected return on Burk's portfolio = 10%

Standard deviation of returns on Burk's portfolio = 12%

Kitna requests advice from MPTA on the proper valuation of two stocks that he is considering. Kitna is interested in determining the fair value of shares of Long Drives, Inc. (LDI), a manufacturer of state-of-the-art golf clubs, and of Cell Chip Technologies (CCT), a manufacturer of cell phone chip processors. MPTA maintains a database of analyst forecasts and finds that the I -year consensus analyst forecast return for the CCT stock equals 15% and the LDI stock equals 13%.

After lengthy conversations with both Burk and Kitna, MPTA decides to advise both of them to use the capital market line, security market line, and capital asset pricing mode! as their primary analytical tools.

MPTA's senior executives are analyzing trends in asset pricing over the past several decades. They conclude that in the period 1998-1999, there was a bubble in stock prices. Stock prices subsequently corrected, however, from 2000-2001. They believe that the downward trend in stock prices from 2002-2003 was an overcorrection; that is, prices fell significantly below fundamental values.

MPTA executives have been discussing the use of the Treynor-Black model with the investment consultants, Benesh Associates. The advisors at Benesh recommend that each investor be allocated a combination of a passive portfolio and an actively managed portfolio, depending on the investor's risk and return preferences. In his presentation on the Treynor-Black model, David Benesh, the principal at Benesh Associates, makes the following statements:

Statement 1: With respect to the actively managed portfolio, the Treynor-Black model will allocate more funds to securities with large alphas and low systematic risk.

Statement 2; The capital asset pricing model assumes that short selling of securities is unrestricted and that unlimited borrowing at the risk-free rate is allowed. If these assumptions are violated, then the relationship between expected return and beta might not be linear. Unlike the theoretical capital asset pricing model, the Treynor-Black model avoids this problem because it does not consider short positions in securities.

In further discussion, Benesh recommends that MPTA consider subscribing to the investment newsletters of two independent equity analysts: Jack Nast and Elizabeth Tackacs. Their alphas, residual risk, and correlation between forecasted and realized alphas arc provided in the table below.

MPTA plans to invest Burk's $100,000 in a combination of Portfolios X and Z that will have the same standard deviation as her original portfolio. Relative to Burk's original portfolio, the change in her expected portfolio value over one year, resulting from following MPTA's recommendation rather than keeping her current portfolio, is:

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Correct Answer: A

MPTA plans to invest Burks money in a combination of the risk-free asset (Portfolio Z) and the market portfolio (Portfolio X). The risk-return values of all combinations of the risk-free asset and the market portfolio comprise the capital market line, which has the following equation:

Therefore, MPTA is able to create Portfolio P, which has an expected return of 11% and a standard deviation of 12%. Burks original portfolio had an expected return of 10% and standard deviation of 12%. By allocating Burks assets along the CML, MPTA is able to increase her expected return by one percentage point, while keeping her portfolio standard deviation unchanged. The expected additional gain equals 1% x $100,000 = $1,000. (Study Session 18, LOS 64.d)


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