The CFA designation is one of the most acclaimed credential for finance professionals around the world. Building upon the foundational knowledge from level 1, Level 2 dives deeper into the core concepts and tests a candidate’s ability to apply that knowledge in real-world situation. Of the 3 levels, Level 2 is considered to be the toughest which is why mock exams become even more crucial, not only to assess your preparedness for the exam but also to familiarise yourself with the exam format ( Level 2 exam introduces case lets that are different from the straight forward MCQ’s of Level 1) , identify your weak points, manage your time more effectively and make yourself comfortable with the stress associated with the actual test.
This article will provide you with quick look of what CFA level 2 case-let looks like. Explanations have been provided where needed:
Sample Questions
Case: You are a portfolio manager at Wallstreet Invest Co. and manage your investments with the help of 6 associates – A1, A2 … A6. Each is assigned a different task :
A1 is tasked with analysing the stock returns of two companies Company X and Company Y and check if they are related. A1 collects monthly data for past 5 years on both companies’ stock returns, and performs a regression analysis.
A2 is analysing the effects of regulation on the financial services sector of a country and raises the following concern : The country’s regulator, concerned about systemic risk, wants accelerated adoption of centralized derivatives settlement (as opposed to bilateral settlement) ahead of other major countries that are considering a similar move.
You also discuss Basel III framework with A2 and mention that “ Basel III sets a minimum equity funding requirement for banks to prevent excessive financial leverage and ensure they can handle loan losses and asset write-downs.”
Given the craze for indexing using exchange-traded funds (ETF), You ask A3 to research ETF’s who suggests :
- ETF shares cannot be shorted unlike mutual fund shares that can be shorted
- In the ETF creation/redemption process, the authorized participants (APs) absorb the costs of transacting securities for the ETF’s portfolio.
- If ETF shares are trading at a discount to NAV and arbitrage costs are sufficiently low, APs will buy the securities in the creation basket and exchange them for ETF shares from the ETF sponsor
A4 is focusing on the real estate sector and makes the following conclusions:
- Benefits of private equity real estate investments include the owners’ ability to attain diversification benefits, to earn current income, and to achieve tax benefits.
- Risk factors of private equity real estate investments include business conditions, demographics, the cost of debt and equity capital, and financial leverage.
A5 (a bond analyst) is reviewing 3 fixed-rate bonds with the highest ratings. Their characteristics are:
|
Bond |
Maturity |
Coupon |
Type of Bond |
|
Bond #1 |
1 October 20X3 |
4.40% annual |
Option-free |
|
Bond #2 |
1 October 20X3 |
4.40% annual |
Callable at par on 1 October 20X1 and on 1 October 20X2 |
|
Bond #3 |
1 October 20X3 |
4.40% annual |
Putable at par on 1 October 20X1 and on 1 October 20X2 |
A6 focusses on equity and makes two statements about dividends:
- “A stock dividend will increase share price on the ex-dividend date, all other things being equal.”
- “One practical concern with a stock split is that it will reduce the company’s P/E ratio.”
Apart from this, you also have a job offer from another firm with higher salary, better benefits, and a larger portfolio. Firm is compliant with local laws and does not involve any unethical activity. You are considering the offer even though your current employer has supported your professional development, clients rely on your expertise and you have a strong rapport with your current team.
Questions:
If p-value for the slope coefficient in the regression analysis is 0.03, what is the significance of the relationship between the two company’s stock returns?
A) It is not statistically significant.
B) It is statistically significant at the 0.05 significance level.
C) It is statistically significant at the 0.10 significance level.
D) It is perfectly linear.
B is correct
What is the most likely basis for the concern noted by A2 ?
A Externalities
B Regulatory arbitrage
C Informational friction
B is correct. Firms in the country are worried about new regulations being implemented earlier than in other countries, which may result in businesses moving to less regulated areas.
The aspect of the Basel III framework that you describe to your associate relates to minimum:
A) capital requirements.
B) liquidity requirements.
C ) amounts of stable funding requirements
A is correct.
As per CFA Institute’s Code of Ethics and Standards of Professional Conduct, which action is most appropriate regarding your job offer?
A) Accept the job offer, as it is a significant career advancement
B) Notify your current employer of the offer and your intention to accept it.
C) Complete your current portfolio management responsibilities before making a decision
D) Accept the offer but maintain your present responsibilities on a part-time basis.
B is correct. Informing your current employer aligns with ethical principles and demonstrates professionalism and integrity. It allows for a smooth transition and upholds fiduciary duties.
Which of A3’s statements regarding ETF is correct?
A) Statement 1
B) Statement 2
C) Statement 3
B is correct. One key advantage of ETFs is that Authorized Participants (APs) handle transaction costs, which are reflected in the ETF’s bid-ask spread, shielding non-transacting shareholders from these costs unlike traditional mutual funds, where all investors are affected by transaction costs when people enter/ exit the fund. ETFs allow short selling, and if they trade at a discount to their Net Asset Value (NAV), APs can buy ETF shares and exchange them for the underlying securities. Statement 3 addresses the scenario when ETF shares are trading at a premium to NAV.
A4’s conclusions are:
A Correct.
B Incorrect, because tax benefits do not apply to tax-exempt entities.
C Incorrect, because the cost of equity capital is not a risk factor.
A is correct. Private equity real estate investments offer diversification, current income, and tax benefits. Risks stem from business conditions, demographics, cost of capital, and financial leverage.
The bond that would most likely protect investors against a significant increase in interest rates is:
A Bond #1.
B Bond #2.
C Bond #3.
C is correct. The putable bond is the best option to protect investors from rising interest rates. It allows bondholders to sell the bonds back to the issuer before maturity and reinvest in higher-yielding bonds.
Are A6’ two statements correct?
A No for both statements.
B Yes for Statement 1, and no for Statement 2.
C No for Statement 1, and yes for Statement 2.
A is correct. Stock dividend decreases price/share, other things equal. A stock split impacts price and earnings proportionately, leaving the P/E ratio same.
Parting Thoughts
The CFA program is designed to ensure that charter holders have a strong foundation in finance. With Level 2, the focus is on the real-world application of the concepts learnt, a skill which can only be achieved with lots of practise. This is where The WallStreet School through its online and classroom bootcamp coaching for the CFA Level 2 exam not only ensures top-notch preparation for the CFA Level 2 exam but also provides 2500+ questions with solutions to help the candidates get thorough with the concepts.
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