CFA Level II Exam 1

✅ Correct answer: A hearing panel of Disciplinary Review Committee members decides

📌 Explanation: Under the Professional Conduct Program, an inquiry can start from a member's self-disclosure on the annual Professional Conduct Statement. Once staff propose a sanction, the member may accept or reject it; if she rejects it, the matter is referred to a hearing panel drawn from the Disciplinary Review Committee, which decides whether a violation occurred and what sanction, if any, applies.

❌ Why the other options are wrong: A proposed censure is imposed only if the member accepts it, so it does not become final by lapse of time while she rejects it; a cautionary letter is an alternative open to staff before a sanction is proposed, not the consequence of the member rejecting one.

📋 Objective: 10.1 (Code of Ethics, Standards of Professional Conduct and the Professional Conduct Program)

✅ Correct answer: Disclose the fee, as the Code is stricter

📌 Explanation: Standard I(A) Knowledge of the Law requires a member or candidate to follow the stricter of applicable law and the Code and Standards. Under Standard I(B) Independence and Objectivity, issuer-paid research is acceptable for a flat fee not linked to the conclusions, but the compensation arrangement must be disclosed in the report, so Cheruiyot should disclose the KES 1.8 million fee even though Kenyan rules do not require it.

❌ Why the other options are wrong: Omitting the fee follows the less strict local rule, whereas the Code governs when it imposes the higher standard; refusing the work goes too far, because the Standards permit issuer-paid research when the fee is flat, disclosed and independent of the recommendation.

📋 Objective: 10.2 (Guidance for Standard I: Professionalism)

✅ Correct answer: No, because he combined public and non-material information sources

📌 Explanation: Standard II(A) Material Nonpublic Information prohibits acting on information that is both material and non-public. Cheruiyot's conclusion rests on public statistics, satellite data available to any subscriber and interviews with farmers who have no access to Lirana's internal figures. Under the mosaic theory, combining public and non-material non-public pieces into a material conclusion is permitted.

❌ Why the other options are wrong: A company's refusal to comment on an estimate does not turn the analyst's own work into inside information; the farmers only describe their own deliveries and have no access to Lirana's results, so their comments are non-material pieces of a legitimate mosaic rather than material non-public information.

📋 Objective: 10.3 (Guidance for Standard II: Integrity of Capital Markets)

✅ Correct answer: Yes, because client commissions buy referrals for Melisoro

📌 Explanation: Brokerage commissions are an asset of the client. Standard III(A) requires Otieno to place clients' interests before her firm's and to seek best execution. Paying 1.10% against 0.70% for similar execution, in exchange for Kendrali referring new mandates to Melisoro, uses client brokerage to benefit the firm, which breaches her duty of loyalty.

❌ Why the other options are wrong: Research from Kendrali does not justify the premium because the other brokers also supply research at 0.70%; internal awareness by the compliance head does not cure the conflict, since clients were not told and the commissions still buy a benefit for Melisoro rather than for them.

📋 Objective: 10.4 (Guidance for Standard III: Duties to Clients)

✅ Correct answer: NGN 2,630 million

📌 Explanation: A 25% stake with two board seats gives significant influence, so Okerin uses the equity method. Carrying amount = cost 2,400 + share of net income 25% x 1,600 = 400 - share of dividends 25% x 600 = 150 - extra depreciation on the building uplift 25% x 800 / 10 = 20, giving NGN 2,630 million. The goodwill of 2,400 - 25% x (8,000 + 800) = 200 stays in the carrying amount and is not amortised.

❌ Why the other options are wrong: NGN 2,650 million leaves out the NGN 20 million of additional depreciation on Okerin's share of the fair value uplift; NGN 2,930 million adds the NGN 150 million share of dividends instead of deducting it, although dividends return part of the investment to the investor.

📋 Objective: 3.1 (Intercorporate investments)

✅ Correct answer: NGN 604 million

📌 Explanation: For the defined contribution plan the expense is the contribution payable, NGN 120 million. For the defined benefit plan IFRS puts service cost and net interest in profit or loss: 310 + 90 + 12% x (4,500 - 3,800) = 310 + 90 + 84 = NGN 484 million. Total = 120 + 484 = NGN 604 million. The actuarial loss and the return on assets above the interest income are remeasurements in OCI.

❌ Why the other options are wrong: NGN 484 million covers only the defined benefit plan and omits the NGN 120 million defined contribution cost; NGN 754 million also charges the NGN 150 million actuarial loss to profit or loss, but under IFRS remeasurements go to other comprehensive income.

📋 Objective: 3.2 (Employee compensation: post-employment and share-based)

✅ Correct answer: NGN as functional currency, using the temporal method

📌 Explanation: The functional currency is the currency of the primary economic environment. The subsidiary resells the parent's cement, remits cash weekly and depends on Lagos for financing and pricing, so it is an extension of the parent and its functional currency is the NGN presentation currency. Its XOF accounts are therefore remeasured into NGN with the temporal method.

❌ Why the other options are wrong: Treating XOF as the functional currency with the current rate method would fit a self-contained subsidiary that finances and manages itself, which this one does not; pairing an XOF functional currency with the temporal method mixes the two cases, since the temporal method applies when the parent's currency is the functional currency.

📋 Objective: 3.3 (Multinational operations)

✅ Correct answer: 26.45%

📌 Explanation: CET1 capital = equity 9,000 - intangible assets 600 - deferred tax assets 200 = NGN 8,200 million. Risk-weighted assets = 30,000 x 100% + 12,000 x 0% + 5,000 x 20% = NGN 31,000 million. CET1 ratio = 8,200 / 31,000 = 26.45%, comfortably above the Basel minimum of 4.5% plus buffers.

❌ Why the other options are wrong: 17.45% divides by total assets of NGN 47,000 million instead of risk-weighted assets; 24.55% applies a 20% risk weight to the government securities, inflating risk-weighted assets to NGN 33,400 million, although domestic sovereign exposure carries a 0% weight here.

📋 Objective: 3.4 (Analysis of financial institutions)

✅ Correct answer: True mispricing plus any error in her estimate

📌 Explanation: The difference between an analyst's value estimate and the market price is the perceived mispricing. It equals the true mispricing (true intrinsic value minus price) plus the error in the analyst's own estimate (her value minus the true value). Because Dlamini's model depends on her own renewal and capex forecasts, part of the ZAR 6.00 may be estimation error.

❌ Why the other options are wrong: Treating the gap as alpha she will earn assumes her estimate is the true value and that the price converges, neither of which is assured; expecting an immediate correction ignores that convergence to intrinsic value is uncertain and may take a long time or not happen.

📋 Objective: 5.1 (Equity valuation: applications and processes)

✅ Correct answer: 6.13%

📌 Explanation: CAPM: r = 9.0% + 0.70 x 5.0% = 12.5%. From P0 = D0 x (1 + g) / (r - g): g = (r x P0 - D0) / (P0 + D0) = (0.125 x 40.00 - 2.40) / (40.00 + 2.40) = 2.60 / 42.40 = 6.13%. Check: 2.40 x 1.0613 / (0.125 - 0.0613) = ZAR 40.00. The implied rate is close to her 6% sustainable growth estimate.

❌ Why the other options are wrong: 6.50% computes r - D0 / P0, treating the dividend just paid as next year's dividend; 7.55% uses a required return of 14.0% by adding the full equity risk premium without scaling it by the 0.70 beta.

📋 Objective: 5.2 (Discounted dividend valuation)

✅ Correct answer: ZAR 2,407 million

📌 Explanation: FCFF = CFO + interest x (1 - tax rate) - fixed capital investment = 3,850 + 900 x (1 - 0.27) - 2,100 = 3,850 + 657 - 2,100 = ZAR 2,407 million. After-tax interest is added back because Rivelo deducts interest paid within CFO and FCFF belongs to all capital providers; depreciation is already reflected in CFO.

❌ Why the other options are wrong: ZAR 1,750 million omits the after-tax interest add-back, which gives a figure closer to FCFE before net borrowing; ZAR 2,650 million adds back the full pre-tax interest of 900, ignoring the tax shield that the firm keeps whoever finances it.

📋 Objective: 5.3 (Free cash flow valuation)

✅ Correct answer: ZAR 38.56

📌 Explanation: Median of 9.6, 10.4, 11.8 and 13.0 = (10.4 + 11.8) / 2 = 11.1x. Enterprise value = 11.1 x 4,600 = ZAR 51,060 million. Equity value = EV - net debt = 51,060 - (14,500 - 2,000) = ZAR 38,560 million, or ZAR 38.56 per share on 1,000 million shares, slightly below the ZAR 40.00 price.

❌ Why the other options are wrong: ZAR 25.24 applies the EBITDA multiple to EBIT of 3,400 (4,600 - 1,200), mismatching the multiple and the metric; ZAR 36.56 deducts the gross debt of 14,500 without crediting the ZAR 2,000 million of cash, overstating the claims ranking ahead of equity.

📋 Objective: 5.4 (Market-based valuation: price and enterprise value multiples)

✅ Correct answer: 19.10%

📌 Explanation: The 1-year spot rate equals the 1-year par rate, 18.00%. A 2-year par bond prices at 100: 100 = 19 / 1.18 + 119 / (1 + s2)^2, so 119 / (1 + s2)^2 = 100 - 16.1017 = 83.8983 and (1 + s2)^2 = 1.41839, giving s2 = 19.10%. The spot rate is above the par rate because the curve is upward sloping.

❌ Why the other options are wrong: 18.50% averages the 1-year and 2-year par rates, which is not how spot rates are derived; 19.00% takes the 2-year par rate as the spot rate, ignoring that the year-1 coupon is discounted at the lower 1-year rate.

📋 Objective: 6.1 (The term structure and interest rate dynamics)

✅ Correct answer: GHS 88.05

📌 Explanation: Bootstrapped spots are 18.00%, 19.10% and 19.79% (the 3-year rate from 100 = 19.6 / 1.18 + 19.6 / 1.1910^2 + 119.6 / (1 + s3)^3). Price = 14 / 1.18 + 14 / 1.1910^2 + 114 / 1.1979^3 = 11.86 + 9.87 + 66.32 = GHS 88.05. Each cash flow is discounted at the spot rate for its own date, so no arbitrage exists against the zero-coupon curve.

❌ Why the other options are wrong: GHS 88.39 discounts each cash flow at the par rate of matching maturity, but par rates are yields on coupon bonds, not zero-coupon rates; GHS 91.30 discounts every cash flow at the 18.00% 1-year rate, ignoring the upward slope of the curve.

📋 Objective: 6.2 (The arbitrage-free valuation framework)

✅ Correct answer: GHS 101.75

📌 Explanation: Year-1 values before the coupon: upper node 121 / 1.2330 = 98.13, below the call price, so not called; lower node 121 / 1.1726 = 103.19, above 100, so the bond is called and worth 100. Value today = [0.5 x (98.13 + 21) + 0.5 x (100 + 21)] / 1.18 = GHS 101.75. The straight bond is [0.5 x (119.13) + 0.5 x (124.19)] / 1.18 = 103.10, so the call is worth 1.35.

❌ Why the other options are wrong: GHS 103.10 is the straight-bond value, which ignores the issuer's call at the lower node; GHS 104.45 adds the 1.35 call value to the straight bond, but the investor is short the call, so a callable bond equals the straight bond minus the call.

📋 Objective: 6.3 (Valuation and analysis of bonds with embedded options)

✅ Correct answer: GHS 3.35

📌 Explanation: Forward rate f(1,1) = 1.1910^2 / 1.18 - 1 = 20.20%. Exposure: year 1 = 21 + 121 / 1.2020 = 121.66; year 2 = 121. LGD (60%): 73.00 and 72.60. POD: 3.00% and 97% x 3% = 2.91%. Discount factors: 1 / 1.18 = 0.8475 and 1 / 1.1910^2 = 0.7050. CVA = 73.00 x 0.0300 x 0.8475 + 72.60 x 0.0291 x 0.7050 = 1.856 + 1.490 = GHS 3.35.

❌ Why the other options are wrong: GHS 2.23 multiplies exposure by the 40% recovery rate instead of the 60% loss given default; GHS 4.30 sums the expected losses without discounting them to today, overstating the CVA.

📋 Objective: 6.4 (Credit analysis models)

✅ Correct answer: EGP 54.06

📌 Explanation: Carry arbitrage: F = [S - PV(dividend)] x (1 + r)^T. PV of the dividend = 1.50 / 1.22^0.25 = 1.4282. F = (48.00 - 1.4282) x 1.22^0.75 = 46.5718 x 1.1608 = EGP 54.06. The dividend lowers the forward price because the long forward holder does not receive it.

❌ Why the other options are wrong: EGP 48.95 compounds the net spot price for only 3 months, using the dividend date instead of the 9-month contract term; EGP 55.72 compounds the full share price and ignores the dividend that the share owner receives during the contract.

📋 Objective: 7.1 (Pricing and valuation of forward commitments)

✅ Correct answer: 21.38%

📌 Explanation: The 3 x 9 FRA rate makes borrowing for 90 days and then for 180 days equal to borrowing for 270 days: [(1 + 0.22 x 270/360) / (1 + 0.21 x 90/360) - 1] x 360/180 = (1.1650 / 1.0525 - 1) x 2 = 0.10689 x 2 = 21.38%. The rate is annualised over the 180-day loan period.

❌ Why the other options are wrong: 10.69% is the unannualised 180-day rate, which omits the 360/180 factor; 14.25% annualises the 180-day rate over 270 days, using the wrong period because the loan itself runs for 180 days.

📋 Objective: 7.1 (Pricing and valuation of forward commitments)

✅ Correct answer: EGP 6.13

📌 Explanation: Six-month rate = 1.22^0.5 - 1 = 10.45%. Up price = 48 x 1.25 = 60.00 (payoff 10.00); down price = 38.40 (payoff 0). Risk-neutral probability = (1.1045 - 0.80) / (1.25 - 0.80) = 0.6767. Call = 0.6767 x 10.00 / 1.1045 = EGP 6.13.

❌ Why the other options are wrong: EGP 6.77 is the expected payoff 0.6767 x 10.00 without discounting it back over the six months; EGP 7.65 uses the full 22% annual rate for the 6-month period, which raises the risk-neutral probability to 0.933 and discounts at 1.22.

📋 Objective: 7.2 (Valuation of contingent claims)

✅ Correct answer: EGP 0.66 million

📌 Explanation: At the upper node the 25.0% rate exceeds the 23.0% strike; the payoff of 100 x (0.25 - 0.23) = EGP 2.0 million is paid a year later, so its year-1 value is 2.0 / 1.25 = 1.60. At the lower node the caplet is out of the money. Value today = 0.5 x 1.60 / 1.22 = EGP 0.66 million.

❌ Why the other options are wrong: EGP 0.80 million takes the probability-weighted year-1 node value without discounting it to today at 22%; EGP 0.82 million discounts the payoff only from year 1, ignoring that it is paid in arrears at the end of year 2.

📋 Objective: 7.2 (Valuation of contingent claims)

✅ Correct answer: 5.7%

📌 Explanation: A default-free nominal yield is the real rate plus expected inflation plus a premium for inflation uncertainty: 1.8% + 2.0% + 0.4% = 4.2%. A corporate bond adds a credit premium and a liquidity premium: 4.2% + 1.2% + 0.3% = 5.7%. Each premium compensates investors for a distinct risk in the bond's cash flows or tradability.

❌ Why the other options are wrong: 3.7% leaves out expected inflation and so gives a real rather than nominal yield; 5.4% omits the 0.3% liquidity premium, which investors demand for a corporate bond that trades less readily than government debt.

📋 Objective: 9.1 (Economics and investment markets)

✅ Correct answer: 0.36%

📌 Explanation: Security selection = sum of portfolio weight x (portfolio return - benchmark return) = 0.45 x 1.4% + 0.40 x (-0.3%) + 0.15 x (-1.0%) = 0.63% - 0.12% - 0.15% = 0.36%. Asset allocation adds sum of (wP - wB) x RB = 0.49% - 0.61% + 0.52% = 0.40%, so total value added is 8.77% - 8.01% = 0.76%.

❌ Why the other options are wrong: 0.31% weights the return differences by benchmark weights instead of portfolio weights; 0.76% is the total value added, which also includes the 0.40% from asset allocation decisions.

📋 Objective: 9.2 (Analysis of active portfolio management)

✅ Correct answer: Deliver the basket, create ETF shares and sell them

📌 Explanation: When an ETF trades above its NAV, authorised participants buy the underlying basket, deliver it to the fund in exchange for new ETF shares and sell those shares in the market. The extra supply pushes the ETF price down toward NAV while the basket purchases lift the underlying prices, so the premium narrows.

❌ Why the other options are wrong: Buying ETF shares and redeeming them is the response to a discount, not a premium; waiting for the premium to narrow by itself ignores the arbitrage profit that leads authorised participants to act and keeps ETF prices close to NAV.

📋 Objective: 9.3 (Exchange-traded funds: mechanics and applications)

✅ Correct answer: 9.15%

📌 Explanation: APT: E(R) = RF + b1 x lambda1 + b2 x lambda2 = 3.0% + 1.10 x 4.5% + 0.60 x 2.0% = 3.0% + 4.95% + 1.20% = 9.15%. The factor risk premiums are already excess returns, so the risk-free rate is added once.

❌ Why the other options are wrong: 6.15% omits the 3.0% risk-free rate and gives only the risk premium; 14.25% adds the risk-free rate to each factor premium before multiplying by the sensitivities, treating the premiums as total factor returns.

📋 Objective: 9.4 (Using multifactor models)