Tag Archives: CFA level 2

How to avoid failing the level 2 CFA exam

Unfortunately, I am not writing this from the perspective of someone who passed the level 2 CFA exam on their first attempt. Recently, I got news that I failed level 2 (June 2009) and have decided to write down some tips for those who are considering attempting the level 2 CFA exam.

To explain how I approached the exam, I really begun studying with about 5 weeks to go and put in a solid 10-15 hours a week (my friends still recall missing me) until the last week when I put in around 35 hours. I watched each of the Schweser videos and made my own personal notes of most of the areas of the course (at least the parts that didn’t totally bore me to death – we’ll get to those later). I did not read the CFAI material or the Schweser notes. In total, I did all the CFAI practice exam questions and a few other select questions for a total of around 200 questions. Whilst I knew this was less than recommended, I was focusing on learning the information myself and hoping an understanding of it (rather than a drummed in repetition effect) would get me through.

This amounted to far less than the CFAI recommended 300+ hours but I thought I stood a somewhat decent chance of passing the exam with this amount of study regardless. This belief was based on my performance in level 1 with a similar amount of work. Additionally, I was learning the information because I was interested in it and found some sections of derivatives, portfolio management and alternative investments particularly hard to find the motivation to study – as they don’t particularly interest me. Though I did find the ICAPM model particularly humourous.

Obviously I was proven wrong; though narrowly. I performed well in the areas I was most interested in (equity valuation, financial statement analysis, and economics; average in ethics (a dart may have assisted me here) corporate finance and alternative investments; and poorly in derivatives, portfolio management and bonds. Of particular interest, my punt not to learn swaps particularly backfired. Bad punt.

The exam itself was difficult for me for two reasons. Firstly, I felt they left out alot of what I see to be the more useful ‘big’ parts of each different section (except those I mentioned that I didn’t focus on). Instead of these areas, they focused on details from the depths of the CFAI curriculum (this, I was obviously underprepared for).

Secondly, to an even greater extent than in level 1, the questions were particularly well written to confuse the living hell out of you. I have no issue with testing in this way as it obviously awards attention to detail. When thinking about several questions after the exam and comparing my response to those being discussed on analyst forum, I realised that i in fact had the correct answer figured out but was misled by the wording in the question to record a different answer. Hypothetical E.g. “Which of the following is not likely to be greater than the ROE of company A?” – here I would miss the “not” or do something stupid like that.

Overall, I feel very happy that I completed the level 2 CFA exam and learned alot from it. In particular, I enjoyed the debt vs equity financing material, the competitive forces material, the aggressive vs conservative accounting material (save the pension accounting), all the equity valuation material, the balance of payments, import / export and the foreign exchange material.

I may have another go at the exam but I feel I have got most of what I want out of the level 2 CFA material. Completing it would just allow me to do level 3 which I have heard is 50% portfolio management (not something i’m sure I could handle). As stated from the beginning of my CFA quest, the plan was to learn the information I wanted to and give myself a deadline, not lock myself in the portfolio delusion, i mean management, gaol. So we’ll see what happens next June.

In terms of tips for those completing the level 2 CFA exam:

  • The minute details matter, nothing is sacred. They are more than content to not test massive sections of the course and instead quiz you on the common name for a random bond that you’ll never have any contact with.
  • A very solid understanding of every section is required – don’t take punts by leaving out sections if you want to be sure to pass.
  • I imagine that lots of practice would have improved my chances (rather than just learning).
  • Do practice questions that involve word and syntax tricks under exam conditions.

CFA Level Two Final Study – 2009 CFAI sample and mock exams

After doing each of the 2009 CFAI mock exams and sample exams following my CFA level two strategy with 14 days left, here are the points that I made a note for myself to remember. I hope they are of use to someone out there…

Alternative Investments

Altinv (bonds) The purpose of credit tranching is for the subordinate tranche to absorb credit losses.

Alt inv (bonds) Non-amortizing assets, prior to the lockout or revolving period, principal repayments can be either paid out to security holders or reinvested in additional loans.

Alt inv (bonds) The main parties to a securitization are the seller or originator, the servicer, and the issuer or SPV.

Alt inv (bonds) The insurance protection provides for the timely payment of principal and interest payments as due.

Fixed Income

Bonds CPR (conditional prepayment rate) = 6% X t/30 X PSA (public sec association prepayment benchmark) / 100

Bonds months elapsed = number of months – WAM

Bonds agency securities still have credit risk

Bonds excess spread accounts don’t pay out all interest to security holders – can cover future defaults

Fixed income succession plan –> character

Fixed income USE quick and current ratios for liquidity

Fixed income high bank loans mean junk likely, high bonds issuance means higher rated likely

Fixed income don’t easily place things on negative outlook

Fixed income larger PAC collar equals more certainty payment schedule will be satisfied, therefore largest prepayment protection – The narrower the PAC window (labelled Expected Principal Repayment Dates in Exhibit 1), the more likely an MBS will behave like a bullet corporate bond.

Fixed income If mortgage rates rise above the contract rate, the expected cash-flow improves, but the cash flow is discounted at a higher rate. The net effect may be either a rise or a fall in IO value.

Fixed income REVISE OAS / volatility / option costs etc for bonds – You would want to own a security with the lowest option cost, a relatively high OAS if volatility decreases and higher OAS as volatility increases, and relatively better price performance if volatility either decreases or increases.

Fixed income Evaluating MBS and other structured securities subject to prepayment risk requires a model that reflects that cash flows are ”interest rate path-dependent”

Fixed income Cash flow duration is an inferior form of effective duration. Even if advanced analytics are used to determine the best prepayment assumption, it will not be as accurate as building a Monte Carlo simulation which determines prepayment rates stochastically given various interest rate changes to determine the average price of the MBS.

Corporate Finance

Corporate finance excessive compensation is asset risk

Corporate finance target payout ratio stuff – = last div + increase in earnings X target X 1/number of years)

Corporate finance value of firm is maximised when WACC is minimised

Corporate finance (S-C) x (1-t) + Dxt

Corporate finance Be very careful for economic vs accounting income

Corporate finance Econ income = cash flow – (ending MV-beginning MV)

Corporate finance greater risk reduces NPV


Derivatives learn the probability up move / down move formula

Derivatives revise meaning of gamma delta bs

Derivatives remember the put call parity thing

Derivatives revise swaps

Derivatives revise swaptions

Derivatives SWAPS _ REVISE = Calculate and interpret the fixed rate on a plain vanilla interest rate swap and the market value of the swap during its life

Derivatives While there is no credit risk at contract initiation, the potential credit risk of an interest rate swap is greatest at the middle of its life; it does not increase throughout the life of the swap.

Derivatives A receiver swaption is equivalent to a call option

Derivatives REVISE SWAPTION PAYOFFS – Calculate and interpret the value of an interest rate swaption on the expiration day -Using the information in Exhibit 1 and Howell’s sixth statement: [4.32% – 3.90%) * (90/360)]= $105,000 () = 1 / ( 1 + 0.0400*90/360) = 0.9901 () = 1 / ( 1 + 0.0435*180/360) = 0.9787 ($105,000 * 0.9901) + ($105,000 * 0.9787) = $206,725

Derivatives F = S x 1+r f / 1+r base

Derivatives learn to price forward contracts

Derivatives learn the derivative % up / down formula

Derivatives Only the position owing money has credit risk near expiry.

Derivatives F0,t = So – PVD x (1+r)^t OR F0,t = So x (1+r)^t – FVD

Derivatives Value (fwd) = So-F / (1+r)^t

Derivatives F = So e ^-cd c^rcT – go over continuous fwd pricing

Derivatives F(o,t)= S0 (1+r for) / 1+r base – DONT FORGET THIS FORMULA

Derivatives to convert given rates to continuous rates do ln(1+rate)

Derivatives convenience yield will decrease the futures price – Fo(t) = So(1+r)^t + FV (CB) – CB = costs of storage minus convenience yield


Economics external factors in porters framework are government , social changes, technology, demographics and foreign influences

Economics graham and dodd want to buy cycling businesses at bargain prices and growth stocks at or under intrinsic value

Economics prem / discount = fwd rate – spot / spot X (12/number of months) X 100%

Economics revise international Fischer relation

Economics Triangular arbitrage

Economics go over uncovered IRP

Economics F=So x (1+Rforeign)/(1+rbase) (IRP)

Economics S1=S0 x (1+Iforeign / (1+Ibase)

Economics foreign/base, base:foreign is how they do quotes. Spastics.


Equity EVA = NI – $WACC (or ke x equity capital)

Equity Value = book + [(ROE – r )/ (r-g)] X book

Equity higher values of tax and interest burden (EAT/EBT and EBT/EBIT) mean lower burden apparently

Equity operating margin is EBIT / rev and pre-tax margin is EBT /rev

Equity Franchise Factor = 1/r – 1/ROE

Equity Sustainable Growth Rate = Retention Ratio X ROE

Equity Growth Factor = g/(r-g)

Equity Franchise P/E = Franchise Factor X Growth Factor

Equity Intrinsic P/E = Franchise P/E + Tangible P/E = (26.66 + 6.67) = 33.33 Tangible P/E = 1/required rate of return = 1/.15 = 6.67 Franchise Factor = 1/r – 1/ROE = 1/0.15 – 1/0.18 = 1.111 Sustainable Growth Rate = Retention Ratio X ROE = (1 – .20) X .18 = .1440 Growth Factor = g/(r-g) = .1440/(.150 – .1440) = 24 Franchise P/E = Franchise Factor X Growth Factor = 1.111 X 24.0 = 26.66


Equity Intrinsic P/E = (1 – retention ratio) / (required rate of return – sustainable growth)

Equity Sustainable growth = (retention ratio * ROE) / ((required return – (retention ratio * ROE))

Equity Intrinsic P/E using prospective earnings: / = 1/ [ρ + (1 – λ)I]; ρ = r – I ρ = 15% – 5% = 10%; / = 1 / [0.10 + (0.40 x 0.05)] = 8.33.

Equity Absolute valuation models specify an asset’s intrinsic value and relative valuation models specify an asset’s value relative to that of another asset.

Equity READ the QUESTION = asset turnover is not the asset multiplier

Equity higher intrinsic P/E’s are LESS attractive

Equity use cost of equity for residual income (not about financing decisions)

Equity use FCF when capacity to pay dividends differs from dividends

Equity FCFF is better than FCFE whenever the capital structure is changing

Equity FCFE = FCFF – int(1-t) + net borrowing

Equity Net borrowing is the change in long term debt

Equity make sure to use end years dividend



Ethics need consent before working for someone else,

Ethics client accounts have priority of account where employees have beneficial ownership

Ethics must provide research reports to audience members at reasonable price

Ethics do not provide other client details to clients

Ethics don’t have to disclose soft dollar arrangements just need to ensure quality blah blah

Ethics can’t have compensation tied to investment banking clients

Ethics Funded status = plan assets – PBO (which SFAS is this? )

ethics can’t communicate a rating different to current rating

ethics issue final report if there is doubt

Financial Statement Analysis

FSA revise consolidation / pc and equity method (incremental effect on NI = total – minority interest for consolidation)

FSA balance sheet carrying values year on year are cost + share of NI – dividends received

FSA equity income is only from those you control (consolidation) or JVs (not equity or small investments)

FSA only include dividend income from AVS, HTM, trading and equity method (check last bit)

FSA all current method (all assets convert at current rate (year end), all income statement converts at the average rate)

FSA PBO – learn the stupid SFAS numbers – Under SFAS No. 158 the pension liability recognized is the ending pension obligation minus the ending pension assets without any adjustments for unrecognized amounts. 972-604 = 368

FSA ECONOMIC vs expected pension expense – be careful – it’s easy – The economic pension expense would include service cost plus interest cost less actual return on assets: 60 + 54 – 56 = 58. Alternatively, it is the change in the pension obligation less the change in plan assets adjusted for cash contributions and benefit payments. [Change in benefit obligation + benefits paid (non-expense item)] – [Change in plan assets – (contributions – benefits paid)]

FSA don’t forget to get Fcinv from investment in fixed assets regardless of fixed asset sales, WCInv from CFS

FSA [NI – (CFO+CFI) / (NOA end – NOA beg / 2)]

FSA Advances from customers are a legitimate liability and should not be part of an adjustment of the firm’s debt. Guarantees represent a contingent liability and need to be included in a firm’s adjusted debt level. Sale of receivables (with recourse) can be thought of as collateralized borrowing and needs to be part of the adjustment to the debt level.

FSA Sweet Home’s reduction of the accounts receivables’ allowance should be reversed; this would increase the allowance for doubtful accounts by 150 and hence reduce the net receivables balance. So total assets decrease by 150. The adjustment would also require an increase the bad debt expense of 150 which reduces net income by 150(1-.35) = 97.50.

FSA Quality of earnings refers to the degree of conservatism in reported earnings. Accelerated depreciation methods are an indication of high earnings quality; both sale of receivables with partial recourse and guarantees of unconsolidated subsidiary debt represent off-balance sheet financing techniques, which lower the quality of earnings.

FSA Go Over equity method and consolidation method.

FSA pension expense reported vs underlying pensions expense — service cost + interest cost -EXP return + amortization of unrecognized loss or prior cost

FSA functional / local / presentation currency. All current (funct + local same), temporal (functional presentation same)

FSA remember which things to translate at which rates

FSA influence but not control is minority active investment

FSA Go over question 20,21,22 for the workings of the equity method