CFA Level 2 · Free topic practice

CFA Level 2 Economics: notes and free practice

CFA Level 2 Economics connects growth and currency analysis to investment cases. Identify the currency quote, valuation relationship and economic assumptions before calculating or interpreting a change.

The key ideas, at a glance

Level 2 · Visual study guide Study illustration of an analyzed worksheet, calculator and checked answer.

Name the parity condition

Read the visual, then follow the worked example below. Use the stated case assumptions.

Illustrative worked case

Rates imply a forward quote, not a future spot forecast

D per F

Spot quote: 2
1-year forward: 2.0194

The case’s domestic and foreign rates are 4% and 3%. Forward = 2 × 1.04 / 1.03 = 2.0194 D/F; values are shown on a zero baseline.

Key methods and mistakes for CFA Level 2 Economics
Concept	Rule or decision	Common mistake
Name the parity condition	D per F: forward = spot × (1 + rD) / (1 + rF)	Reversing the currency quotation also reverses the rate ratio.
Cancel the currency units	(D per X) × (X per F) = D per F	An apparent midpoint discrepancy may disappear after spreads and transaction costs.
Separate inputs from productivity	Growth Y ≈ growth A + α × growth K + (1 - α) × growth L	Aggregate output growth and output-per-worker growth are different measures.
Translate the ending investment	Domestic profit = foreign maturity proceeds × ending spot - domestic debt	An unhedged carry position is exposed to exchange-rate losses, not a risk-free arbitrage.

01Name the parity condition
D per F: forward = spot × (1 + rD) / (1 + rF)
Watch for: Reversing the currency quotation also reverses the rate ratio.
02Cancel the currency units
(D per X) × (X per F) = D per F
Watch for: An apparent midpoint discrepancy may disappear after spreads and transaction costs.
03Separate inputs from productivity
Growth Y ≈ growth A + α × growth K + (1 - α) × growth L
Watch for: Aggregate output growth and output-per-worker growth are different measures.
04Translate the ending investment
Domestic profit = foreign maturity proceeds × ending spot - domestic debt
Watch for: An unhedged carry position is exposed to exchange-rate losses, not a risk-free arbitrage.

Selected 2026 study concepts. Match your preparation to your registered exam-year curriculum. These notes are not complete curriculum coverage.

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CFA Level II: 20 practice MCQs

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Put the method to work

One worked example, from facts to answer

Given
Spot 2 D/F; one-year rates 4% D and 3% F.
Method
Forward = 2 × 1.04 / 1.03 = 2.0194 D/F.
Answer and interpretation
The forward quote is higher; this does not guarantee the realized future spot rate.

Original independent teaching example. Assumptions are stated above; this is not an official exam question or scoring key.

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10 free Economics questions

Five mini-cases, two questions each. Read the case facts, choose an answer and review the method. Short teaching cases, not complete exam item sets or a mock.

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Question 1 of 10Level II topic sample · Case 1 of 5EconomicsMultiple choice
Case facts
A dealer quotes spot at USD 1.20 per EUR. One-year effective risk-free rates are 5% in USD and 2% in EUR. Borrowing and lending use those same rates; ignore costs, credit risk and capital controls. An analyst prices a one-year forward using covered interest parity.
The dealer’s one-year covered-parity forward quote is closest to:
Answer and explanations
1.20 × 1.05 / 1.02 = USD 1.2353 per EUR, using the stated quote convention.
Review the method
- A: 1.1657 reverses the USD and EUR rate ratio.
- B - correct: 1.20 × 1.05 / 1.02 = USD 1.2353 per EUR, using the stated quote convention.
- C: 1.2600 ignores the interest earned on the EUR investment.
Question 2 of 10Level II topic sample · Case 1 of 5EconomicsMultiple choice
Case facts
A dealer quotes spot at USD 1.20 per EUR. One-year effective risk-free rates are 5% in USD and 2% in EUR. Borrowing and lending use those same rates; ignore costs, credit risk and capital controls. An analyst prices a one-year forward using covered interest parity.
Relative to spot, the EUR forward premium in the supplied USD-per-EUR quotation is closest to:
Answer and explanations
(1.05 / 1.02 - 1) × 100 = 2.94% over the one-year horizon.
Review the method
- A - correct: (1.05 / 1.02 - 1) × 100 = 2.94% over the one-year horizon.
- B: This reflects the inverse rate ratio rather than the specified quotation.
- C: The USD rate alone does not determine the forward premium.
Question 3 of 10Level II topic sample · Case 2 of 5EconomicsMultiple choice
Case facts
A strategist quotes 1.50 domestic currency units per foreign unit. Expected annual inflation is 6% domestically and 2% abroad. She uses the exact relative purchasing-power-parity relation for a one-year scenario, while recognizing that it is not a short-run pricing guarantee.
Under the strategist’s exact relative-PPP scenario, next year’s D-per-F quote is closest to:
Answer and explanations
1.50 × 1.06 / 1.02 = 1.5588 domestic units per foreign unit.
Review the method
- A: 1.4434 reverses the domestic and foreign inflation ratio.
- B: 1.5900 applies domestic inflation but ignores foreign inflation.
- C - correct: 1.50 × 1.06 / 1.02 = 1.5588 domestic units per foreign unit.
Question 4 of 10Level II topic sample · Case 2 of 5EconomicsMultiple choice
Case facts
A strategist quotes 1.50 domestic currency units per foreign unit. Expected annual inflation is 6% domestically and 2% abroad. She uses the exact relative purchasing-power-parity relation for a one-year scenario, while recognizing that it is not a short-run pricing guarantee.
Which interpretation best qualifies the strategist’s PPP estimate?
Answer and explanations
Price stickiness and other market forces can produce deviations; the estimate is conditional on the PPP model.
Review the method
- A: Relative PPP is not a guarantee of short-horizon market pricing.
- B - correct: Price stickiness and other market forces can produce deviations; the estimate is conditional on the PPP model.
- C: A parity scenario does not provide an actual currency hedge.
Question 5 of 10Level II topic sample · Case 3 of 5EconomicsMultiple choice
Case facts
A frictionless currency screen shows USD 1.20 per EUR, JPY 150 per USD and a directly executable JPY 190 per EUR. Ignore bid-offer spreads and all costs. An arbitrageur considers buying EUR 1,000 through USD and immediately selling those euros directly for JPY.
The synthetic JPY-per-EUR quote from the two indirect screen quotes is:
Answer and explanations
USD 1.20/EUR × JPY 150/USD = JPY 180/EUR; the USD units cancel.
Review the method
- A - correct: USD 1.20/EUR × JPY 150/USD = JPY 180/EUR; the USD units cancel.
- B: 125 divides the quotes despite the units calling for multiplication.
- C: 190 is the direct quote, not the synthetic cross rate.
Question 6 of 10Level II topic sample · Case 3 of 5EconomicsMultiple choice
Case facts
A frictionless currency screen shows USD 1.20 per EUR, JPY 150 per USD and a directly executable JPY 190 per EUR. Ignore bid-offer spreads and all costs. An arbitrageur considers buying EUR 1,000 through USD and immediately selling those euros directly for JPY.
For the stated EUR 1,000 round trip, the immediate arbitrage profit is:
Answer and explanations
Buy for JPY 180,000 through USD and sell for JPY 190,000, earning JPY 10,000 before the excluded costs.
Review the method
- A: The price discrepancy is JPY 10 per euro, not one yen.
- B: 180,000 is the synthetic purchase cost, not the profit.
- C - correct: Buy for JPY 180,000 through USD and sell for JPY 190,000, earning JPY 10,000 before the excluded costs.
Question 7 of 10Level II topic sample · Case 4 of 5EconomicsMultiple choice
Case facts
An economy is modeled by Y = A × K^0.35 × L^0.65. TFP grows 1.2%, capital 4% and labor 1% annually. Use the usual growth-accounting approximation. The analyst separately asks whether capital deepening alone sustains indefinite productivity growth under neoclassical diminishing returns.
The economy’s approximate annual aggregate output growth is:
Answer and explanations
1.2% + 0.35 × 4% + 0.65 × 1% = 3.25% approximate output growth.
Review the method
- A: 6.20% adds unweighted input growth and ignores output elasticities.
- B - correct: 1.2% + 0.35 × 4% + 0.65 × 1% = 3.25% approximate output growth.
- C: 2.05% is the input contribution before adding TFP growth.
Question 8 of 10Level II topic sample · Case 4 of 5EconomicsMultiple choice
Case facts
An economy is modeled by Y = A × K^0.35 × L^0.65. TFP grows 1.2%, capital 4% and labor 1% annually. Use the usual growth-accounting approximation. The analyst separately asks whether capital deepening alone sustains indefinite productivity growth under neoclassical diminishing returns.
Under the stated neoclassical assumption, capital deepening alone most likely:
Answer and explanations
With diminishing marginal returns, more capital per worker alone cannot sustain indefinite per-worker growth at a constant rate.
Review the method
- A - correct: With diminishing marginal returns, more capital per worker alone cannot sustain indefinite per-worker growth at a constant rate.
- B: Sustained per-worker growth requires more than capital accumulation under these assumptions.
- C: Technological progress remains central to sustained productivity growth.
Question 9 of 10Level II topic sample · Case 5 of 5EconomicsMultiple choice
Case facts
A trader borrows USD 100 for one year at 2%, converts at USD 1.00 per foreign unit and invests abroad at 6%. At maturity the foreign currency is worth USD 0.95 per unit. No hedge, fees or taxes apply. The trader repays the USD loan at maturity.
After repaying the USD loan, the trader’s net profit is:
Answer and explanations
Foreign proceeds are 106 units worth USD 100.70; subtract USD 102 debt to obtain USD -1.30.
Review the method
- A: 4.00 ignores the foreign currency’s depreciation.
- B: 0.70 is the translated asset gain before paying borrowing interest.
- C - correct: Foreign proceeds are 106 units worth USD 100.70; subtract USD 102 debt to obtain USD -1.30.
Question 10 of 10Level II topic sample · Case 5 of 5EconomicsMultiple choice
Case facts
A trader borrows USD 100 for one year at 2%, converts at USD 1.00 per foreign unit and invests abroad at 6%. At maturity the foreign currency is worth USD 0.95 per unit. No hedge, fees or taxes apply. The trader repays the USD loan at maturity.
Which fact explains why the interest-rate advantage did not produce a profit?
Answer and explanations
Translation at USD 0.95 reduces the foreign maturity proceeds enough to outweigh the yield advantage.
Review the method
- A: The position is unhedged and does not lock a covered-parity return.
- B - correct: Translation at USD 0.95 reduces the foreign maturity proceeds enough to outweigh the yield advantage.
- C: The loan requires repayment of principal plus 2% interest.

Four ideas to put to work

Find the method you need

Start with: Exchange-rate units, compound returns, inflation and production-function notation.

METHOD 01

Name the parity condition

D per F: forward = spot × (1 + rD) / (1 + rF)

For covered parity, match currency-specific rates and the forward horizon.
Relative PPP substitutes inflation rates to form a scenario for the future spot quote.
Separate an arbitrage pricing relation from an uncertain economic forecast.

Worked example

Given: Spot 2 D/F; one-year rates 4% D and 3% F.
Calculate / decide: Forward = 2 × 1.04 / 1.03 = 2.0194 D/F.
Result: The forward quote is higher; this does not guarantee the realized future spot rate.

Watch for: Reversing the currency quotation also reverses the rate ratio.

Practise this idea

METHOD 02

Cancel the currency units

(D per X) × (X per F) = D per F

Write units beside each quote before multiplying or dividing.
Compare the synthetic cross rate with an executable direct quote.
For real trades, apply the correct bid or offer at every leg.

Worked example

Given: USD 1.25/EUR and JPY 140/USD, with no costs.
Calculate / decide: 1.25 USD/EUR × 140 JPY/USD = 175 JPY/EUR.
Result: USD cancels, leaving a synthetic price of JPY 175 per EUR.

Watch for: An apparent midpoint discrepancy may disappear after spreads and transaction costs.

Practise this idea

METHOD 03

Separate inputs from productivity

Growth Y ≈ growth A + α × growth K + (1 - α) × growth L

Weight capital and labor growth by their output elasticities.
Add TFP growth separately rather than weighting it again.
Under diminishing returns, capital deepening alone does not sustain indefinite per-worker growth.

Worked example

Given: TFP 1%, capital 3%, labor 2%, capital elasticity 0.4.
Calculate / decide: 1 + 0.4 × 3 + 0.6 × 2 = 3.4%.
Result: Approximate aggregate output growth is 3.4% under this model.

Watch for: Aggregate output growth and output-per-worker growth are different measures.

Practise this idea

METHOD 04

Translate the ending investment

Domestic profit = foreign maturity proceeds × ending spot - domestic debt

Convert the initial borrowing into foreign units using the spot quote.
Accrue the foreign investment and reconvert at the ending spot rate.
Subtract borrowing principal and interest; the rate spread alone is not profit.

Worked example

Given: Borrow 100 D at 3%; invest 100 F at 5%; ending quote 0.96 D/F.
Calculate / decide: 100 × 1.05 × 0.96 - 100 × 1.03 = -2.20 D.
Result: Currency depreciation more than offsets the interest advantage.

Watch for: An unhedged carry position is exposed to exchange-rate losses, not a risk-free arbitrage.

Practise this idea

Questions about this topic

Does a forward exchange rate guarantee the future spot rate?: No. A forward price can reflect a pricing relationship under interest-rate and market assumptions; it is not a guarantee of the realized future spot rate.
Is an unhedged currency carry position risk-free?: No. Exchange-rate movements can offset the interest-rate advantage. Evaluate the ending base-currency proceeds and the funding obligation rather than focusing on the yield difference alone.
How does output growth differ from output-per-worker growth?: Aggregate output can grow because there are more workers as well as because output per worker improves. Keep labor growth, capital accumulation and productivity distinct in the stated growth framework.

Sources and curriculum scope

Official outlines establish curriculum scope. The explanations and worked examples are independent teaching material; the sources do not verify or endorse them.

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One worked example, from facts to answer

Given

Method

Answer and interpretation

10 free Economics questions

The dealer’s one-year covered-parity forward quote is closest to:

Relative to spot, the EUR forward premium in the supplied USD-per-EUR quotation is closest to:

Under the strategist’s exact relative-PPP scenario, next year’s D-per-F quote is closest to:

Which interpretation best qualifies the strategist’s PPP estimate?

The synthetic JPY-per-EUR quote from the two indirect screen quotes is:

For the stated EUR 1,000 round trip, the immediate arbitrage profit is:

The economy’s approximate annual aggregate output growth is:

Under the stated neoclassical assumption, capital deepening alone most likely:

After repaying the USD loan, the trader’s net profit is:

Which fact explains why the interest-rate advantage did not produce a profit?

Find the method you need

Name the parity condition

Worked example

Cancel the currency units

Worked example

Separate inputs from productivity

Worked example

Translate the ending investment

Worked example

Questions about this topic

Sources and curriculum scope