CFA Level II: format, topics and preparation

Level II topic map

Published weight ranges guide coverage; they are not a forecast of the questions on your sitting. Use the outline for your exam year.

1. Question 1 of 10Level II previewFinancial Statement AnalysisMultiple choice

   Case facts

   Asteria Group reports under IFRS. At the beginning of the year, it paid $120 million for 30% of Northfield Ltd. Asteria can exercise significant influence over Northfield. During the year, Northfield earned $30 million and paid $10 million in dividends.

   Asteria also acquired 80% of Lumen Co. for $480 million. At acquisition, the fair value of Lumen's identifiable net assets was $500 million and the fair value of the non-controlling interest was $110 million.

   Asteria's defined-benefit plan reported current service cost of $5 million, net interest expense of $2 million, and a $3 million remeasurement gain. A trading debt security bought for $100 million had a year-end fair value of $106 million.

   The year-end carrying amount of Asteria's investment in Northfield is closest to:

   A.$120 millionB.$126 millionC.$129 million
   Answer and explanations

   Asteria owns 30%, has significant influence, and Northfield reports $30 million of income and $10 million of dividends. Significant influence supports the equity method. Asteria recognizes 30% of Northfield's $30 million income, or $9 million, and reduces the investment for 30% of the $10 million dividend, or $3 million. The ending carrying amount is $120 million plus $9 million minus $3 million, which equals $126 million.

   • A: $120m ignores the net share of earnings less dividends.
   • B - correct: $120m + $9m - $3m = $126m.
   • C: $129m includes earnings but ignores dividends.
2. Question 2 of 10Level II previewFinancial Statement AnalysisMultiple choice

   Case facts

   Asteria Group reports under IFRS. At the beginning of the year, it paid $120 million for 30% of Northfield Ltd. Asteria can exercise significant influence over Northfield. During the year, Northfield earned $30 million and paid $10 million in dividends.

   Asteria also acquired 80% of Lumen Co. for $480 million. At acquisition, the fair value of Lumen's identifiable net assets was $500 million and the fair value of the non-controlling interest was $110 million.

   Asteria's defined-benefit plan reported current service cost of $5 million, net interest expense of $2 million, and a $3 million remeasurement gain. A trading debt security bought for $100 million had a year-end fair value of $106 million.

   Goodwill recognized in the Lumen acquisition is closest to:

   A.$80 millionB.$90 millionC.$110 million
   Answer and explanations

   Consideration is $480 million, fair-value non-controlling interest is $110 million, and identifiable net assets are $500 million. Using the full-goodwill data supplied, goodwill equals consideration transferred plus the fair value of the non-controlling interest minus identifiable net assets. The calculation is $480 million plus $110 million minus $500 million, which produces $90 million of goodwill.

   • A: $80m does not use the supplied fair value of the non-controlling interest.
   • B - correct: $480m + $110m - $500m = $90m.
   • C: $110m is the non-controlling interest, not goodwill.
3. Question 3 of 10Level II previewFinancial Statement AnalysisMultiple choice

   Case facts

   Asteria Group reports under IFRS. At the beginning of the year, it paid $120 million for 30% of Northfield Ltd. Asteria can exercise significant influence over Northfield. During the year, Northfield earned $30 million and paid $10 million in dividends.

   Asteria also acquired 80% of Lumen Co. for $480 million. At acquisition, the fair value of Lumen's identifiable net assets was $500 million and the fair value of the non-controlling interest was $110 million.

   Asteria's defined-benefit plan reported current service cost of $5 million, net interest expense of $2 million, and a $3 million remeasurement gain. A trading debt security bought for $100 million had a year-end fair value of $106 million.

   The defined-benefit pension expense reported in profit or loss is closest to:

   A.$2 millionB.$5 millionC.$7 million
   Answer and explanations

   Current service cost is $5 million, net interest expense is $2 million, and the $3 million remeasurement is a gain. Under the supplied IFRS presentation, current service cost and net interest are recognized in profit or loss, while the remeasurement gain is recognized in other comprehensive income. Profit-or-loss pension expense is therefore $5 million plus $2 million, or $7 million.

   • A: $2m includes net interest alone.
   • B: $5m includes service cost alone.
   • C - correct: $5m service cost + $2m interest = $7m; remeasurement goes to OCI.
4. Question 4 of 10Level II previewFinancial Statement AnalysisMultiple choice

   Case facts

   Asteria Group reports under IFRS. At the beginning of the year, it paid $120 million for 30% of Northfield Ltd. Asteria can exercise significant influence over Northfield. During the year, Northfield earned $30 million and paid $10 million in dividends.

   Asteria also acquired 80% of Lumen Co. for $480 million. At acquisition, the fair value of Lumen's identifiable net assets was $500 million and the fair value of the non-controlling interest was $110 million.

   Asteria's defined-benefit plan reported current service cost of $5 million, net interest expense of $2 million, and a $3 million remeasurement gain. A trading debt security bought for $100 million had a year-end fair value of $106 million.

   The trading debt security most likely increases current-year profit before tax by:

   A.$0 millionB.$3 millionC.$6 million
   Answer and explanations

   The security is identified as trading, cost $100 million, and has a year-end fair value of $106 million. A trading security measured at fair value through profit or loss recognizes its unrealized fair-value change in current profit. The security increased from $100 million to $106 million, so the vignette supports a $6 million increase in profit before tax.

   • A: Trading classification does not defer this fair-value gain.
   • B: $3m is not the change between the supplied values.
   • C - correct: $106m - $100m = $6m recognized in profit.
5. Question 5 of 10Level II previewEquitiesMultiple choice

   Case facts

   An analyst forecasts Beacon Medical's next-year free cash flow to the firm at $75 million. The analyst uses a 9% weighted average cost of capital and a 3% perpetual growth rate. Beacon has $250 million of debt, no excess cash, and 50 million shares outstanding.

   Beacon's beginning book value per share is $30. Expected return on equity is 14%, the required return on equity is 10%, expected long-run growth is 4%, and forecast earnings per share are $4.20.

   For a separate free-cash-flow-to-equity estimate, the analyst forecasts net income of $90 million, depreciation of $20 million, capital expenditures of $35 million, a $5 million increase in working capital, and $10 million of net borrowing.

   Beacon's estimated equity value per share from the constant-growth FCFF model is closest to:

   A.$15B.$20C.$25
   Answer and explanations

   Next-year FCFF is $75 million, WACC is 9%, growth is 3%, debt is $250 million, and 50 million shares are outstanding. Enterprise value is next-year FCFF divided by WACC minus growth: $75 million divided by 6%, or $1,250 million. Subtracting $250 million of debt gives $1,000 million of equity value. Dividing by 50 million shares produces $20 per share.

   • A: $15 understates equity value after the debt deduction.
   • B - correct: ($75m / 0.06 - $250m) / 50m = $20.
   • C: $25 is enterprise value per share before deducting debt.
6. Question 6 of 10Level II previewEquitiesMultiple choice

   Case facts

   An analyst forecasts Beacon Medical's next-year free cash flow to the firm at $75 million. The analyst uses a 9% weighted average cost of capital and a 3% perpetual growth rate. Beacon has $250 million of debt, no excess cash, and 50 million shares outstanding.

   Beacon's beginning book value per share is $30. Expected return on equity is 14%, the required return on equity is 10%, expected long-run growth is 4%, and forecast earnings per share are $4.20.

   For a separate free-cash-flow-to-equity estimate, the analyst forecasts net income of $90 million, depreciation of $20 million, capital expenditures of $35 million, a $5 million increase in working capital, and $10 million of net borrowing.

   Using beginning book value B0, Beacon's justified price-to-book ratio P0/B0 is closest to:

   A.1.50B.1.67C.2.33
   Answer and explanations

   Expected ROE is 14%, required return on equity is 10%, and expected growth is 4%. The justified price-to-book multiple is expected ROE minus growth divided by the required return minus growth. Substituting the vignette inputs gives 10% divided by 6%, or approximately 1.67. Book value per share is not needed for this multiple.

   • A: 1.50 does not apply the supplied ROE, growth and required return.
   • B - correct: (14% - 4%) / (10% - 4%) = 1.67.
   • C: 2.33 divides ROE by the return-growth spread without subtracting growth from ROE.
7. Question 7 of 10Level II previewEquitiesMultiple choice

   Case facts

   An analyst forecasts Beacon Medical's next-year free cash flow to the firm at $75 million. The analyst uses a 9% weighted average cost of capital and a 3% perpetual growth rate. Beacon has $250 million of debt, no excess cash, and 50 million shares outstanding.

   Beacon's beginning book value per share is $30. Expected return on equity is 14%, the required return on equity is 10%, expected long-run growth is 4%, and forecast earnings per share are $4.20.

   For a separate free-cash-flow-to-equity estimate, the analyst forecasts net income of $90 million, depreciation of $20 million, capital expenditures of $35 million, a $5 million increase in working capital, and $10 million of net borrowing.

   Forecast residual income per share for Beacon is closest to:

   A.$0.90B.$1.20C.$3.00
   Answer and explanations

   Forecast EPS is $4.20, beginning book value per share is $30, and the required return on equity is 10%. Residual income equals earnings minus the equity charge on beginning book value. The equity charge is 10% of $30, or $3.00 per share. Subtracting that charge from forecast EPS of $4.20 produces residual income of $1.20 per share.

   • A: $0.90 is not EPS less the charge on beginning book value.
   • B - correct: $4.20 - 10% x $30 = $1.20.
   • C: $3.00 is the equity charge, not residual income.
8. Question 8 of 10Level II previewEquitiesMultiple choice

   Case facts

   An analyst forecasts Beacon Medical's next-year free cash flow to the firm at $75 million. The analyst uses a 9% weighted average cost of capital and a 3% perpetual growth rate. Beacon has $250 million of debt, no excess cash, and 50 million shares outstanding.

   Beacon's beginning book value per share is $30. Expected return on equity is 14%, the required return on equity is 10%, expected long-run growth is 4%, and forecast earnings per share are $4.20.

   For a separate free-cash-flow-to-equity estimate, the analyst forecasts net income of $90 million, depreciation of $20 million, capital expenditures of $35 million, a $5 million increase in working capital, and $10 million of net borrowing.

   Beacon's forecast free cash flow to equity is closest to:

   A.$70 millionB.$80 millionC.$90 million
   Answer and explanations

   Net income is $90 million, depreciation is $20 million, capital expenditures are $35 million, working capital rises $5 million, and net borrowing is $10 million. FCFE starts with net income, adds non-cash depreciation, subtracts capital expenditures and the working-capital investment, and adds net borrowing. The calculation is $90 million plus $20 million minus $35 million minus $5 million plus $10 million, or $80 million.

   • A: $70m omits the $10m of net borrowing.
   • B - correct: $90m + $20m - $35m - $5m + $10m = $80m.
   • C: $90m is net income before the cash-flow adjustments.
9. Question 9 of 10Level II previewFixed IncomeMultiple choice

   Case facts

   Cedar Ridge observes an annualized one-year spot rate of 4.0% and a two-year spot rate of 5.0%. Rates use annual compounding.

   An option-free bond in the desk portfolio has modified duration of 5.2. The desk is evaluating a 30-basis-point parallel increase in yield. A separate corporate bond trades at a 180-basis-point spread over a government yield of 4.2%.

   The desk also reviews a $10 million loan exposure with a one-year probability of default of 2% and a loss given default of 40%.

   The one-year forward rate beginning one year from today is closest to:

   A.5.0%B.6.0%C.6.5%
   Answer and explanations

   The one-year spot rate is 4.0%, the two-year spot rate is 5.0%, and both use annual compounding. No-arbitrage links the rates through (1.05 squared) divided by 1.04. Subtracting one gives approximately 6.01%, so the one-year forward rate beginning in one year is closest to 6.0%. The 5.0% input is the two-year spot rate, not the forward rate.

   • A: 5% is the two-year spot rate.
   • B - correct: (1.05 x 1.05) / 1.04 - 1 is approximately 6.01%.
   • C: 6.5% is inconsistent with the supplied annual spot rates.
10. Question 10 of 10Level II previewFixed IncomeMultiple choice

    Case facts

    Cedar Ridge observes an annualized one-year spot rate of 4.0% and a two-year spot rate of 5.0%. Rates use annual compounding.

    An option-free bond in the desk portfolio has modified duration of 5.2. The desk is evaluating a 30-basis-point parallel increase in yield. A separate corporate bond trades at a 180-basis-point spread over a government yield of 4.2%.

    The desk also reviews a $10 million loan exposure with a one-year probability of default of 2% and a loss given default of 40%.

    Using modified duration only, the bond's approximate percentage price change is closest to:

    A.-1.56%B.-0.30%C.1.56%
    Answer and explanations

    Modified duration is 5.2 and the yield change is an increase of 30 basis points, or 0.0030. The duration approximation is negative modified duration multiplied by the yield change. Multiplying negative 5.2 by 0.0030 gives negative 0.0156, or an approximate 1.56% price decline. The negative sign reflects the inverse price-yield relation.

    • A - correct: -5.2 x 0.003 = -1.56%.
    • B: -0.30% ignores duration.
    • C: The positive sign contradicts the price effect of a yield increase.

How preparation changes at Level II

Independent study guidance, not an official timetable or a prediction of passing.

1. 01

   Map the case to each question

   Read the question, locate the relevant exhibit and record the condition that changes the answer. Avoid answering from memory of the story.

2. 02

   Explain model selection

   Before calculating, name why the model fits the firm, asset or assumption. Recheck the model if your result contradicts the case.

3. 03

   Review the evidence chain

   Record whether the miss came from selecting facts, choosing the model or executing the calculation. Retest with a different vignette.

Build a plan you can actually complete

1. 01

   Choose the correct curriculum

   Check the year and, for Level III, the pathway before buying material or reusing old notes.

2. 02

   Separate learning from rehearsal

   Reserve sessions for new content, missed-question review and timed mixed practice. Use the linked level-specific plan for a weekly schedule.

3. 03

   Finish the PSM requirement

   Account for the Practical Skills Module separately from exam preparation. Check its completion requirements in your candidate account.

What changes in a Level II valuation case

Original illustration: next-year free cash flow to the firm is USD 12 million, perpetual growth is 3%, WACC is 9%, debt is USD 50 million and excess cash is USD 5 million. Assume a stable-growth model is appropriate.

Choose the resource for the task

What you actually need to do in each topic

Use these original practice prompts to turn the topic map into observable skills. They illustrate selected tasks, rather than replacing the exam-year learning outcome statements.

How to judge difficulty without relying on a pass-rate headline

1. 01

   The case adds a selection problem

   Several numbers can be individually correct while only one fits the requested period or model. Label the exhibit, date and units of each input. If you cannot explain why a number belongs in the calculation, the case is not yet understood.

2. 02

   Model choice matters before arithmetic

   A correct calculation using an unsuitable model is still the wrong answer. State the assumptions that permit a stable-growth valuation or a statistical inference. Revisit the choice when the question changes a financing policy, growth pattern or data assumption.

3. 03

   A topic score hides different errors

   Two equity misses may come from entirely different causes: one from misreading a dividend date, another from valuing equity with a firm cash flow. Record the mechanism so the next study session repairs the actual failure.

Registration, results and preparation: the short answers