CFA Level 2 Free Practice Test

. Annisquam is correct with regards to his comments on calibrating a binomial interest rate tree. because his comments are correct. because his comments are correct.

. A reduced form model requires that one of the company’s liabilities trade; it can be a zero-coupon bond or an estimation of zero-coupon bonds from observable risky coupon bond prices that trade. In addition, the company’s default prospects are dependent on macroeconomic state variables. These explanatory variables can include such inputs as the growth rate of GDP and the level of unemployment. The model also requires a risk-free rate.
because a reduced form model requires that the state of the economy can be described as a vector of macroeconomic state variables. because a reduced form model requires that some of the company’s debt trades, either a zero-coupon or coupon bond.

. Both points that Marlin makes regarding structural models of credit risk are correct.
because the first point is correct.
because the second point is correct.

. The primary reason for crash risks is related to the fact that carry trades are leveraged: The low-yield currency is borrowed, with proceeds invested in the high-yield currency. The leverage magnifies the effect of losses and gains relative to the investors’ equity base. In low-volatility markets, investors can become complacent and allow positions to grow large in a search for yield. This crowded positioning tends to unwind rapidly when a market shock occurs because many traders try to exit their positions almost simultaneously before the leverage effects wipe out their equity. Stop-loss orders are triggered, and given the market uncertainty, there is a flight to safety that further increases demand for the low-yield currency.
. Another factor that accelerates selling is that traders often have stop-loss orders in place that are triggered when price declines reach a certain level. This can lead to cascades of selling in which position liquidation begets further position liquidation.
. During periods of market turmoil, there is generally a flight to safety into assets and currencies that seem to offer the most protection during times of uncer- tainty—typically low interest rate currencies.

. According to Standards I(B)–Independence and Objectivity and V(A)–Diligence and Reasonable Basis, members and candidates must exercise diligence, independence, objectivity, and thoroughness in analyzing investments, making investment recommen- dations, and taking investment actions. Changing a written recommendation to what a subject company desires is not acting diligently, independently, objectively, and/or thoroughly, and the analyst should immediately revise her recommendation to express her stated opinion of the company.
Changing a written recommendation to what a subject company desires is not acting diligently, independently, objectively, and/or thoroughly.