Chartered Financial Analyst Level II
Exam Practice Questions And Correct
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Rationale 2026 Q&A| Instant Download
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1. An analyst is valuing a company using a residual income model. The
company’s book value of equity is expected to grow because of
retained earnings. Which component is essential in calculating residual
income?
A. Dividend yield
B. Earnings minus equity charge
C. Market capitalization minus debt
D. Free cash flow minus capital expenditure
Answer: B. Earnings minus equity charge
Residual income is calculated as net income less the required return on
beginning book value of equity, often called the equity charge. It measures
value created above the shareholders’ required return.
2. Under IFRS, a company revalues property upward. The resulting gain is
generally recognized in:
,A. Net income immediately
B. Retained earnings directly
C. Other comprehensive income
D. Operating cash flow
Answer: C. Other comprehensive income
IFRS generally records upward revaluation gains for property, plant, and
equipment in other comprehensive income unless reversing a previous loss
recognized in earnings.
3. In a discounted cash flow valuation, increasing the discount rate while
keeping all other assumptions constant will most likely:
A. Increase intrinsic value
B. Decrease intrinsic value
C. Have no impact
D. Increase terminal value only
Answer: B. Decrease intrinsic value
A higher discount rate reduces the present value of future cash flows,
lowering the estimated intrinsic value of the asset.
4. A company reports declining inventory turnover. This most likely
indicates:
A. Improved inventory efficiency
B. Lower inventory investment
C. Possible excess inventory accumulation
D. Higher operating margins
Answer: C. Possible excess inventory accumulation
A declining inventory turnover ratio means inventory is being sold more
slowly, which may indicate inefficient inventory management or weak
demand.
, 5. In financial statement analysis, capitalization of operating leases
generally causes reported:
A. Assets and liabilities to increase
B. Assets and liabilities to decrease
C. Equity to disappear
D. Revenue to decrease
Answer: A. Assets and liabilities to increase
Capitalizing leases recognizes a right-of-use asset and corresponding lease
liability, increasing both reported assets and liabilities.
6. A bond’s duration measures its sensitivity primarily to changes in:
A. Credit rating
B. Interest rates
C. Inflation only
D. Dividend growth
Answer: B. Interest rates
Duration estimates the percentage change in a bond’s price resulting from
changes in market interest rates.
7. A portfolio manager wants to reduce exposure to market risk without
selling securities. The most appropriate strategy is:
A. Buy additional equities
B. Use equity index futures to hedge
C. Increase leverage
D. Purchase lower-rated bonds
Answer: B. Use equity index futures to hedge
Equity index futures can offset systematic market exposure while allowing
the manager to maintain ownership of underlying securities.
, 8. A company with high operating leverage will generally experience:
A. Stable earnings regardless of sales changes
B. Greater earnings sensitivity to sales changes
C. Lower fixed costs
D. No business risk
Answer: B. Greater earnings sensitivity to sales changes
High operating leverage means fixed costs represent a larger portion of
expenses, causing operating income to change significantly when revenue
changes.
9. In private company valuation, a discount for lack of marketability
reflects:
A. Lower expected growth
B. Difficulty converting ownership into cash
C. Higher operating expenses
D. Increased dividend payments
Answer: B. Difficulty converting ownership into cash
Private company shares are less liquid than publicly traded shares, so
investors often require a valuation discount for limited marketability.
10. A company’s weighted average cost of capital decreases when:
A. Business risk increases
B. Debt becomes cheaper relative to equity
C. Required equity return rises
D. Tax rates become zero
Answer: B. Debt becomes cheaper relative to equity
A lower after-tax cost of debt can reduce the weighted average cost of
capital if other factors remain unchanged.
Exam Practice Questions And Correct
Answers (Verified Answers) Plus
Rationale 2026 Q&A| Instant Download
1. An analyst is valuing a company using a residual income model. The
company’s book value of equity is expected to grow because of
retained earnings. Which component is essential in calculating residual
income?
A. Dividend yield
B. Earnings minus equity charge
C. Market capitalization minus debt
D. Free cash flow minus capital expenditure
Answer: B. Earnings minus equity charge
Residual income is calculated as net income less the required return on
beginning book value of equity, often called the equity charge. It measures
value created above the shareholders’ required return.
2. Under IFRS, a company revalues property upward. The resulting gain is
generally recognized in:
,A. Net income immediately
B. Retained earnings directly
C. Other comprehensive income
D. Operating cash flow
Answer: C. Other comprehensive income
IFRS generally records upward revaluation gains for property, plant, and
equipment in other comprehensive income unless reversing a previous loss
recognized in earnings.
3. In a discounted cash flow valuation, increasing the discount rate while
keeping all other assumptions constant will most likely:
A. Increase intrinsic value
B. Decrease intrinsic value
C. Have no impact
D. Increase terminal value only
Answer: B. Decrease intrinsic value
A higher discount rate reduces the present value of future cash flows,
lowering the estimated intrinsic value of the asset.
4. A company reports declining inventory turnover. This most likely
indicates:
A. Improved inventory efficiency
B. Lower inventory investment
C. Possible excess inventory accumulation
D. Higher operating margins
Answer: C. Possible excess inventory accumulation
A declining inventory turnover ratio means inventory is being sold more
slowly, which may indicate inefficient inventory management or weak
demand.
, 5. In financial statement analysis, capitalization of operating leases
generally causes reported:
A. Assets and liabilities to increase
B. Assets and liabilities to decrease
C. Equity to disappear
D. Revenue to decrease
Answer: A. Assets and liabilities to increase
Capitalizing leases recognizes a right-of-use asset and corresponding lease
liability, increasing both reported assets and liabilities.
6. A bond’s duration measures its sensitivity primarily to changes in:
A. Credit rating
B. Interest rates
C. Inflation only
D. Dividend growth
Answer: B. Interest rates
Duration estimates the percentage change in a bond’s price resulting from
changes in market interest rates.
7. A portfolio manager wants to reduce exposure to market risk without
selling securities. The most appropriate strategy is:
A. Buy additional equities
B. Use equity index futures to hedge
C. Increase leverage
D. Purchase lower-rated bonds
Answer: B. Use equity index futures to hedge
Equity index futures can offset systematic market exposure while allowing
the manager to maintain ownership of underlying securities.
, 8. A company with high operating leverage will generally experience:
A. Stable earnings regardless of sales changes
B. Greater earnings sensitivity to sales changes
C. Lower fixed costs
D. No business risk
Answer: B. Greater earnings sensitivity to sales changes
High operating leverage means fixed costs represent a larger portion of
expenses, causing operating income to change significantly when revenue
changes.
9. In private company valuation, a discount for lack of marketability
reflects:
A. Lower expected growth
B. Difficulty converting ownership into cash
C. Higher operating expenses
D. Increased dividend payments
Answer: B. Difficulty converting ownership into cash
Private company shares are less liquid than publicly traded shares, so
investors often require a valuation discount for limited marketability.
10. A company’s weighted average cost of capital decreases when:
A. Business risk increases
B. Debt becomes cheaper relative to equity
C. Required equity return rises
D. Tax rates become zero
Answer: B. Debt becomes cheaper relative to equity
A lower after-tax cost of debt can reduce the weighted average cost of
capital if other factors remain unchanged.
