CFA LEVEL 2 EXAM GUIDE 2025 – 180 MOST TESTED
QUESTIONS AND ANSWERS WITH DETAILED EXPLANATIONS
Which of the following investment problems is least likely to be addressed by using a multiple
regression model?
A)Prediction of the likelihood of monetary tightening by the central bank using macroeconomic
variables.
B)Uncovering a systematic pattern in the value of a currency using historical daily price data for
that currency.
C)Determining if the five-factor Fama-French model can be improved by adding an earnings
momentum factor. - ANSWER****B) Uncovering a systematic pattern in the value of a
currency using historical daily price data for that currency.
Uncovering a pattern in a time series of a single variable can be accomplished using
autoregressive models (not multiple regression). Tightening (or not) of monetary policy can be
represented as a binary variable and can be modeled using a logistic regression model. Multiple
regression models can be used to test existing theories, or identify relationships between
variables.
For a 1-year quarterly-pay swap, an equivalent position with short puts and long calls would
involve:
A) put-call combinations expiring on each of the four settlement dates.
B) three put-call combinations on the last three settlement dates of the swap.
C) three put-call combinations expiring on the first three settlement dates of the swap -
ANSWER****C) three put-call combinations expiring on the first three settlement dates of the
swap.
Interest rate options pay one period after exercise. Options expiring on settlements at t = 1,2,3,
will mimic the uncertain swap payments at t = 2,3,4.
Regarding options on a stock without dividends, it is:
,A) sometimes worthwhile to exercise calls early but not puts.
B) sometimes worthwhile to exercise puts early but not calls.
C) never worthwhile to exercise puts or calls early. - ANSWER****B) sometimes worthwhile to
exercise puts early but not calls.
After early exercise of a put, and in particular a deep in-the-money put, the sale proceeds can
be invested at the risk-free rate and may earn interest worth more than the time value of the
put option. The same is not true for call options: early exercise of call options on non-dividend-
paying stock is never optimal.
Which of the following best explains a delta-neutral portfolio? A delta-neutral portfolio is
perfectly hedged against:
A) small price decreases in the underlying asset.
B) all price changes in the underlying asset.
C) small price changes in the underlying asset. - ANSWER****C) small price changes in the
underlying asset.
A delta-neutral portfolio is perfectly hedged against small price changes in the underlying asset.
This is true both for price increases and decreases. That is, the portfolio value will not change
significantly if the asset price changes by a small amount. However, large changes in the
underlying will cause the hedge to become imperfect. This means that overall portfolio value
can change by a significant amount if the price change in the underlying asset is large.
Which of the following comments relating to the use of a forward rate agreement is least
accurate?
A) A short FRA can be used to lock into a fixed rate of borrowing commencing in two months'
time and expiring in five months' time.
B) The use of a FRA to hedge interest rate risk would lock Brodeur into paying a fixed rate plus
40 basis points for her borrowing.
,C) The use of a FRA to hedge interest rate risk on her future loan will mean that she no longer
benefits if interest rates fall. - ANSWER****A) A short FRA can be used to lock into a fixed rate
of borrowing commencing in two months' time and expiring in five months' time.
A is the least accurate because it describes a short FRA being used for borrowing, which would
not be the typical way a short FRA is used. Typically, a long FRA would be used to lock in a fixed
borrowing rate. (Paying fixed aka borrowing at a fixed rate)
The fixed-rate on a semiannual 2-year interest rate swap is closest to the:
A) current 180-day T-bill rate.
B) coupon rate on a 2-year par bond with the same credit risk as the fixed-rate payer.
C) coupon rate on a 2-year par bond with the same credit risk as the reference rate. -
ANSWER****C) coupon rate on a 2-year par bond with the same credit risk as the reference
rate.
In an interest rate swap, the fixed rate is set so that the present value of the fixed payments
equals the present value of the floating payments (i.e., the net present value of the swap is zero
at initiation). The floating leg is typically based on an index like LIBOR or another reference rate
A swap is equivalent to a series of:
A) FRAs priced at market rates.
B) off-market FRAs.
C) interest rate calls. - ANSWER****B) off-market FRAs.
Since the fixed rate on the swap is the same at every settlement date, a series of FRAs at those
fixed rates will have values that differ from zero to the extent the fixed rate and the zero-value
rate differ. This makes them off-market FRAs.
Jason Fye, CFA, wants to check for seasonality in monthly stock returns (i.e., the January effect)
after controlling for market cap and systematic risk. The type of model that Fye would most
appropriately select is:
A) Neither multiple regression nor logistic regression.
, B) Multiple regression model.
C) logistic regression model. - ANSWER****B) Multiple regression model.
Fye wants to test a theory of January effect on stock returns (dependent variable) using a
dummy (January = 1, other months = 0), market cap, and beta (independent variables). A
multiple regression model would be most appropriate. Because the dependent variable (stock
returns) is not a qualitative variable, a logistic regression would not apply.
Which of the following statements is most accurate? A random walk process:
A) is nonstationary.
B) has a finite mean-reverting level.
C) can be appropriately fit as an AR(1) model. - ANSWER****A) is nonstationary.
A random walk process does not have a finite mean-reverting level and hence covariance
nonstationary. An AR(1) model cannot be used to fit a covariance nonstationary time series.
An analyst runs a regression of portfolio returns on three independent variables. These
independent variables are price-to-sales (P/S), price-to-cash flow (P/CF), and price-to-book
(P/B). The analyst discovers that the p-values for each independent variable are relatively high.
However, the F-test has a very small p-value. The analyst is puzzled and tries to figure out how
the F-test can be statistically significant when the individual independent variables are not
significant. What violation of regression analysis has occurred?
A) serial correlation.
B) conditional heteroskedasticity.
C) multicollinearity. - ANSWER****C) multicollinearity.
An indication of multicollinearity is when the independent variables individually are not
statistically significant but the F-test suggests that the variables as a whole do an excellent job
of explaining the variation in the dependent variable.
Which of the following statements regarding the R2 is least accurate?
QUESTIONS AND ANSWERS WITH DETAILED EXPLANATIONS
Which of the following investment problems is least likely to be addressed by using a multiple
regression model?
A)Prediction of the likelihood of monetary tightening by the central bank using macroeconomic
variables.
B)Uncovering a systematic pattern in the value of a currency using historical daily price data for
that currency.
C)Determining if the five-factor Fama-French model can be improved by adding an earnings
momentum factor. - ANSWER****B) Uncovering a systematic pattern in the value of a
currency using historical daily price data for that currency.
Uncovering a pattern in a time series of a single variable can be accomplished using
autoregressive models (not multiple regression). Tightening (or not) of monetary policy can be
represented as a binary variable and can be modeled using a logistic regression model. Multiple
regression models can be used to test existing theories, or identify relationships between
variables.
For a 1-year quarterly-pay swap, an equivalent position with short puts and long calls would
involve:
A) put-call combinations expiring on each of the four settlement dates.
B) three put-call combinations on the last three settlement dates of the swap.
C) three put-call combinations expiring on the first three settlement dates of the swap -
ANSWER****C) three put-call combinations expiring on the first three settlement dates of the
swap.
Interest rate options pay one period after exercise. Options expiring on settlements at t = 1,2,3,
will mimic the uncertain swap payments at t = 2,3,4.
Regarding options on a stock without dividends, it is:
,A) sometimes worthwhile to exercise calls early but not puts.
B) sometimes worthwhile to exercise puts early but not calls.
C) never worthwhile to exercise puts or calls early. - ANSWER****B) sometimes worthwhile to
exercise puts early but not calls.
After early exercise of a put, and in particular a deep in-the-money put, the sale proceeds can
be invested at the risk-free rate and may earn interest worth more than the time value of the
put option. The same is not true for call options: early exercise of call options on non-dividend-
paying stock is never optimal.
Which of the following best explains a delta-neutral portfolio? A delta-neutral portfolio is
perfectly hedged against:
A) small price decreases in the underlying asset.
B) all price changes in the underlying asset.
C) small price changes in the underlying asset. - ANSWER****C) small price changes in the
underlying asset.
A delta-neutral portfolio is perfectly hedged against small price changes in the underlying asset.
This is true both for price increases and decreases. That is, the portfolio value will not change
significantly if the asset price changes by a small amount. However, large changes in the
underlying will cause the hedge to become imperfect. This means that overall portfolio value
can change by a significant amount if the price change in the underlying asset is large.
Which of the following comments relating to the use of a forward rate agreement is least
accurate?
A) A short FRA can be used to lock into a fixed rate of borrowing commencing in two months'
time and expiring in five months' time.
B) The use of a FRA to hedge interest rate risk would lock Brodeur into paying a fixed rate plus
40 basis points for her borrowing.
,C) The use of a FRA to hedge interest rate risk on her future loan will mean that she no longer
benefits if interest rates fall. - ANSWER****A) A short FRA can be used to lock into a fixed rate
of borrowing commencing in two months' time and expiring in five months' time.
A is the least accurate because it describes a short FRA being used for borrowing, which would
not be the typical way a short FRA is used. Typically, a long FRA would be used to lock in a fixed
borrowing rate. (Paying fixed aka borrowing at a fixed rate)
The fixed-rate on a semiannual 2-year interest rate swap is closest to the:
A) current 180-day T-bill rate.
B) coupon rate on a 2-year par bond with the same credit risk as the fixed-rate payer.
C) coupon rate on a 2-year par bond with the same credit risk as the reference rate. -
ANSWER****C) coupon rate on a 2-year par bond with the same credit risk as the reference
rate.
In an interest rate swap, the fixed rate is set so that the present value of the fixed payments
equals the present value of the floating payments (i.e., the net present value of the swap is zero
at initiation). The floating leg is typically based on an index like LIBOR or another reference rate
A swap is equivalent to a series of:
A) FRAs priced at market rates.
B) off-market FRAs.
C) interest rate calls. - ANSWER****B) off-market FRAs.
Since the fixed rate on the swap is the same at every settlement date, a series of FRAs at those
fixed rates will have values that differ from zero to the extent the fixed rate and the zero-value
rate differ. This makes them off-market FRAs.
Jason Fye, CFA, wants to check for seasonality in monthly stock returns (i.e., the January effect)
after controlling for market cap and systematic risk. The type of model that Fye would most
appropriately select is:
A) Neither multiple regression nor logistic regression.
, B) Multiple regression model.
C) logistic regression model. - ANSWER****B) Multiple regression model.
Fye wants to test a theory of January effect on stock returns (dependent variable) using a
dummy (January = 1, other months = 0), market cap, and beta (independent variables). A
multiple regression model would be most appropriate. Because the dependent variable (stock
returns) is not a qualitative variable, a logistic regression would not apply.
Which of the following statements is most accurate? A random walk process:
A) is nonstationary.
B) has a finite mean-reverting level.
C) can be appropriately fit as an AR(1) model. - ANSWER****A) is nonstationary.
A random walk process does not have a finite mean-reverting level and hence covariance
nonstationary. An AR(1) model cannot be used to fit a covariance nonstationary time series.
An analyst runs a regression of portfolio returns on three independent variables. These
independent variables are price-to-sales (P/S), price-to-cash flow (P/CF), and price-to-book
(P/B). The analyst discovers that the p-values for each independent variable are relatively high.
However, the F-test has a very small p-value. The analyst is puzzled and tries to figure out how
the F-test can be statistically significant when the individual independent variables are not
significant. What violation of regression analysis has occurred?
A) serial correlation.
B) conditional heteroskedasticity.
C) multicollinearity. - ANSWER****C) multicollinearity.
An indication of multicollinearity is when the independent variables individually are not
statistically significant but the F-test suggests that the variables as a whole do an excellent job
of explaining the variation in the dependent variable.
Which of the following statements regarding the R2 is least accurate?
