CFA ESG - Mock Exam Qestions With Verified Answers

Which of the following is a governance issue? A. Tax transparency B. Health and safety C. Working conditions - Answer A is correct because "[e]xamples of the definition and scope of ESG issues can be illustrated by the two widely-referenced organisations...Tax Transparency [falls under the umbrella of] Governance". B is incorrect because "[e]xamples of the definition and scope of ESG issues can be illustrated by the two widely-referenced organisations...Health & Safety [falls under the umbrella of] Social" by FTSE Russell. C is incorrect because "[e]xamples of the definition and scope of ESG issues can be illustrated by the two widely-referenced organisations...Working conditions [is an example of] Social" in the taxonomy by PRI. 1-Introduction to ESG Investing 1.1.1 Triple bottom line accounting takes into account a company's financial performance and its: A. social and governance factors. B. environmental and social factors. C. environmental and governance factors. - Answer B is correct because "[t]he TBL (Triple bottom line) accounting theory expands the traditional accounting framework focused only on profit to include two other performance areas: the social and environmental impacts of a company." A is incorrect because "[t]he TBL (Triple bottom line) accounting theory expands the traditional accounting framework focused only on profit to include two other performance areas: the social and environmental impacts of a company." C is incorrect because "[t]he TBL [Triple Bottom Line] accounting theory expands the traditional accounting framework focused only on profit to include two other performance areas: the social and environmental impacts of a company." 1-Introduction to ESG Investing 1.1.2 Which of the following investment styles often uses negative screening? A. Impact investing B. Thematic investing C. Faith-based investing - Answer C is correct because "faith-based investment refers to investing in line with certain principles, often using negative screening to avoid investing in companies whose products and services are deemed morally objectionable by the investor or certain religions, international declarations, conventions and voluntary agreements." A is incorrect because "impact investing refers to investments made with the specific intent of generating positive, measurable social and/or environmental impact alongside a financial return." Therefore, impact investing uses the positive screening approach. B is incorrect because "thematic investment refers to selecting companies that fall under a sustainability-related theme, such as clean-tech, sustainable agriculture, healthcare or climate change mitigation." Therefore, thematic investing uses the positive screening approach. 1-Introduction to ESG Investing 1.1.2 Negative externalities: A. result from internalization of costs. B. result in private costs that are higher than societal costs. C. result in societal costs that are not reflected in the prices of goods. - Answer C is correct because "[t]he term externalities refers to situations where the production or consumption of goods and services creates costs or benefits to others that are not reflected in the prices charged for them...when externalities are negative, private costs are lower than societal costs...leading to 'market failures'...[i]nternalisation refers to all measures (public or private) to ensure that externalities become reflected in the prices of commercial goods and services." A is incorrect because "...governments should tax polluters an amount equivalent to the cost of the harm incurred by others. Such a tax would yield the market outcome that would have prevailed with adequate internalisation of all costs by polluters. Internalisation refers to all measures (public or private) to ensure that externalities become reflected in the prices of commercial goods and services." Hence, internalization of costs would eliminate negative externalities. B is incorrect because "when externalities are negative, private costs are lower than societal costs, resulting in market outcomes which may not be efficient or, in other words, leading to 'market failures'." 1-Introduction to ESG Investing 1.1.3 Which of the following statements about ESG integration is most accurate? A. Good ESG standards lower a company's cost of capital B. ESG performance and fund performance are positively correlated C. ESG performance and a company's stock price are negatively correlated - Answer A is correct because "[t]he University of Oxford and asset manager Arabesque in 2014 reviewed the academic literature on sustainability and corporate performance, and found that out of the 200 studies analyzed:... 90% conclude that good ESG standards lower the cost of capital..." B is incorrect because "[i]n most research papers, there was a positive correlation between ESG performance and corporate financial performance, including stock prices. This provides academic evidence for the financial materiality of ESG factors. This correlation, however, does not hold for fund performance, suggesting that the asset management industry in general has not been consistently able to translate ESG analysis into alpha." C is incorrect because "[i]n summary, these meta studies suggest that in most research papers, there was a positive correlation between ESG performance and corporate financial performance, including stock prices." 1-Introduction to ESG Investing 1.1.5 Which of the following statements is most accurate? The Principles for Responsible Investment (PRI): A. comprises six mandatory principles. B. requires members to report quarterly on their responsible investment practices. C. provides guidance on actions signatories can take to incorporate ESG issues into investment practice. - Answer C is correct because "[t]he PRI developed six principles, which are voluntary, but provide overarching guidance on actions members can take to incorporating ESG issues into investment practice." A is incorrect because the "PRI developed six principles, which are voluntary." B is incorrect because the "PRI does require members to report annually on their responsible investment practices." 1-Introduction to ESG Investing 1.1.7 Which of the following is a minimum requirement for signatories of the Principles for Responsible Investment (PRI)? A. Implementation of a responsible investment policy must be monitored by external parties B. Senior-level commitment and accountability mechanisms for responsible investment implementation must be in place C. The investment policy that covers the firm's responsible investment approach must apply to all assets under management - Answer B is correct because the three requirements include that "[s]enior-level commitment and accountability mechanisms [must be in place for responsible investment implementation]." A is incorrect because "[i]nternal or external staff ... [may be] responsible for implementing responsible investment policy" is the correct description of this minimum requirement. C is incorrect because it is required that the "[i]nvestment policy that covers the firm's responsible investment approach ... [must cover] >50% of assets under management (AUM)." 1-Introduction to ESG Investing 1.1.7 As policies on ESG and financial regulation mature, regulatory requirements will most likely move from: A. mandatory to voluntary. B. implementation and reporting to policy. C. 'comply or explain' to 'comply and explain'. - Answer C is correct because "it is anticipated that as policies on ESG and financial regulation reach maturity, an increasing number of governments will recognize the importance of moving to stronger requirements, moving away from: 'comply or explain' to 'comply and explain'; voluntary to mandatory; and policy to implementation and reporting." A is incorrect because "it is anticipated that as policies on ESG and financial regulation reach maturity, an increasing number of governments will recognize the importance of moving to stronger requirements, moving away from ... voluntary to mandatory." B is incorrect because "it is anticipated that as policies on ESG and financial regulation reach maturity, an increasing number of governments will recognize the importance of moving to stronger requirements, moving away from: ... policy to implementation and reporting." 2-The ESG Market 2.1.3 When an asset manager receives an investment mandate from a pension fund, the asset manager: A. assumes a fiduciary duty to the pension fund's members. B. becomes the legal owner of the assets under management. C. acts as the counterparty to investment transactions on behalf of the pension fund. - Answer A is correct because the asset manager is "[r]equired to act as a fiduciary to clients." B is incorrect because "[a]sset managers ... [are n]ot legal owner[s] of [their] assets under management." C is incorrect because "[a]sset managers ... [are n]ot the counterparty to transactions or to derivatives." 2-The ESG Market 2.1.4 Which of the following high-net-worth investor groups are most likely to review the ESG impact of their investment holdings? A. Retired investors B. Millennial investors C. Generation X investors - Answer B is correct because a "2017 study of high-net-worth investors stated that 90% of millennials want to direct their allocations to responsible investments in the next five years ... Another study found that 75% of individual investors in the USA were interested in sustainable investment; the percentage of millennials was higher, at 86% Younger high-net-worth investors are most likely to review the ESG impact of their investment holdings, including 88% of millennials and 70% of Generation X." A is incorrect because "[y]ounger high-net-worth investors are most likely to review the ESG impact of their investment holdings, including 88% of millennials and 70% of Generation X." C is incorrect because a "[y]ounger high-net-worth investors are most likely to review the ESG impact of their investment holdings, including 88% of millennials and 70% of Generation X." 2-The ESG Market 2.1.4 Which of the following statements about ESG integration is most accurate? The investment mandate of sovereign wealth funds: A. must align with ESG principles. B. is usually aligned to the short-term objectives of their state. C. may include secondary objectives such as economic stabilization. - Answer C is correct because "[s]overeign wealth funds ... might go beyond optimising financial return and include broader policy objectives, such as: economic stabilisation." A is incorrect because for sovereign wealth funds "[t]hese objectives can, but don't necessarily have to, align with ESG concerns. There is some evidence that SWFs take ESG into account in asset selection and investor engagement in listed equities, but this evidence is mainly driven by observation of the practices of some of the more transparent SWFs." B is incorrect because "[s]overeign wealth funds are often mandated in line with mid- to long-term objectives of their state." 2-The ESG Market 2.1.4 Which of the following groupings are best described as asset owners in the financial system value chain? A. Fund managers, endowments and banks B. Pension funds, insurance companies and foundations C. Sovereign wealth funds, family offices and investment consultants - Answer B is correct because asset owners include "pension funds, insurers, banks, sovereign wealth funds, foundations, endowments, family offices, individuals." A is incorrect because asset managers "[a]ct as agent on behalf of clients (asset owners)" and are differentiated from asset owners in the value chain. "The main stakeholders are: Asset owners ... Asset managers." C is incorrect because investment consultants are intermediaries and act between asset owners and asset managers in the value chain by "[providing] investment advice" , and therefore represent their own category. Also, "[t]he main stakeholders are: Asset owners ... Asset managers ... Fund promoters." Since asset consultants are fund promoters, they are not part of the asset owner group. 2-The ESG Market 2.1.4 An environmental objective of the EU Taxonomy Regulation is the transition to: A. net zero. B. renewable energy. C. a circular economy. - Answer C is correct because transition to a circular economy is one of the six environmental objectives of the EU Taxonomy. Specifically, the "Taxonomy Regulation establishes six environmental objectives: 1. Climate change mitigation. 2. Climate change adaptation. 3. The sustainable use and protection of water and marine resources. 4. The transition to a circular economy. 5. Pollution prevention and control. 6. The protection and restoration of biodiversity and ecosystem." A is incorrect because transition to a net zero is not one of the environmental objectives of the EU Taxonomy. The term transition to net zero is referenced in the curriculum, as follows: "UNEP Finance Initiative and the Institutional Investor Group on Climate Change are developing frameworks to help benchmark investors' transition to net zero." B is incorrect because transition to a renewable energy is not one of the environmental objectives of the EU Taxonomy. The term transition to renewable energy is an ESG opportunity referenced in the curriculum, as follows: "Mapping can also be done for material opportunities (e.g. opportunity from recycling or the transition to renewable energy) as well as risks." 2-The ESG Market 2.1.4 According to a survey of asset owners by the Principles of Responsible Investment (PRI), which of the following clauses is most commonly included in investment mandates? A. Voting requirements B. Engagement requirements C. Reporting on agreed responsible investment activities - Answer C is correct because "Figure 2.7 shows the expectations that asset owners' signatories of the PRI have included as explicit expectations within clauses of investment mandates... over half of the asset owners (65%) also require reporting. The survey was conducted in 2015..." Figure 2.7 presents "reporting on agreed responsible investment activities" as the second most common at 65%, which is greater than "voting requirements" at 45% and "engagement requirements" of 22%. A is incorrect because "Figure 2.7 shows the expectations that asset owners' signatories of the PRI have included as explicit expectations within clauses of investment mandates... over half of the asset owners (65%) also require reporting. The survey was conducted in 2015..." Figure 2.7 presents "reporting on agreed responsible investment activities" as the second most common at 65%, which is greater than "voting requirements" at 45% and "engagement requirements" of 22%. B is incorrect because "Figure 2.7 shows the expectations that asset owners' signatories of the PRI have included as explicit expectations within clauses of investment mandates... over half of the asset owners (65%) also require reporting. The survey was conducted in 2015..." Figure 2.7 presents "reporting on agreed responsible investment activities" as the second most common at 65%, which is greater than "voting requirements" at 45% and "engagement requirements" of 22%. 2-The ESG Market 2.1.4 According to the Intergovernmental Panel on Climate Change (IPCC) in 2018, the most likely impact of 1.5°C (2.7°F) warming is that: A. Arctic summer sea ice is likely to be maintained. B. the risk of an ice-free Arctic in summer is about 50% higher. C. Arctic summer sea ice will disappear. - Answer A is correct because a 1.5°C (2.7°F) rise in temperature could lead to "Arctic summer sea ice [that] is likely to be maintained." B is incorrect because this is an impact of a 2°C (3.6°F) rise in temperature. "The risk of an ice-free Arctic in summer is about 50% or higher." C is incorrect because this is an impact of a 3°C+ (5.4°F) rise in temperature. "The Arctic is very likely to be ice free in summer." 3-Environmental Factors 3.1.1 Which of the following best characterizes a climate adaptation strategy rather than a climate mitigation strategy? A. Deploying solar energy B. Building flood defenses C. Expanding the use of electric vehicles - Answer B is correct because "[e]xamples of adaptation strategies include a variety of development plans on how to deal with:...building flood defences". A is incorrect because deploying renewable energy sources is a mitigation, not adaptation strategy: "[e]xamples of mitigation strategies include...deploying renewable energy sources" C is incorrect because deploying energy sources is a mitigation, not an adaptation strategy: "[e]xamples of mitigation strategies include... adopting more sustainable transportation and infrastructure, particularly in cities (such as electric vehicles...)." 3-Environmental Factors 3.1.2 An analyst argues that a rapid transition from conventional to electric cars would continue to put a strain on natural resources. This would best be explained by: A. population growth. B. the Jevons paradox. C. the shift in materials used. - Answer C is correct because one of the aspects related to a further strain on natural resources and their depletion is the result of the shift in materials used in production. "Another aspect is the shift in the resources used. For example: Clean energy technologies generally require more minerals than fossil fuel-based counterparts. An electric car uses five times as much minerals as a conventional car (...)." A is incorrect because population growth would not be the most likely reason behind a strain on natural resources related to rapid transition from conventional to electric cars. Population growth, in general, is listed among the biggest causes of increased pressure on natural resources: "The rising population will put increased strain on the world's natural resources, most notably in terms of access to food." However, the main source of a strain related to rapid transition of the industry is stemming from the change in resources used and the fact that the new technology requires more of the minerals. "Clean energy technologies generally require more minerals than fossil fuel-based counterparts. An electric car uses five times as much minerals as a conventional car (...)." B is incorrect because the Jevons paradox is observed when "(...) relative improvements in efficiency (using fewer resources per unit of production) may be offset by increased consumption of a given product." However, switching rapidly production line from conventional to electric cars means using more resources than for fuel-based vehicles (per car produced): "An electric car uses five times as much minerals as a conventional car (...)." 3-Environmental Factors 3.1.2 Which of the following is one of the three principles of the circular economy? A. Keep products and materials in use B. Produce a minimal amount of non-recyclable waste C. Divide waste between recyclable and non-recyclable - Answer A is correct because "[t]he circular economy is based on three principles: 1. design out waste and pollution; 2. keep products and materials in use; and 3. regenerate natural systems." B is incorrect because "[t]he circular economy is based on three principles: 1. design out waste and pollution; 2. keep products and materials in use; and 3. regenerate natural systems." C is incorrect because "[t]he circular economy is based on three principles: 1. design out waste and pollution; 2. keep products and materials in use; and 3. regenerate natural systems" while dividing waste between recyclable and non-recyclable is a feature of the reuse economy. 3-Environmental Factors 3.1.2 An automotive supplier develops new products that will increase the fuel efficiency of vehicles. These products will most likely contribute to a reduction in the supplier's: A. Scope 1 emissions. B. Scope 2 emissions. C. Scope 3 emissions. - Answer C is correct because new products that will increase the fuel efficiency of vehicles purchased by final customers will contribute to a reduction in the supplier's Scope 3 emissions. Scope 3 of the GHG Protocol standards cover emissions further in the supply chain, among other emissions arising from the activities of consumers. "(...) there is increasing focus on how to measure and incorporate indirect emissions from the whole value chain, including those produced by suppliers and customers ('Scope 3' emissions)." A is incorrect because Scope 1 emissions cover direct emissions from a company's core operations. "(...) in terms of GHG emissions, the initial focus has been on direct emissions from core operations ('Scope 1' emissions) and purchased energy ('Scope 2')." B is incorrect because Scope 2 emissions cover emissions from purchased energy. "(...) in terms of GHG emissions, the initial focus has been on direct emissions from core operations ('Scope 1' emissions) and purchased energy ('Scope 2')." 3-Environmental Factors 3.1.3 Which of the following statements is most accurate? An emission trading system: A. sets an explicit price on greenhouse gas emissions. B. mandates similar levels of emissions reductions for all actors. C. creates an economic incentive for emissions reductions to occur at the point of least cost. - Answer C is correct because "[a]n ETS [emission trading system] is a system based on the exchange of permits for emission units, where actors who exceed their emissions limits are required to buy permits from those that have emitted less. The overall quantity of emissions is fixed, and market mechanisms are used to set their price. In theory, this creates an economic incentive for emissions reductions to occur at the point of least cost; rather than mandating similar levels of reductions for all actors, price discovery helps reward those that can afford to reduce more." A is incorrect because "[c]arbon taxation takes a different approach [compared to ETS] by directly setting an explicit price on GHG emissions (e.g. per tonne of CO2)." B is incorrect because an ETS "creates an economic incentive for emissions reductions to occur at the point of least cost; rather than mandating similar levels of reductions for all actors, price discovery helps reward those that can afford to reduce more." 3-Environmental Factors 3.1.4 Which of the following statements is most accurate? The Paris Agreement: A. is legally binding under international law. B. requires signatories to update their commitments to reduce emissions every five years. C. defines nationally determined contributions capturing mandatory efforts to reduce emissions. - Answer B is correct because "Nationally determined contributions (NDCs) are at the heart of the agreement. ... require every signatory (both developed and developing nations) to determine, plan and report on its NDCs, with updates to commitments every five years." A is incorrect because "the Paris Agreement is not legally binding under international law." C is incorrect because "Nationally determined contributions (NDCs) are at the heart of the agreement. Instead of top-down imposed contributions, they capture voluntary efforts by each country to reduce national emissions and adapt to the impacts of climate change, and require every signatory (both developed and developing nations) to determine, plan and report on its NDCs, with updates to commitments every five years." 3-Environmental Factors 3.1.4 The EU taxonomy: A. is a set of recommendations for companies to report on climate-related metrics and targets. B. provides a proprietary tool that compares environmental disclosures across different industries. C. is a classification system to determine whether an economic activity is environmentally sustainable. - Answer C is correct because the EU taxonomy "aims to significantly reduce... the risk of green-washing financial products by providing a classification system to determine whether an economic activity is environmentally sustainable." A is incorrect because the "Financial Stability Board Task Force on Climate-related Financial Disclosures (TCFD) [not the EU taxonomy] takes the Paris Agreement's target ... and tries to operationalise it for the business world. Its June 2017 Final Report urges companies to disclose against the following: ... metrics and targets: the metrics and targets used to assess and manage relevant climate-related risks and opportunities." B is incorrect because the Sustainability Accounting Standards Board or the "SASB [not the EU taxonomy] provides an interactive proprietary tool that identifies and compares disclosure topics across different industries and sectors, described as a 'materiality map'." 3-Environmental Factors 3.1.4 Which of the following statements is most accurate? The 'materiality map' developed by the Sustainability and Accounting Standards Board (SASB): A. quantifies financially material ESG factors across different industries and sectors. B. identifies and compares ESG disclosure topics across different industries and sectors. C. assesses the impact of financially material ESG factors on the investment performance of a company. - Answer B is correct because "SASB provides an interactive proprietary tool that identifies and compares disclosure topics across different industries and sectors, described as a 'materiality map'." "The [sustainability accounting] standards identify financially material issues that are reasonably likely to impact the financial condition or operating performance of a company and therefore are most important to investors." A is incorrect because the 'materiality map' does not quantify financially material ESG factors across different industries and sectors. "SASB provides an interactive proprietary tool that identifies and compares disclosure topics across different industries and sectors, described as a 'materiality map'." C is incorrect because "[t]he research stage [not materiality map] typically contains a materiality assessment to identify the ESG issues that are likely to have an impact on the company's financial performance." "After the research stage and any relevant risk and materiality mapping... , practitioners assess the impact of material financial and ESG factors on the corporate and investment performance of a company." 3-Environmental Factors 3.1.5 For an energy company, Scope 1 emissions most likely result from: A. purchasing freight services. B. using the company's vehicles. C. disposing of waste at the company's gas stations. - Answer B is correct because, for an energy company, the emissions generated from driving and using the company's vehicles are Scope 1 emissions as they are under the direct control of the company. According to GHG Protocol Standards, emissions related to company vehicles are Scope 1 emissions. "While Scopes 1 and 2 cover direct emissions sources (such as the fuel used in company vehicles and purchased electricity), Scope 3 emissions cover all indirect emissions arising from the activities of an organisation." A is incorrect because emissions arising from purchasing freight services are Scope 3 emissions for an energy company. An energy company relies on various services produced by third parties. These third parties generate GHG in their production and operating processes and these are Scope 1 GHG for the third parties. At the same time, they represent Scope 3 emissions for the energy company. C is incorrect because emissions arising from waste disposal processes are Scope 3 emissions for an energy company. Managing waste disposal is not an energy company's main business, nor is waste used in its operations. Thus emissions from waste disposal represent Scope 3 emissions and are not under the company's direct control.