Free CFA Institute CFA-Level-II Practice Exam Questions and Answers 2026

Nigel Holmes, CFA, is an investment manager for a small money management firm in London. All of Holmes' clients are citizens of the U.K. Holmes urges all of his clients to maintain internationally diversified portfolios. In his efforts to find undervalued securities, he is currently analyzing a Canadian company called Slapshot, Inc. Slapshot produces hockey equipment at its Canadian manufacturing facilities. About 85% of Slapshot's sales are to the U .S . market, and the remainder are domestic (i.e., in Canada). Sales have been growing at 12% per year. Last year's sales were C$68,000,000. Holmes has gathered the following market information (inflation is perfectly predictable):* /$ spot exchange rate = 0.8* /C$ spot exchange rate = 0.4* U.K. risk-free rate = 6%* U.K. expected inflation rate = 4%* Canadian risk-free rate = 9%* Canadian expected inflation rate = 7%* U .S . risk-free rate = 4%* U .S . expected inflation = 2%Holmes uses the international CAPM (ICAPM) to value international investments. For Slapshot, Holmes believes that the stock's returns are sensitive to the /C$ exchange rate. In order to apply the model, he estimates the following parameters using the as the base currency:* World market risk premium = 6%* Sensitivity of Slapshot to the world market = 1.2* Sensitivity of Slapshot to changes in the /C$ exchange rate = 1.4* Holmes' expectation for the depreciation of the C$ against the = 2%* The ratio of the price of the U.K. consumption basket to the Canadian consumption basket is 0.3.Holmes adds Slapshot stock to several client portfolios at a purchase price of C$ 100. One year later, the stock is trading at C$ 122. There were no dividend payments during the year.If the real exchange rate remained constant, the GBP () return on Slapshot for Holmes' clients is closest to

Sharon Foster, 56, is an executive at a large Biotech firm. Foster plans to retire in five years, to travel and spend time with her grandchildren. Foster is in excellent health, although her husband died several years ago. Foster's only significant asset is her employer's 401(k) retirement plan. Her salary is more than adequate to cover her living expenses until she retires, but she does not anticipate that she will accumulate any additional savings beyond her retirement account. The balance in her account currently is $3.2 million, but Foster estimates that by the time she retires the account will have grown to $4.5 million. She expects that her pretax living expenses, including a liberal travel budget, will be $150,000 per year, beginning when she retires. She is willing to take risk to achieve her financial goals. Her retirement account is currently invested 80% in stocks and 20% in bonds. Foster estimates her post-retirement income tax rate to be 35%, which is about the same as her current tax rate.As she is starting to plan her retirement, Foster has turned to her longtime friend, Don Welch, CFA, who is a portfolio manager at Scientific Investments, LLC . Welch is considering three different mutual funds for Foster's account. All three are well-diversified funds of large capitalization stocks. The expected returns and standard deviations of each fund are shown below in Exhibit 1. Welch assumes a risk-free rate of return of 3.0%.Welch believes in stock market efficiency, but he also believes that individual securities are mispriced by the market from time to time. He has recently reviewed research related to the Treynor-Black (TB) model of security selection and portfolio optimization. Welch refers to a prospectus from Fund D, which uses the TB framework in developing its portfolios. In discussing their use of the TB model, the prospectus cites an example where an active portfolio of five stocks is combined with a passive, index portfolio. The portfolio weights of the stocks are in Exhibit 2.Welch further notes that the beta of the active portfolio is 0.90, although the standard deviation of the portfolio's returns is high. Of the five stocks shown in the portfolio, three have positive alphas, and two have negative alphas. A footnote to the sample data states that the sample assumes that the analysts* alpha forecasts are perfect.Welch is reviewing Foster's account, together with the mutual fund data, in an attempt to develop a long-term investment plan for Foster.In preparing an investment policy statement for Foster, which of the following best describes her post-retirement risk tolerance?

The board members for Kazmaier Foods have gathered for their quarterly board of directors meeting. Presiding at the meeting is the Chairman and CEO for Kazmaier, Phil Hinesman. The other eight members of the board are also present, including Allen Kazmaier, the brother of Kazmaier's founder; Elaine Randall, Executive Vice President for Emerald Bank, which Kazmaier uses to obtain short-term financing; and Bill Schram, Kazmaier's President and Chief Operating Officer. Each of the directors was elected to serve on the board for a 4-year term. They were elected two at a time over the past three years. With the exception of Hinesman, Allen Kazmaier, Randall, and Schram, board members had no ties to Kazmaier prior to joining the board and had no personal relationships with management. In addition to the regular board meetings, the five independent board members get together annually, in a meeting separate from the regular board meetings, to discuss the company's operations.Item 1 on the board meeting agenda is a discussion about the importance of corporate governance and how Kazmaier can improve its corporate governance system. Hinesman begins the discussion by saying, 'A strong system of corporate governance is important to our shareholders. Studies have shown that, on average, companies with strong corporate governance systems have higher measures of profitability than companies with weak corporate governance systems.' Randall adds her comment to the discussion: 'The lack of an effective corporate governance system increases risk for our investors. If we do not have the appropriate checks and balances in place, our investors may be exposed to the risk that information used to make decisions about our firm is misleading or incomplete, as well as the risk that mergers or acquisitions the firm enters into will benefit management at the expense of shareholders.'After a lengthy discussion, the board agrees on five separate recommendations that will enhance its current system of corporate governance. One of these recommendations is to change the function and structure of the board's audit committee. Currently the audit committee consists of Matthew Bortz, David Smith, and Ann Williams---three independent directors who each have backgrounds in finance and accounting. The board agrees that one more member should be added to the committee and that the committee should expand its list of responsibilities.Item 2 on the agenda for the board of directors' meeting is a report from Kazmaicr's Chief Financial Officer, Doug Layman. The following information was included in the material that was distributed to each board member before the meeting:Current share price: $40.00Shares outstanding: 56, 250,000Estimated earnings: $112.5 millionPlanned capital spending: $150 millionTarget debt-to-equity ratio 1 to ICost of equity: 8.0%Constant growth rate: 5.2%Layman tells the board that his analysis indicates that, based on a constant-growth dividend discount model, the initiation of an $0.80 per share dividend would reduce the cost of equity by 1.2% and increase the value of the firm's stock, assuming that earnings, the cost of debt, and the constant growth rate don't change.Item 3 on the agenda is the sale of Kazmaier's condiment packaging division to Sautter Packaging and Supply Company. Layman believes the sale will net the company $50 million, payable in cash. After discussing the pros and cons of selling the division, the directors agree that the sale is in the best interests of the company and its shareholders. The directors then move to a vote, and the sale of the condiment packaging division is approved unanimously. The committee then moves on to discuss what to do with the proceeds from the sale. Williams suggests that paying out the $50 million to shareholders as a special dividend would continue to give the firm flexibility in how it uses its excess cash. Smith tells the board that a share repurchase can be thought of as an alternative to a cash dividend, and that if the tax treatment between the two alternatives is the same, investors should be indifferent between the two. After debating the merits of special dividends and stock repurchases, Kazmaier's board authorizes the proceeds from the sale of the condiment packaging division to be used for the purchase of $50 million worth of outstanding shares.An external agency recently included Kazmaier in a review of corporate governance systems to determine whether or not the structure of the board of directors was consistent with corporate governance best practices. The agency scored companies based on the following criteria:Criterion 1: Composition of the board of directors.Criterion 2: Chairman of the board of directors.Criterion 3; Method of electing the board.Criterion 4: Frequency of separate sessions for independent directors.Each of the four criteria was weighted equally, with the firm receiving a positive mark for being in compliance with corporate governance best practice.A month after the board meeting, the price of Kazmaier stock is still at $40 per share, and the sale of Kazmaier's condiment packaging division does not go through. In order to finance the approved share repurchase, Kazmaier is forced to borrow funds. Schram states, 'I am concerned that the cost of the debt used to repurchase shares may cause a reduction in earnings per share.'Jennifer Nagy, a vice president in Kazmaier's finance division, tells Schram not to be concerned about using debt to finance the share repurchase because the rationale behind the repurchase is sound. Nagy then writes down some of the common rationales for share repurchases and hands them to Schram.Rationale 1: Repurchasing shares can prevent the EPS dilution that comes from the exercise of employee stock options.Rationale 2: Management can use a share repurchase to alter the company's capital structure by decreasing the percentage of equity.Rationale 3: Like a dividend increase, a share repurchase is a way to send a signal to investors that Kazmaier's management believes the outlook for the company's future is strong.Are the comments made by Hinesman and Randall about corporate governance systems correct?

Matthew Emery, CFA, is responsible for analyzing companies in the retail industry. He is currently reviewing the status of Ferguson Department Stores, Inc. (FDS). FDS has recently gone through extensive restructuring in the wake of a slowdown in the economy that has made retailing particularly challenging. As part of his analysis, Emery has gathered information from a number of sources.Ferguson Department Stores, Inc.FDS went public in 1969 following a major acquisition, and the Ferguson name quickly became one of the most recognized in retailing. Ferguson had been successful through most of its first 30 years in business and has prided itself on being the one-stop shopping destination for consumers living on the West Coast of the United States. Recently, FDS began to experience both top and bottom line difficulties due to increased competition from specialty retailers who could operate more efficiently and offer a wider range of products in a focused retailing sector. When the company's main bank reduced FDS's line of credit, a serious working capital crisis ensued, and the company was forced to issue additional equity in an effort to overcome the problem. FDS has a cost of capital of 10% and a required rate of return on equity of 12%. Dividends are growing at a rate of 8%, but the growth rate is expected to decline linearly over the next six years to a long-term growth rate of 4%. The company recently paid an annual dividend of $1.At the end of 2008, FDS announced that it would be expanding its retail operations, moving to a warehouse concept, and opening new stores around the country. FDS also announced it would close some existing stores, write-down assets, and take a large restructuring charge. Upon reviewing the prospects of the firm, Emery issued an earnings per share forecast for 2009 of $0.90. He set a 12-month share price target of $22.50. Immediately following the expansion announcement, the share price of FDS jumped from $14 to $18In 2008, FDS also reported an unusual expense of $189.1 million related to restructuring costs and asset write downs.In response to questions from a colleague, Emery makes the following statements regarding the merits of earnings yield compared to the P/E ratio:Statement 1: For ranking purposes, earnings yield may be useful whenever earnings are either negative or close to zero.Statement 2: A high E/P implies the security is overpriced.Assuming that the cost of equity for FDS does not change, the present value of growth opportunities in the share price following the announcement that the company would be expanding its retail operations, using Emery's 2009 earnings forecast, is closest to:

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President ai Langsford Investments, has asked for assistance with the evaluation of mortgage-backed and collateralized mortgage obligation (CMO) derivative securities for potential inclusion in several client portfolios. Langsford Investments mainly deals with equity investments and REITs, but the company recently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models for fixed-income securities and wants to clarify some points. He wants to know if the following statements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured using the option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfolio manager for Langsford, is attempting to purchase bonds that may also provide her with equity exposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 years to maturity. The bonds are convertible into 10 common shares for each $ 1,000 of par (face) value. The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimates that the stock will increase in value to $70 within the next two years. The stock's annual dividend is $0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and other asset-based securities. He provides Lullum with a list of credit enhancements for asset-backed securities, which includes letters of credit, excess servicing spread funds, overcollateralization, and bond insurance. Lullum then asks him for a status report of the firm's exposure to paythrough securities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate the prepayment for the month for a seasoned mortgage pool with a $500,000 principal balance remaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate (CPR) is 7%.Which of the following pairs correctly identifies the two external credit enhancements in Leighton's list?