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CFA Level II — Equity and Fixed Income flashcards

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Equity valuation (multistage DDM and H-model, FCFF and FCFE, multiples, residual income, private companies) and fixed income (term structure, binomial trees, embedded options, credit models, CDS).

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Learn deck · part of CFA Program Level II · written against: CFA Program Level II curriculum topics (concepts and formulas; no figures that change yearly). Updated 2026-10-10.

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  1. An analyst estimates a share's intrinsic value at 52 while it trades at 45. Why is the 7-point gap not automatically an opportunity?
    The gap equals the true mispricing plus the analyst's own valuation error; only the first part is a real opportunity, so the estimate must be stress-tested before acting.

    Watch out: a model with weak inputs can manufacture an apparent mispricing.
    Equity Valuation › Valuation Concepts
  2. How does a stock's required return differ from its expected return?
    The required return is the minimum return that compensates for the stock's risk (for example a CAPM estimate); the expected return is what the investor anticipates given her value estimate and the current price, including any convergence of price to value.

    Why: expected above required signals an undervalued stock in the analyst's view.
    Equity Valuation › Valuation Concepts
  3. Which conditions make a dividend discount model a sensible choice for valuing a stock?
    The company pays dividends, its dividend policy bears a clear, stable relationship to profitability, and the analyst takes a minority (non-control) perspective.
    Equity Valuation › Dividend Discount Models
  4. A firm just paid a dividend of 1.00. Dividends grow 15% for three years and then 5% forever, and the required return is 10%. What is the share worth?
    About 27.28. Dividends are 1.15, 1.3225 and 1.5209 (PV about 3.28); the terminal value at year 3 is 1.5209×1.050.10−0.05≈31.94\frac{1.5209 \times 1.05}{0.10 - 0.05} \approx 31.94⁠, worth about 24.00 today.
    Equity Valuation › Dividend Discount Models
  5. In a two-stage DDM, at what date is the terminal value measured and which dividend goes in its numerator?
    At the end of the high-growth stage (year n), using the first mature-stage dividend: Vn=Dn+1r−gLV_n = \frac{D_{n+1}}{r - g_L}⁠, then discount it back n years.

    Watch out: using DnD_n instead of Dn+1D_{n+1} undervalues the stock.
    Equity Valuation › Dividend Discount Models
  6. Why is a forward rate described as a breakeven reinvestment rate?
    It is the future short rate that makes an investor indifferent between buying a longer bond and rolling shorter ones; if realized rates beat the forward, rolling wins.
    Fixed Income › Term Structure
  7. The 2-year spot rate is 3% and the 3-year spot rate is 3.5% (annual compounding). What is the implied 1-year rate two years from now?
    About 4.51%. f=1.03531.032−1f = \frac{1.035^3}{1.03^2} - 1⁠.
    Fixed Income › Term Structure
  8. Under what condition does riding an upward-sloping yield curve outperform a maturity-matching strategy?
    When future spot rates turn out lower than today's forward rates — for example, when the curve stays unchanged. If rates evolve exactly as forwards imply, every strategy earns the same return.
    Fixed Income › Term Structure
  9. What is the swap spread, and what is the I-spread?
    The swap spread is the swap rate minus the government bond yield of the same maturity; the I-spread is a bond's yield minus the swap rate of the same maturity when swaps are the stated reference curve.
    Fixed Income › Term Structure
  10. How does the local expectations theory differ from the unbiased expectations theory?
    Local expectations says all bonds earn the risk-free rate only over short holding periods, allowing risk premiums at longer horizons; the unbiased version says forwards are unbiased forecasts at all horizons.
    Fixed Income › Term Structure

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