Arizona Accredited Financial Analyst
(CFA) Level II Exam Practice Questions
And Correct Answers (Verified Answers)
Plus Rationale 2026 Q&A| Instant
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1. A financial analyst is evaluating a company using the residual income
model. Which of the following best describes residual income?
A. Net income minus total assets
B. Net income minus a charge for equity capital
C. Operating income minus interest expense
D. Cash flow minus capital expenditures
B. Net income minus a charge for equity capital
Residual income represents net income adjusted for the cost of
equity capital, reflecting value creation beyond required returns.
2. In multiple regression analysis, which assumption ensures that the
error terms are not correlated with each other?
A. Homoskedasticity
B. Linearity
C. No autocorrelation
D. Normality
C. No autocorrelation
No autocorrelation means error terms are independent across
observations, which is critical for unbiased standard errors.
3. Which of the following best describes the concept of duration in fixed
income analysis?
, A. Measure of bond price volatility to credit risk
B. Measure of sensitivity to interest rate changes
C. Time to maturity of a bond
D. Coupon payment frequency
B. Measure of sensitivity to interest rate changes
Duration quantifies how much a bond’s price changes in response to
interest rate fluctuations.
4. A forward contract is best described as:
A. An exchange-traded standardized contract
B. A contract with daily settlement
C. A customized over-the-counter agreement
D. A contract with embedded options
C. A customized over-the-counter agreement
Forward contracts are privately negotiated and not standardized like
futures contracts.
5. In financial statement analysis, which method is used to account for
investments where the investor has significant influence?
A. Cost method
B. Equity method
C. Consolidation method
D. Fair value method
B. Equity method
The equity method applies when ownership typically ranges from
20% to 50%, reflecting influence over operations.
6. Which of the following is most likely to increase a company’s weighted
average cost of capital (WACC)?
A. Increase in tax rate
B. Increase in debt proportion
C. Increase in cost of equity
D. Decrease in risk-free rate
C. Increase in cost of equity
An increase in cost of equity raises the overall WACC if other factors
remain constant.
7. In derivatives pricing, arbitrage opportunities exist when:
A. Markets are perfectly efficient
, B. Prices reflect intrinsic value
C. Identical assets have different prices
D. Interest rates are constant
C. Identical assets have different prices
Arbitrage arises when identical or equivalent assets are mispriced
across markets.
8. Which valuation model is most appropriate for firms with stable
dividend growth?
A. Free cash flow to equity model
B. Residual income model
C. Gordon growth model
D. Asset-based valuation
C. Gordon growth model
The Gordon model assumes constant growth and is suitable for
stable dividend-paying firms.
9. In time-series analysis, stationarity implies that:
A. Data trends upward over time
B. Variance changes over time
C. Statistical properties remain constant
D. Observations are independent
C. Statistical properties remain constant
Stationarity means mean, variance, and autocorrelation are constant
over time.
10. Which of the following best describes credit default swaps
(CDS)?
A. Insurance against equity losses
B. Contract exchanging fixed and floating rates
C. Protection against bond default
D. Agreement to buy commodities
C. Protection against bond default
CDS provides protection to investors against default risk of a
borrower.
11. Which of the following is a key feature of private equity
investments?
A. High liquidity
(CFA) Level II Exam Practice Questions
And Correct Answers (Verified Answers)
Plus Rationale 2026 Q&A| Instant
Download Pdf
1. A financial analyst is evaluating a company using the residual income
model. Which of the following best describes residual income?
A. Net income minus total assets
B. Net income minus a charge for equity capital
C. Operating income minus interest expense
D. Cash flow minus capital expenditures
B. Net income minus a charge for equity capital
Residual income represents net income adjusted for the cost of
equity capital, reflecting value creation beyond required returns.
2. In multiple regression analysis, which assumption ensures that the
error terms are not correlated with each other?
A. Homoskedasticity
B. Linearity
C. No autocorrelation
D. Normality
C. No autocorrelation
No autocorrelation means error terms are independent across
observations, which is critical for unbiased standard errors.
3. Which of the following best describes the concept of duration in fixed
income analysis?
, A. Measure of bond price volatility to credit risk
B. Measure of sensitivity to interest rate changes
C. Time to maturity of a bond
D. Coupon payment frequency
B. Measure of sensitivity to interest rate changes
Duration quantifies how much a bond’s price changes in response to
interest rate fluctuations.
4. A forward contract is best described as:
A. An exchange-traded standardized contract
B. A contract with daily settlement
C. A customized over-the-counter agreement
D. A contract with embedded options
C. A customized over-the-counter agreement
Forward contracts are privately negotiated and not standardized like
futures contracts.
5. In financial statement analysis, which method is used to account for
investments where the investor has significant influence?
A. Cost method
B. Equity method
C. Consolidation method
D. Fair value method
B. Equity method
The equity method applies when ownership typically ranges from
20% to 50%, reflecting influence over operations.
6. Which of the following is most likely to increase a company’s weighted
average cost of capital (WACC)?
A. Increase in tax rate
B. Increase in debt proportion
C. Increase in cost of equity
D. Decrease in risk-free rate
C. Increase in cost of equity
An increase in cost of equity raises the overall WACC if other factors
remain constant.
7. In derivatives pricing, arbitrage opportunities exist when:
A. Markets are perfectly efficient
, B. Prices reflect intrinsic value
C. Identical assets have different prices
D. Interest rates are constant
C. Identical assets have different prices
Arbitrage arises when identical or equivalent assets are mispriced
across markets.
8. Which valuation model is most appropriate for firms with stable
dividend growth?
A. Free cash flow to equity model
B. Residual income model
C. Gordon growth model
D. Asset-based valuation
C. Gordon growth model
The Gordon model assumes constant growth and is suitable for
stable dividend-paying firms.
9. In time-series analysis, stationarity implies that:
A. Data trends upward over time
B. Variance changes over time
C. Statistical properties remain constant
D. Observations are independent
C. Statistical properties remain constant
Stationarity means mean, variance, and autocorrelation are constant
over time.
10. Which of the following best describes credit default swaps
(CDS)?
A. Insurance against equity losses
B. Contract exchanging fixed and floating rates
C. Protection against bond default
D. Agreement to buy commodities
C. Protection against bond default
CDS provides protection to investors against default risk of a
borrower.
11. Which of the following is a key feature of private equity
investments?
A. High liquidity
