CFA Program Level II Practice Test

CFA Program Level II emphasizes application and analysis, especially valuation, item-set reasoning, interpretation of case data, and connecting topic knowledge to investment decisions.

This page includes 12 original sample questions for initial review. They are not official CFA Institute questions and do not reproduce a live exam; they are designed to preview the applied valuation, case-data, and professional-standards judgment that a full Finance Prep route would need to support.

What this route should test

• interpreting item-set facts before choosing a calculation or valuation method
• equity, fixed income, derivatives, alternatives, financial reporting, and portfolio-management analysis
• ethics scenarios where the subtle issue is disclosure, loyalty, misrepresentation, or professional conduct
• avoiding answer choices that use the right formula for the wrong fact pattern

Sample Exam Questions

These questions compress item-set style reasoning into short prompts. Use them to check whether you are reading the facts before choosing a valuation method or risk conclusion.

Question 1

Topic: equity valuation

An analyst values a mature utility using a high-growth technology peer multiple because both companies have similar recent share-price momentum. What is the strongest critique?

• A. Market multiples are never useful for valuation
• B. The peer group may be inappropriate because business model, growth, risk, and capital intensity differ
• C. Share-price momentum is the only valid peer-selection criterion
• D. Mature utilities should always be valued at book value only

Best answer: B

Explanation: Level II valuation requires matching the method and peer set to economic characteristics. Momentum alone does not justify using high-growth technology peers for a regulated utility.

Question 2

Topic: financial reporting analysis

A company capitalizes a cost that peers expense immediately. What is the most likely analytical adjustment concern?

• A. Capitalization always lowers current-period profit
• B. The accounting choice has no effect because cash flow is unchanged
• C. The accounting choice has no effect on ratios
• D. The choice affects reported assets, expenses, margins, and comparability

Best answer: D

Explanation: Capitalization can increase current-period profit and assets compared with expensing. Analysts should adjust or interpret ratios carefully because accounting choices can affect margins, asset balances, depreciation or amortization, and comparability.

Question 3

Topic: fixed income

A credit analyst observes that a bond’s spread widens while the risk-free curve is unchanged. What is the most direct interpretation?

• A. The market is demanding more compensation for issuer or credit-related risk
• B. The bond’s coupon has automatically increased
• C. Interest-rate duration has become zero
• D. Default is certain

Best answer: A

Explanation: Credit spread widening usually indicates higher required compensation for credit, liquidity, or related risk. It does not prove default is certain, and it does not automatically change the coupon.

Question 4

Topic: derivatives valuation

A company uses an interest-rate swap to convert floating-rate borrowing into fixed-rate exposure. What is the main economic purpose?

• A. Increase exposure to rising short-term rates
• B. Eliminate counterparty risk entirely
• C. Reduce uncertainty in interest payments by exchanging floating-rate cash flows for fixed-rate cash flows
• D. Create equity ownership in the swap dealer

Best answer: C

Explanation: A pay-fixed, receive-floating swap can transform floating-rate liability exposure into more predictable fixed-rate payments. The swap creates counterparty and valuation risks; it does not eliminate all risk.

Question 5

Topic: alternative investments

A hedge fund reports strong returns, but the strategy uses leverage, hard-to-value assets, and monthly liquidity gates. What should due diligence emphasize?

• A. Past return only because controls are irrelevant if returns are high
• B. The manager’s logo and office location
• C. The number of pages in the marketing deck
• D. Valuation policy, leverage, liquidity terms, risk controls, and operational due diligence

Best answer: D

Explanation: Alternative-investment analysis should look beyond return. Leverage, valuation uncertainty, liquidity constraints, and operational controls can materially affect risk and investor outcomes.

Question 6

Topic: portfolio management

A portfolio has strong historical alpha, but most excess return came from one sector bet that is no longer in the benchmark. What should the analyst investigate?

• A. Whether the manager’s name changed
• B. Whether the performance was skill, factor exposure, concentration, or a nonrepeatable active bet
• C. Whether all benchmarks should be discarded
• D. Whether alpha guarantees future outperformance

Best answer: B

Explanation: Level II performance analysis often requires decomposing results. Apparent alpha may come from factor exposures or concentrated bets rather than repeatable security-selection skill.

Question 7

Topic: ethics

An investment banker privately tells an analyst to delay a downgrade because the firm is pitching for a mandate from the issuer. What should the analyst do?

• A. Maintain independence and follow research and compliance procedures
• B. Delay the downgrade until the mandate decision is known
• C. Publish a neutral rating without analysis
• D. Let the banker edit the research report

Best answer: A

Explanation: Conflicts of interest and independence issues are central Level II ethics traps. The analyst should not let investment-banking pressure influence research conclusions.

Question 8

Topic: residual income valuation

When is residual income valuation especially useful?

• A. When a company has no book value
• B. When accounting clean-surplus relations are irrelevant
• C. When dividends are not aligned with economic value creation but book value and return on equity can be analyzed
• D. When forecast earnings are unnecessary

Best answer: C

Explanation: Residual income models can be useful when dividends are not meaningful or do not reflect value creation. The model still depends on accounting quality, book value, required return, and forecast residual income.

Question 9

Topic: currency effects

A foreign subsidiary’s financial results improve in local currency, but the parent reports lower translated earnings after exchange-rate movements. What should the analyst distinguish?

• A. Dividends from voting rights only
• B. Common-size analysis from accounting policy
• C. Credit risk from tax-loss carryforwards only
• D. Operating performance from translation effects

Best answer: D

Explanation: The subsidiary may be performing well in local currency even if parent-company translated results fall because of exchange-rate movements. Analysts should separate business performance from translation effects.

Question 10

Topic: private company valuation

A private company has no traded shares and limited disclosure. Which valuation issue is most relevant?

• A. Private companies cannot be valued
• B. Discounts or adjustments may be needed for illiquidity, control, size, and limited marketability
• C. Public market data is never useful
• D. The valuation must equal book value

Best answer: B

Explanation: Private-company valuation can use income, market, and asset approaches, but analysts often need to consider control, marketability, size, information quality, and liquidity differences.

Question 11

Topic: item-set reading

An item set gives a management forecast, a normalized earnings estimate, and a note that a one-time gain inflated reported profit. What is the best first step before calculating a multiple?

• A. Identify which earnings measure best matches sustainable performance
• B. Use reported profit because it is always the most conservative
• C. Ignore all notes because item-set notes are distractors
• D. Apply the same multiple to every earnings measure

Best answer: A

Explanation: Level II often tests fact selection before calculation. A one-time gain may require normalization if the valuation should reflect sustainable earnings.

Question 12

Topic: risk interpretation

A risk report shows low average volatility but large losses in a few stress periods. What should the analyst conclude?

• A. The strategy is risk-free because average volatility is low
• B. Stress periods should be removed from analysis
• C. Tail risk can be important even when average volatility looks modest
• D. Risk is always fully described by a single average number

Best answer: C

Explanation: Removing stress periods would hide important risk. Tail risk can matter even when average volatility looks low, so analysts should consider drawdowns, skewness, scenario performance, and stress exposure.

CFA Level II quick checklist

• Can you identify the relevant fact in a case before choosing the formula?
• Can you normalize data when reported numbers do not match sustainable economics?
• Can you explain why a plausible method is wrong for the fact pattern?

Related CFA Institute pages

• CFA Level I
• CFA Level III
• CFA Institute updates