🎓 CFA Level II - Study Guide

📋 Course Structure

📖 Chapter 1: The Term Structure and Interest Rate Dynamics

What this chapter covers:

🔑 Essential Concepts & Formulas

🛠️ Problem Types

Type A: Calculating Bond Price Using Spot Rates

Type B: Calculating Forward Rate

🧮 Solved Example

Problem:

Given:

Answer:

⚠️

❌ Mistake 1: Using YTM instead of spot rates for valuation. ✅ How to avoid:

❌ Mistake 2: Incorrectly applying the forward rate formula. ✅ How to avoid:

🦁

Visualize the yield curve. Understanding the shape (upward sloping, downward sloping, flat) helps in predicting future rate movements and applying the correct formulas.

📖 Chapter 2: The Arbitrage-Free Valuation Framework

What this chapter covers:

🔑 Essential Concepts & Formulas

🛠️ Problem Types

Type A: Valuing a Bond Using a Binomial Tree

Type B: Calculating OAS

🧮 Solved Example

Problem:

Given:

Answer:

⚠️

❌ Mistake 1: Not considering the call/put option when valuing bonds with embedded options. ✅ How to avoid:

❌ Mistake 2: Forgetting to discount by (1 + forward rate) in the binomial tree. ✅ How to avoid:

🦁

Draw the binomial tree clearly. Label each node with the corresponding interest rate and bond value. This helps in visualizing the process and avoiding errors.

📖 Chapter 3: Valuation and Analysis of Bonds with Embedded Options

What this chapter covers:

🔑 Essential Concepts & Formulas

🛠️ Problem Types

Type A: Valuing a Callable Bond

Type B: Calculating Effective Duration for a Callable Bond

🧮 Solved Example

Problem:

Given:

Answer:

⚠️

❌ Mistake 1: Ignoring the call/put feature when calculating bond values. ✅ How to avoid:

❌ Mistake 2: Using modified duration instead of effective duration for bonds with embedded options. ✅ How to avoid:

🦁

Remember that callable bonds have negative convexity when rates are near the call price. This means their price appreciation is limited as rates fall.

📖 Chapter 4: Credit Analysis Models

What this chapter covers:

🔑 Essential Concepts & Formulas

🛠️ Problem Types

Type A: Calculating Expected Loss

Type B: Calculating Expected Return Given Credit Migration

🧮 Solved Example

Problem:

Given:

Answer:

⚠️

❌ Mistake 1: Ignoring recovery rates when calculating loss given default. ✅ How to avoid:

❌ Mistake 2: Not considering credit migration when evaluating bond performance. ✅ How to avoid:

🦁

Understand the difference between structural and reduced-form models. Structural models rely on balance sheet information, while reduced-form models use statistical modeling.

📖 Chapter 5: Credit Default Swaps

What this chapter covers:

🔑 Essential Concepts & Formulas

🛠️ Problem Types

Type A: Calculating CDS Spread

Type B: Determining CDS Payout

🧮 Solved Example

Problem:

Given:

Answer:

⚠️

❌ Mistake 1: Confusing CDS spread with the actual payout after a credit event. ✅ How to avoid:

❌ Mistake 2: Ignoring the impact of the recovery rate on the CDS spread. ✅ How to avoid:

🦁

Remember that buying CDS protection is equivalent to shorting credit risk, while selling CDS protection is equivalent to going long credit risk.