FREE CFA Level 2 Study Guide 2026: All 10 Topics, Built to the Exam

This free CFA Level 2 study guide teaches to the CFA Program Level II exam — all 10 topic areas the CFA Institute tests, organized the way the exam is built.^[1] Level II is widely seen as the hardest of the three levels because it combines broad coverage with deep, applied asset valuation, so this guide is built to teach — real models, worked formulas, and the high-yield judgment calls the vignettes reward — not a summary.

And it’s interactive, not a wall of text: every topic has a built-in checkpoint quiz, hover-able glossary terms, and concept questions, so you learn by doing.

Read it topic by topic, test yourself at each checkpoint, then round out your free CFA Level 2 study resources with our practice item sets and flashcards.

CFA Level 2 Exam Snapshot

The single biggest change from Level I is the format: instead of 180 free-standing questions, you face 22 item sets — each a short case (a vignette) with about four questions you must answer from the case.^[1] That rewards connecting concepts, not isolated recall:

The exam also re-weights toward asset valuation. Five topics — Ethics, Financial Statement Analysis, Equity, Fixed Income, and Portfolio Management — each carry the higher 10–15% band; the other five carry 5–10%:^[1]

CFA Institute publishes the topic weights as ranges, so the exact mix shifts slightly each window. This guide groups the 10 topics into 8 study modules — the two smallest related pairs (Economics with Corporate Issuers, Alternatives with Portfolio Management) are taught together — but all 10 official topics are covered.^[1]

1 · Ethical & Professional Standards

10–15% of the exam. The Code and the seven Standards are the same as Level I, but the testing is harder: Level II buries the issue inside a realistic vignette where several facts compete, so you must spot which Standard a member violated and the recommended fix. Ethics also breaks ties at the borderline.

The Code & Seven Standards in Vignettes

Memorize the seven Standards in order — the exam tests the sub-standards by scenario:

MNPI, Mosaic Theory & Conflicts

Standard II(A) forbids acting (or causing others to act) on material nonpublic information. The mosaic theory is your defense: combining public data with nonmaterial nonpublic pieces into a conclusion is acceptable, even if that conclusion is itself material. Standard VI requires disclosing conflicts of interest, giving clients priority in transactions, and disclosing referral fees — all common vignette traps.

GIPS at Level II

The Global Investment Performance Standards get more attention at Level II.^[4] Know that only an entire firm can claim compliance (not a product or person); results are grouped into composites by strategy; and performance must be calculated and presented so it is fair and comparable. Time-weighted returns are the standard for performance presentation.

2 · Quantitative Methods

5–10% of the exam, and at Level II it is almost entirely regression and time series — the statistical machinery behind factor models, valuation, and forecasting. Master the assumptions and what breaks them.

Multiple Linear Regression

Multiple regression fits $Y = b_0 + b_1 X_1 + b_2 X_2 + \dots + \varepsilon$. Each slope $b_j$ is the effect of that variable holding the others constant. Know the tests: a t-test on each coefficient (is it individually significant?), the F-test (is the model jointly significant?), and $R^2$ versus adjusted $R^2$, which penalizes adding useless variables.

Heteroskedasticity, Serial Correlation & Multicollinearity

Three violations dominate the vignettes, and the trick is knowing the symptom and the fix:

Time Series & Machine Learning

For time series, know autoregressive (AR) models, the need for covariance stationarity, unit roots (a random walk is non-stationary — test with Dickey-Fuller and difference the series), and seasonality. The big-data and machine-learning readings introduce supervised vs unsupervised learning and overfitting, tested conceptually rather than computationally.

3 · Economics & Corporate Issuers

Economics is 5–10% and Corporate Issuers is 5–10%. They are taught together here because Level II narrows Economics largely to exchange rates, and Corporate Issuers to capital structure and payout — two compact, formula-light topics.

Exchange Rates & Parity Conditions

The heart of Level II economics is the set of parity conditions that link interest rates, inflation, and spot and forward exchange rates:

Covered interest rate parity is the one that holds exactly, because the position is fully hedged with a forward. The higher-yielding currency trades at a forward discount. A break in covered parity is a riskless arbitrage.

Economic Growth & Regulation

Growth comes from labor, capital, and total factor productivity; the production-function and growth-accounting view explains long-run output. The regulation reading frames why regulation exists (externalities, information asymmetry) and how it affects firms and analysts.

Capital Structure (Modigliani-Miller)

The Modigliani-Miller propositions are the backbone of capital-structure theory. Without taxes, firm value and the WACC are independent of leverage (Prop I), while the cost of equity rises linearly with leverage (Prop II). Add the tax deductibility of interest and debt creates a valuable tax shield — but financial distress and agency costs cap how much debt is optimal (the trade-off theory).

Dividends, Buybacks & ESG

A share repurchase and a cash dividend of equal size are economically equivalent in a no-tax world, but differ in signaling, flexibility, and tax treatment. Know the residual, stable, and target-payout dividend policies, and how a buyback can increase EPS only when the after-tax cost of funds is below the earnings yield. ESG factors are increasingly integrated into issuer analysis.

4 · Financial Statement Analysis

10–15% of the exam — a high-band topic and a Level II favorite. The Level II FSA content is more technical than Level I: how one company accounts for owning another, pensions, foreign-currency translation, and spotting low-quality reporting.

Intercorporate Investments

How an investor reports an investment depends on the degree of influence:

Net income is the same under the equity method and consolidation, but consolidation grosses up revenue, assets, and liabilities — so it changes margins and leverage ratios. In a business combination, the excess paid over fair value of net assets is goodwill, which is tested for impairment, not amortized.

Employee Benefits (Pensions)

For a defined-benefit plan, the balance sheet reports the funded status — plan assets minus the benefit obligation:

A lower discount rate raises the obligation and worsens funded status, so the actuarial assumptions (discount rate, compensation growth, expected return) are where analysts dig. Periodic pension cost is split between profit or loss and other comprehensive income, differing somewhat between IFRS and U.S. GAAP.

Multinational Operations (Translation)

Translating a foreign subsidiary depends on its functional currency:

Because the temporal method runs the gain or loss through income, it makes earnings more volatile than the current-rate method.

Financial Reporting Quality

High-quality reporting is both decision-useful (relevant and faithful) and a sign of high-quality earnings(sustainable, cash-backed). Watch for aggressive revenue recognition, capitalizing costs that should be expensed, classifying operating cash outflows as investing, and recurring “one-time” charges. The Beneish M-score and accruals ratios are common red-flag tools.

5 · Equity Valuation

10–15% of the exam — and the signature Level II skill. Level I asked what a stock is worth with one formula; Level II asks you to choose the right model for the firm in the vignette and apply it. Master the model map first.

Dividend Discount Models

The Gordon constant-growth model values a stock as $V_0 = \dfrac{D_1}{r - g}$, valid only when $g < r$. For firms whose growth fades, use a two-stage model (high growth then a terminal Gordon value) or the H-model, which assumes growth declines linearly from a high to a stable rate.

Free Cash Flow (FCFF & FCFE)

When dividends are absent or erratic, discount free cash flow instead. The two measures answer different questions:

FCFF is discounted at the WACC to get firm value (then subtract debt for equity); FCFE is discounted at the cost of equity to get equity value directly. Use FCFE when leverage is stable, FCFF when it is changing or FCFE is negative.

Residual Income

The residual income model values a firm as current book value plus the present value of future residual income (net income minus an equity charge). Because it starts from book value, it recognizes value earlier than DDM or free-cash-flow models — useful for firms with negative early cash flow. It assumes clean-surplus accounting.

Multiples & Private Company Valuation

Relative valuation uses multiples — P/E, P/B, P/S, EV/EBITDA — where a justified P/E from fundamentals checks whether the market multiple is reasonable, and enterprise value makes EV/EBITDA capital-structure-neutral. For private companies, apply the income, market, or asset-based approach, then adjust for a discount for lack of marketability (DLOM) and a discount for lack of control (DLOC).

6 · Fixed Income

10–15% of the exam. Level II goes from a single yield to the whole term structure, then values bonds — including those with embedded options — arbitrage-free along an interest-rate tree.

The Term Structure & Forward Rates

Spot rates (zero-coupon yields) and forward rates are linked by no-arbitrage. When the spot curve slopes up, implied forwards lie above it:

Bootstrappingderives spot rates from coupon-bond prices, and the four term-structure theories — pure expectations, liquidity preference, segmented markets, and preferred habitat — explain the curve’s shape and the term premium. The swap rate curve and the par curve are related no-arbitrage representations.

Arbitrage-Free Valuation & Trees (OAS)

An option-free bond is valued arbitrage-free by discounting each cash flow at its own spot rate. For bonds with embedded options, build a binomial interest-rate tree calibrated to the benchmark curve and roll values back.

A callable bond’s value at a node is capped at the call price (the issuer calls when it helps the issuer). The option-adjusted spread is the constant spread that makes the model price match the market price once the option is removed — so bonds with different options can be compared.

Credit Analysis & Structured Securities

Credit risk is analyzed with structural models (default as equity-as-an-option on firm assets) and reduced-form models (default as a statistical hazard). Credit spreads compensate for expected loss (probability of default × loss given default). Structured products — mortgage-backed and asset-backed securities — add prepayment and tranching (credit) considerations.

7 · Derivatives

5–10% of the exam, but content-dense: Level II moves from describing derivatives to pricing and valuing them with no-arbitrage logic.

Forwards, Futures & Swaps Pricing

The no-arbitrage forward price is the spot compounded at the risk-free rate, adjusted for carry: $F_0 = S_0 \times (1 + r)^T$, plus storage costs and minus income or a convenience yield. After initiation, the value of a long forward is the present value of the gap between today’s forward price and the contract price. A swap is priced as a series of forwards (or as off-market forwards) so that its initial value is zero, which sets the fixed swap rate.

Binomial Option Valuation

The binomial model assumes the underlying moves up by factor u or down by factor d each period. Because the option can be replicated with the stock and risk-free borrowing, actual probabilities are irrelevant — only the risk-neutral probability matters:

Value the option as the discounted risk-neutral expected payoff. American options add the check of early exercise at each node.

Black-Scholes-Merton & the Greeks

Black-Scholes-Merton prices a European option from five inputs — underlying price, strike, time, the risk-free rate, and volatility — where volatility is the only unobservable one. The Greeks measure sensitivities: delta (to the underlying), gamma (to delta), vega (to volatility), theta (to time), and rho (to rates). Delta hedging neutralizes small price moves.

8 · Alternatives & Portfolio Management

Alternative Investments is 5–10% and Portfolio Management is 10–15%. Alternatives adds real-asset valuation; Portfolio Management adds multifactor models and active-risk measurement — the analytical core of building and judging a portfolio.

Private Real Estate & REITs

Private real estate is valued three ways — the income approach (capitalize NOI at a cap rate, or discount cash flows), the cost approach, and the sales-comparison approach. Direct capitalization is $\text{Value} = \dfrac{NOI}{\text{cap rate}}$, so a lower cap rate implies a higher value. REITs are valued with net asset value, price-to-FFO, and price-to-AFFO multiples.

Private Equity & Hedge Funds

Private equity (venture and buyout) is valued with DCF and comparable approaches, and judged on IRR and multiple-of-invested-capital net of the 2-and-20 fee structure (a management fee plus carried interest). Hedge funds pursue strategies — equity long/short, event driven, relative value, global macro — with similar fee structures and illiquidity. Both bring diversification but high fees and valuation difficulty.

Multifactor Models & Active Management

A multifactor model (the APT and the Carhart four-factor model) explains return through several systematic factors, each with a risk premium. Active management is measured by the information ratio — active return divided by tracking error — and the fundamental law of active management links it to skill and breadth.

Measuring & Managing Risk (VaR)

Value at risk estimates the minimum loss over a horizon at a confidence level, computed three ways — parametric (variance-covariance), historical simulation, and Monte Carlo. Know its limits (it says nothing about the size of losses beyond the cutoff), and complements such as conditional VaR, stress testing, and scenario analysis.

How to Use This Study Guide

A study guide is a map, not the whole territory — use it alongside the CFA Program curriculum and our practice tools, weighting your time toward the heaviest topics and, crucially, practicing full item sets. Level II punishes shallow, question-at-a-time preparation.

CFA Level 2 Glossary

Quick definitions for the terms you’ll see most across the CFA Level 2 exam:

Binomial option model

An option valuation method assuming the underlying moves up or down each period. It computes a risk-neutral probability and discounts the expected payoff at the risk-free rate.

Black-Scholes-Merton (BSM)

A continuous-time model that prices a European option from the underlying price, strike, time to expiration, risk-free rate, and volatility (the only unobservable input).

Bootstrapping

Deriving the sequence of spot (zero-coupon) rates from the prices of coupon-bearing bonds, one maturity at a time, so each cash flow can be discounted at its own spot rate.

Capitalization rate (cap rate)

Net operating income divided by property value. In real estate, a lower cap rate implies a higher value and typically a lower-risk, prime asset.

Consolidation

Accounting for a controlled subsidiary (over 50%): the parent combines all of the subsidiary's assets, liabilities, revenues, and expenses, reporting any non-controlling interest.

Covered interest rate parity

A no-arbitrage condition: the forward premium or discount on a currency equals the interest-rate differential between the two currencies, holding exactly because the position is hedged with a forward.

Current-rate method

Translating a foreign subsidiary at the current rate for assets and liabilities and the average rate for income, with the translation gain or loss reported in equity. Used when the local currency is functional.

Enterprise value (EV)

Market value of equity plus debt minus cash — the cost to acquire the whole firm. EV/EBITDA is a capital-structure-neutral multiple favored at Level II.

Equity method

Accounting for an investment with significant influence (typically 20–50% ownership): a single balance-sheet line, with the investor recording its share of the associate's net income.

Forward rate

An interest rate agreed today for a loan or investment that begins at a future date. Forward rates are implied by, and kept consistent with, the spot curve through no-arbitrage.

Free cash flow to equity (FCFE)

Cash available to common shareholders after operating expenses, taxes, investment, and net debt repayments. Discounted at the cost of equity to value equity directly. FCFE = FCFF − interest × (1 − tax) + net borrowing.

Free cash flow to the firm (FCFF)

Cash available to all of a firm's capital providers (debt and equity) after operating expenses, taxes, and investment in working and fixed capital. Discounted at the WACC to value the entire firm.

Funded status

The fair value of a defined-benefit pension plan's assets minus its benefit obligation. Positive is overfunded (a net asset); negative is underfunded (a net liability).

GIPS

Global Investment Performance Standards — voluntary, ethical standards for calculating and presenting investment performance so results are fair and comparable across firms.

Goodwill

The excess of the purchase price over the fair value of identifiable net assets in a business combination. It is not amortized but tested for impairment.

H-model

A two-stage dividend discount model in which the growth rate declines linearly from a high initial rate to a stable long-run rate over a defined period, approximating a gradually maturing firm.

Implied volatility

The volatility that, put into an option pricing model, makes the model price equal the option's market price — the market's expectation of future movement.

Information ratio

Active return (portfolio return minus benchmark return) divided by tracking error. It measures consistent value added by active management per unit of active risk.

Item set (vignette)

A Level II question format: a case scenario with exhibits, followed by about four multiple-choice questions that must be answered using the scenario's information rather than free-standing recall.

Justified P/E

A price-to-earnings multiple derived from fundamentals (payout, growth, and required return) rather than from peers, used to judge whether a stock's market multiple is reasonable.

Modigliani-Miller propositions

Theorems that, without taxes, capital structure does not affect firm value (Prop I) while the cost of equity rises with leverage (Prop II); with taxes, debt adds value via the interest tax shield.

Mosaic theory

Combining public information with non-material non-public information to reach an investment conclusion. It is permitted and is a defense against an insider-trading allegation under Standard II(A).

Multifactor model

A model expressing expected return as the risk-free rate plus the sum of factor sensitivities times factor risk premiums. Arbitrage pricing theory (APT) is the foundational example.

Net operating income (NOI)

A property's rental income less vacancy, collection losses, and operating expenses, before financing and taxes. The numerator in direct capitalization.

Option-adjusted spread (OAS)

The constant spread added to a benchmark interest-rate tree that makes a bond's model value equal its market price after removing the effect of any embedded option, allowing comparison across bonds.

Residual income

Net income minus an equity charge (equity capital × cost of equity). The residual income model values a stock as current book value plus the present value of future residual income.

Risk-neutral probability

The probability used in arbitrage-free option pricing: π = (1 + r − d) ÷ (u − d). It is a pricing device, not a real-world likelihood, because the option can be replicated.

Spot rate

The interest rate today for a single cash flow to be received at one future date — a zero-coupon yield. The spot curve underlies arbitrage-free bond valuation.

Temporal method

Translating monetary items at the current rate and non-monetary items at historical rates, with the gain or loss in net income. Used when the parent's currency is functional.

Tracking error

The standard deviation of a portfolio's active return (its return minus the benchmark's). It quantifies how closely a portfolio follows its benchmark.

Value at risk (VaR)

An estimate of the minimum loss expected over a set period at a given confidence level (e.g., a 5% one-day VaR of $1M means a 5$1M in a day).

Free CFA Level 2 Study Materials & Resources

Everything you need to prepare for the CFA Level 2 exam is free here — no paywall, no sign-up. This guide is the foundation; pair it with the rest of our free CFA Level 2 study materials for active recall, full-vignette practice, and last-minute review:

• CFA Level 2 Practice Test — exam-style item sets across all 10 topics, with explanations.
• CFA Level 2 Flashcards — active-recall decks for the high-yield valuation models, formulas, and concepts.

CFA Level 2 Study Guide FAQ

References

1. 1.CFA Institute. “CFA Program Level II Exam.” CFA Institute. ↑
2. 2.CFA Institute. “CFA Program — Become a Chartered Financial Analyst.” CFA Institute. ↑
3. 3.CFA Institute. “Code of Ethics and Standards of Professional Conduct (Guidance).” CFA Institute. ↑
4. 4.CFA Institute. “Global Investment Performance Standards (GIPS).” CFA Institute. ↑
5. 5.U.S. Securities and Exchange Commission. “Interest Rate Risk — When Interest Rates Go Up, Prices of Fixed-Rate Bonds Fall.” SEC.gov. ↑
6. 6.U.S. Securities and Exchange Commission. “Beginners' Guide to Financial Statements.” Investor.gov. ↑
7. 7.Board of Governors of the Federal Reserve System. “What is the difference between monetary policy and fiscal policy?.” Federal Reserve. ↑
8. 8.U.S. Securities and Exchange Commission. “Diversification — Investor.gov.” Investor.gov. ↑

Sources for the concept answers

Every answer in the CFA Level 2 concept questions above is drawn from an official primary source:

1. Board of Governors of the Federal Reserve System. “Foreign Exchange Rates and Interest Rate Parity.” Federal Reserve.

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