Free CFA Institute Sustainable-Investing Practice Exam with Questions & Answers | Set: 14

Thematic fundsfocus onspecific investment themes(e.g., renewable energy, clean tech, diversity-focused companies), often leading toconcentration riskandlimited portfolio diversification. Because they focus on anarrow subsetof industries or trends, their risk profile ishigherthan broadly diversified funds.

While some thematic funds may outperform in certain cycles (C),performance is not guaranteed, and they can underperform in downturns. Poor cash flow profiles (A) depend on the companies selected, not a universal characteristic of thematic funds.

TheEU Sustainable Finance Disclosure Regulation (SFDR)requires asset managers todisclose ESG risksin investment decisions, promotingtransparency on sustainability factors. It applies toall financial market participantsin the EU.

TheEU Taxonomy (A)defineswhat qualifies as a "green" investment, while theShareholder Rights Directive (B)focuses oncorporate governance and investor engagement.

Berg, Koelbel, and Rigobon (2022) found thatESG ratings from different providers (e.g., MSCI, Sustainalytics, FTSE) have low correlation, makingcomparisons difficult. This inconsistencyhinders empirical researchandleads to investor confusion.

Cultural dynamics are not a primary engagement dynamic identified by PRI.The key dynamics that drive engagement value include:

Learning dynamics (B): Mutual knowledge-sharing between investors and companies

Communicative dynamics (C): Effective dialogue leading to ESG improvements

Double materialitymeans a company must reportnot only how ESG risks impact financial performancebut alsohow the company’s activities impact society and the environment.

For example, under theEU Corporate Sustainability Reporting Directive (CSRD), companies must disclose:

Financial materiality(how ESG issues affect financial performance)

Impact materiality(how the company affects the environment and society)

Employee relations(e.g., fair wages, diversity, workplace safety) are a keysocial factorunder ESG. Companies withstrong labor policiestend to havehigher productivity and lower turnover risks.

Lobbying (A)is agovernanceissue.

Bribery & corruption (C)are alsogovernance risks, not social risks.

ESG indices exist forboth equity and fixed income, covering a range of investment vehicles such ascorporate bonds, sovereign bonds, and green bonds. Major providers likeMSCI, S&P, and FTSE Russelloffer ESG indices across asset classes.

Option A is incorrect because ESG index methodologies vary significantly between providers. Option C is misleading becausebacktesting ESG performanceis complex due tolimited historical ESG data.

Brown divestmentrefers topublicly traded firms selling off polluting assets (e.g., coal mines, oil refineries) to third partiesrather than shutting them down.

Screening out fossil fuels (A) is part of exclusionary ESG investing but does not define brown divestment.

Investing only in positive-impact firms (B) is more aligned with green or impact investing.

Regime-switching modelsare used instrategic asset allocationtocapture shifts in market conditions, such as economic recessions, financial crises, or climate-related disruptions. These models allow investors toadjust portfolio allocations based on different market regimes.

They do capture fat tails (A),meaning they can account for extreme events.

They incorporate both historical and forward-looking data (B).

Share buybacks impact a company’s capital structure, and investors may voteagainst excessive buybacksif theyweaken financial stability or reduce reinvestment in sustainable growth.

Auditor compensation (B) and board elections (C) are important but do not directly affect capital structure decisions.

Income inequality oftenreduces access to education, particularly for lower-income individuals who may struggle withtuition costs, lack of resources, and unequal schooling quality. This, in turn, canreduce upward social mobilityand widen wealth disparities over time.

Option C (tax optimization strategies) is a separate corporate governance issue and not adirectresult of income inequality. Option A (increase in social mobility) is incorrect ashigher inequality often reduces social mobility.

ESG data variability is more pronounced between countries (B) than between companies (C) within the same country. Developed marketshave more standardized ESG disclosure requirements, while emerging marketslack regulatory consistency, making cross-country comparisons difficult.

TheJevons paradoxoccurs whenincreased efficiency in using a resource leads to a higher overall consumption of that resourcerather than a decrease.

Example:As fuel efficiency improves in cars, people maydrive more, increasing overall fuel consumption.

This effect can reduce the expected benefits of energy efficiency measures.

Option A relates to climate economics but does not describe the Jevons paradox.

Option C describes the albedo effect, not Jevons paradox.

Thecircular economyfocuses onreducing waste and maximizing resource efficiency.Sustainable resource use (B)aligns directly with circular economy principles, as it promotesrecycling, renewable materials, and closed-loop production systems.

Pollution (A) and climate change (C) are environmental risks but do notdirectlysupport the transition to a circular economy.

Themanagement gaprefers torisks that are known but not yet actively managed. This could includeESG risks that companies acknowledge but have not integrated into their governance or risk management processes.

Unrated credit positions (B) are a separate riskrelated to credit ratings.

All risks (A) can technically be managed, but some may beneglected due to lack of prioritization or resources.