Free CFA Institute Sustainable-Investing Practice Exam with Questions & Answers | Set: 8

TheEnvironmental Economicssection of the OTM references key climate economists and their frameworks. It notes:

“EconomistMartin Weitzmandeveloped theDismal Theorem, arguing that conventional cost–benefit analysis cannot capture the potentially infinite downside risks associated with catastrophic climate outcomes.”

Weitzman’s theorem suggests that when the probability distribution of climate damage includes “fat tails,” the expected utility approach underestimates extreme losses. As a result, traditional economic models fail to justify sufficient precautionary action.

The OTM contrasts this with Nicholas Stern’s work on economic externalities and Kate Raworth’s “Doughnut Economics,” which focuses on social and ecological boundaries. Thus,option Cis the correct answer, supported directly by the cited theoretical framework.

????Reference:2021-Final-Book.pdf, Chapter 3 — Environmental Factors (Climate Economics and Theoretical Models section).

TheESG Data and Analytical Toolssection of the Official Training Manual (OTM) discusses the evolving landscape of ESG assessment systems. It emphasizes:

“Completeness of coverage varies substantially across ESG tools, with differences in geographic scope, sector coverage, and data frequency. Some tools prioritize disclosure-based indicators, while others integrate estimated data or controversies.”

This statement captures the complexity and fragmentation of ESG analytics—no single platform offers comprehensive global coverage. The manual warns that “investors should evaluate tools based on coverage, data timeliness, and methodological transparency.”

Option A is incorrect since most ESG tools (e.g., MSCI ESG Manager, Refinitiv, Bloomberg ESG) aresubscription-based. Option C is also wrong because methodologies evolve continually to incorporate new standards such as SASB, TCFD, and SFDR.

Thus, the verified correct answer isB.

????Reference:2021-Final-Book.pdf, Chapter 7 — ESG Data Quality and Integration (Analytical Tools and Methodologies section).

Within theEnvironmental Factorschapter, the OTM discusses climate risk in project valuation, highlighting physical risk impacts:

“Rising temperatures, flooding, and heat stress can increaseoperating expensesfor infrastructure assets due to higher cooling requirements, maintenance costs, and efficiency losses.”

For instance, energy facilities may require enhanced insulation, cooling systems, or backup capacity—all directly impacting operating expenditure (OPEX). Revenues might also fluctuate, but theprimary and quantifiable effectlies in cost escalation rather than revenue reduction.

Therefore, the correct analytical adjustment in discounted cash flow (DCF) models would be to increaseoperating expenses, makingoption Ccorrect.

????Reference:2021-Final-Book.pdf, Chapter 3 — Environmental Factors (Physical Climate Risks and Financial Implications section).

Most companies, particularly those operating under strong corporate governance frameworks (e.g., UK Corporate Governance Code), are expected to maintainthree principal board committees: audit, nomination, and remuneration. These committees serve critical governance functions—financial oversight, board composition, and executive pay.

“Expectations and duties of the three principal board committees that almost all major companies have in place: the audit committee… the nominations committee… and the remuneration committee.”

While sustainability or risk committees may exist in some firms, they are not as universally established as the three mentioned above.

The manual explicitly notes: “One can deduce that individual companies in the same market-defined sector may be judged to have different material ESG factors impacting their business.” It illustrates this with examples within insurance.

More broadly, it stresses that identifying “issues which are genuinely material to a sector and company is one of the most active challenges within ESG investment… there are also differences between what is most material to individual companies within a single sector.”

TheESG Investment Strategiessection of the Official Training Manual (OTM) describes systematic ESG approaches, including long–short equity models. It states:

“Quantitative ESG long–short strategiestypically involve takinglong positions in top-decile ESG-rated stocksandshort positions in bottom-decile ESG-rated stockswithin the same sector or region, to neutralize market beta while capturing ESG-related alpha.”

This method uses ESG scores as a differentiating signal while maintaining overall factor neutrality (e.g., size, sector). The manual further notes that these strategies “allow investors to isolate ESG-driven return differentials, removing market or style bias.”

Sectors are not typically shorted directly (eliminating option C), and “non-ESG-rated” stocks (option A) would not fit within systematic ranking models since such firms lack data for quant selection.

Hence, the verified and precise answer isB, supported by direct methodological reference.

????Reference:2021-Final-Book.pdf, Chapter 8 — ESG Integrated Portfolio Construction (Quantitative ESG Approaches section).

Stock exchanges play a critical role in enhancing ESG transparency by mandating or encouraginghigher ESG disclosure standardsfor listed companies. This helps investors accessmaterial ESG informationfor better decision-making.

“Stock exchanges can increase disclosure requirements on ESG data by listed companies (as encouraged by the Sustainable Stock Exchange Initiative).”

While they may support ESG-related products, such as green bonds, theircore contributionlies inregulatory influenceover disclosures.

The Official Training Manual (OTM) explains that although passive ESG strategies replicate indices, they have evolved to incorporate engagement and stewardship functions to influence corporate behavior. It states:

“While active managers have traditionally led on stewardship,passive managers are increasingly demonstrating that stewardship activity can be focused, consistent, and long termin nature. By holding positions indefinitely, they have a structural incentive to engage companies to enhance long-term value creation.”

This directly supports optionB, as passive ESG managers, such as those managing ESG ETFs, cannot “walk away” by selling and instead use stewardship as a primary tool. The OTM further notes that these strategies rely on “systematic engagement across all holdings” to improve ESG outcomes rather than short-term trading.

Options A and C are not universally correct: passive funds tend to belower cost(contradicting A), and while some exclusions occur, the OTM does not identify that as their most defining feature (contradicting C).

????Reference:2021-Final-Book.pdf, Chapter 8 — ESG Integrated Portfolio Construction and Management (Passive ESG Strategies section).

Environmental degradation such asdesertificationandwater scarcityis a major driver ofclimate-induced migration. These factors reduce agricultural productivity, cause food insecurity, and make regions uninhabitable.

“Water scarcity and desertification are both drivers of migration as communities seek access to resources and economic opportunities in less-affected regions.”

Both stressors contribute significantly to human displacement, particularly from rural areas in developing countries.

TheBlue Economy and Natural Resourcessection of the OTM cites the OECD’s “Ocean Economy in 2030” report:

“The OECD estimates thatocean-based industriessuch as shipping, offshore wind, and aquaculture couldoutperform global GDP growth rates by 2030, contributing strongly toboth value added and employment.”

This dual benefit arises from technological innovation, renewable energy expansion, and sustainable fisheries management. The manual highlights that marine sectors not only drive economic productivity but also generate millions of jobs globally, aligning with SDG 14 (“Life Below Water”).

Therefore,option Cis correct, as the OECD’s analysis explicitly references both economic (value added) and social (employment) dimensions.

????Reference:2021-Final-Book.pdf, Chapter 3 — Environmental Factors (Ocean Economy and Resource Sustainability section).

Inissue-based engagement, investors addressspecific ESG issuesthat affect multiple companies or sectors. These engagements are often supported byexamples of best practice, which may emerge through prior engagements or research.

“Issue-based approaches to engagement are often accompanied by examples of what best practice in a particular area looks like... By expecting all companies in a given sector to adopt these best practices, investors may over time move sector or industry practice forward overall.”

While active investors may prefer company-specific engagements,issue-based engagementsare more commonly used bypassive or diversified investors.

“There are many types of diversity needed for a board to be successful,though the most important is diversity of thought. The other types include diversity of gender, race, age, culture, nationality and experience….”

TheAudit and Assurancesection of the OTM provides clear definitions from international auditing standards. It states:

“Performance materialityrepresents the threshold below overall materiality that auditors use to reduce the risk that aggregate uncorrected misstatements exceed overall materiality. It alsoreflects the auditor’s confidence in the company’s control environment and financial systems.”

This means auditors lower performance materiality when they haveless trustin internal controls and raise it when controls are robust. The concept thus indicates thedegree of auditor trustin the company’s systems—exactly as captured inoption C.

Options A and B contradict the principle: performance materiality isalways lowerthan overall materiality, and its adjustment direction depends on risk, not the absolute control strength.

Hence,option Cis verified as correct.

????Reference:2021-Final-Book.pdf, Chapter 5 — Governance Factors (Audit Quality and Assurance Frameworks section).

The OTM defines engagement as a cornerstone of active ownership, describing it as:

“A structured process by which investorscommunicate expectations to investee companieson ESG practices and long-term value creation.”

It further notes:

“Engagement helps companiesbetter understand investor expectations and prioritieswhile giving investors insight into corporate governance and risk management practices.”

This explanation precisely reflectsoption A. Conversely, the manual emphasizes that engagement is least effective when a company shows resistance or lacks openness (contradicting option C) and that successful engagement islong-term and relationship-driven, not reactive to short-term price movements (contradicting option B).

Thus, engagement’s primary value lies in facilitating two-way understanding between investors and companies, confirming optionAas correct.

????Reference:2021-Final-Book.pdf, Chapter 6 — Engagement and Stewardship (Purpose and Benefits of Engagement section).

One of the most cited issues in ESG data is thelow correlationbetween ESG ratings from different providers. This inconsistency arises from differing methodologies, weightings, and data sources.

“ESG ratings from different providers often show low correlation… making it difficult for investors to compare ratings and for companies to respond to a unified set of ESG expectations.”

Thus,option A is least accurate, while B and C reflect common observations.