A hedge fund charges a 2% management fee and a 20% incentive fee subject to a high-water mark. In Year 1, NAV per unit falls from $100 to $90. In Year 2, NAV rises from $90 to $105 before fees. What is the most likely effect of the high-water mark provision on the Year 2 incentive fee?

The incentive fee is calculated only on the gain above the prior high-water mark of $100, i.e., on $5 ($105 − $100), not the full $15 recovery.

Best practice in corporate governance calls for the audit committee of the board to be composed:

Entirely, or almost entirely, of independent directors with relevant financial expertise

Free CFA Level I Practice Exam

More than 250 questions · Updated Nov 3, 2026

The CFA Program Level I exam, administered by CFA Institute, covers the fundamentals of investment tools, ethical standards, and asset valuation.

CFA Level I at a glance

Number of questions: 180 multiple-choice questions (90 per session, two sessions)
Time: approximately 4.5 hours

Full exam format

This site has more than 250 free CFA Level I practice questions with explanations.

Source: CFA Institute 2026 Level I Topic Outlines (learning outcomes)

Try a few CFA Level I questions

Question 1
A hedge fund charges a 2% management fee and a 20% incentive fee subject to a high-water mark. In Year 1, NAV per unit falls from $100 to $90. In Year 2, NAV rises from $90 to $105 before fees. What is the most likely effect of the high-water mark provision on the Year 2 incentive fee?
- A.The incentive fee is calculated on the entire $15 gain in Year 2 ($90 to $105).
- B.The incentive fee is calculated only on the gain above the prior high-water mark of $100, i.e., on $5 ($105 − $100), not the full $15 recovery.
- C.No incentive fee is owed in Year 2, because the fund must first recover to $110 (10% above the prior high) before any performance fee applies to later gains.
- D.The incentive fee is waived entirely for two years following any decline in NAV, regardless of subsequent performance.
Show answer and explanationHide answer
Correct answer: B. The incentive fee is calculated only on the gain above the prior high-water mark of $100, i.e., on $5 ($105 − $100), not the full $15 recovery.
A high-water mark ensures the manager earns an incentive fee only on net new gains above the highest previous NAV achieved (here, $100), preventing the manager from being paid twice on gains that merely restore prior losses. Since Year 2's ending NAV of $105 exceeds the prior high-water mark of $100 by $5, the incentive fee applies only to that $5, not the full $15 recovery from $90.
- A. Wrong. Ignores the high-water mark; charging on the full recovery would double-charge the investor for losses already suffered.
- B. Correct.
- C. Wrong. Invents an additional 10% hurdle beyond the actual high-water mark, which is simply the prior peak NAV; the fee applies to gains above $100, not only above $110.
- D. Wrong. Overstates the mechanism; a high-water mark is based on NAV levels relative to the prior peak, not a fixed time-based waiver.
- Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes)
Question 2
Best practice in corporate governance calls for the audit committee of the board to be composed:
- A.Entirely of members of executive management, who best understand the company's financials
- B.Entirely, or almost entirely, of independent directors with relevant financial expertise
- C.Of a majority of shareholders holding at least 5% of outstanding shares
- D.Of the company's external auditors, to ensure continuity of financial oversight
Show answer and explanationHide answer
Correct answer: B. Entirely, or almost entirely, of independent directors with relevant financial expertise
Governance best practice (and most listing standards) require the audit committee to consist entirely, or almost entirely, of independent directors, with at least some members possessing financial expertise, so the committee can objectively oversee financial reporting and the external auditor relationship without management influence.
- A. Incorrect. Staffing the audit committee with executive management undermines the independent oversight the committee exists to provide; management shouldn't police itself.
- B. Correct. Governance best practice calls for the audit committee to consist entirely or almost entirely of independent directors with financial expertise, ensuring objective oversight of financial reporting.
- C. Incorrect. The audit committee is a board committee made up of directors, not a body of large shareholders exercising direct control.
- D. Incorrect. External auditors must remain independent of the governance structure they report to; seating them on the audit committee would itself create a conflict of interest.
- Source: 15 U.S.C. § 78j-1
- Source: 17 CFR § 240.10A-3
Question 3
A stock currently trades at $50. Over the next period, it will move up to $60 or down to $45. The risk-free rate over the period is 5%. Using a one-period binomial model, the value of a call option with a strike price of $50 is closest to:
- A.$4.76
- B.$5.00
- C.$7.14
- D.$4.54
Show answer and explanationHide answer
Correct answer: A. $4.76
Up factor u = 60/50 = 1.20, down factor d = 45/50 = 0.90. Risk-neutral probability π = [(1+r) − d] / (u − d) = (1.05 − 0.90)/(1.20 − 0.90) = 0.50. Payoffs: Cu = max(60−50,0) = 10; Cd = max(45−50,0) = 0. C0 = [π×Cu + (1−π)×Cd] / (1+r) = [0.5×10 + 0.5×0] / 1.05 = 5/1.05 = $4.76. The $5.00 answer forgets to discount the expected payoff back at the risk-free rate. The $7.14 answer mistakenly uses a put-style payoff (max(X−S,0)) for the down state instead of $0. The $4.54 answer mistakenly discounts the expected payoff for two periods instead of one.
- A. Correct. With u=1.2, d=0.9, risk-neutral probability p=(1.05−0.9)/(1.2−0.9)=0.5; call payoffs are $10 (up) and $0 (down), so value = [0.5×$10 + 0.5×$0]/1.05 ≈ $4.76.
- B. Incorrect. $5.00 is the undiscounted expected payoff (0.5×$10); it must still be discounted back one period at the risk-free rate.
- C. Incorrect: $7.14 equals 7.50/1.05. It comes from putting a $5 payoff in the down state (the $5 by which $45 falls below the strike) and averaging it with the $10 up payoff. A call pays $0 when the stock ends below the strike, so the expected payoff is $5.00, not $7.50.
- D. Incorrect: $4.54 equals 5.00/1.05^2. It discounts the $5.00 risk-neutral expected payoff twice, though this is a one-period model and needs only one discounting step at 5%, which gives $4.76.
- Source: CFA Institute refresher reading: Valuing a Derivative Using a One-Period Binomial Model

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What’s on the CFA Level I

Ethical and Professional Standards15-20%
- Ethics and Trust in the Investment Profession
  Covers why codified ethics matter for a profession, how trust is built between investment practitioners and clients, and a general framework for working through ethical dilemmas.
- Code of Ethics and Standards of Professional Conduct
  Introduces the six components of the CFA Institute Code of Ethics and the seven Standards of Professional Conduct, along with how the Professional Conduct Program investigates and enforces violations.
- Guidance for Standards I-VII
  Applies each Standard to realistic practitioner scenarios so candidates can distinguish compliant conduct from violations and recommend firm policies that prevent breaches.
- Introduction to the Global Investment Performance Standards (GIPS)
  Explains why GIPS exists, who can claim compliance, how composites are built for performance reporting, and what independent verification of a firm's claim involves.
Quantitative Methods6-9%
- Rates and Returns
  Covers how to interpret interest rates as compensation for risk and time, and how to compute and compare money-weighted versus time-weighted portfolio returns.
- Statistical Measures of Asset Returns
  Builds fluency with central tendency, dispersion, skewness, and kurtosis so a candidate can characterize a return distribution's shape and risk.
- Hypothesis Testing
  Walks through setting up a hypothesis test, evaluating statistical significance, and understanding Type I/Type II errors and test power in an investment context.
- Simple Linear Regression
  Covers estimating a regression line via least squares, checking model assumptions through residual analysis, and interpreting fit statistics like R-squared.
Economics6-9%
- The Firm and Market Structures
  Compares how firms set price and output under perfect competition, monopolistic competition, oligopoly, and monopoly, and how to identify which structure a firm operates in.
- Understanding Business Cycles
  Describes the phases of the business and credit cycle and how indicators like housing, trade, and consumer activity move across them.
- Monetary and Fiscal Policy
  Contrasts the tools and objectives of central banks versus government fiscal policy, and how the two interact to influence growth, inflation, and exchange rates.
- Capital Flows and the FX Market
  Explains how the foreign exchange market functions, how exchange rate regimes affect trade and capital flows, and how to compute currency cross-rates and forward premiums/discounts.
Financial Statement Analysis11-14%
- Analyzing Income Statements
  Covers revenue and expense recognition principles, how accounting choices distort comparability, and calculating basic and diluted EPS.
- Analyzing Balance Sheets and Cash Flow Statements
  Covers reporting for intangibles, goodwill, and financial instruments on the balance sheet, plus how to derive and interpret direct/indirect cash flow statements and free cash flow measures.
- Financial Reporting Quality
  Teaches a framework for judging how aggressive or conservative a company's reporting is, and how to spot warning signs of earnings or balance-sheet manipulation.
- Financial Analysis Techniques
  Applies ratio analysis (liquidity, solvency, profitability) and DuPont decomposition to evaluate and forecast a company's financial performance.
Corporate Issuers6-9%
- Corporate Governance: Conflicts, Mechanisms, Risks, and Benefits
  Examines principal-agent conflicts among management, shareholders, and other stakeholders, and the governance mechanisms firms use to manage them.
- Capital Investments and Capital Allocation
  Covers evaluating capital projects with NPV, IRR, and ROIC, along with common pitfalls and the value of embedded real options in investment decisions.
- Capital Structure
  Explains what drives a company's financing mix, the Modigliani-Miller propositions, and how to estimate a company's weighted-average cost of capital.
- Working Capital and Liquidity
  Covers the cash conversion cycle and the methods companies use to manage short-term liquidity needs.
Equity Investments11-14%
- Market Organization and Structure
  Covers how securities and orders move through primary and secondary markets, margin trading mechanics, and the purpose of market regulation.
- Market Efficiency
  Contrasts weak-, semi-strong-, and strong-form efficiency and discusses anomalies and behavioral finance as challenges to the efficient markets view.
- Industry and Competitive Analysis
  Applies frameworks like Porter's Five Forces to size an industry, group comparable companies, and assess a firm's competitive position.
- Equity Valuation: Concepts and Basic Tools
  Covers dividend discount models and price-multiple approaches (P/E, P/S, P/B, enterprise-value multiples) for judging whether a stock is fairly valued.
Fixed Income11-14%
- Fixed-Income Bond Valuation: Prices and Yields
  Covers pricing a bond from its yield-to-maturity and the relationships among a bond's price, coupon, maturity, and yield.
- Yield-Based Duration and Convexity
  Covers modified duration, money duration, and convexity as tools for estimating how a bond's price reacts to yield changes, including portfolio-level measures.
- Credit Risk and Credit Analysis
  Explains probability of default and loss given default, how rating agencies assess creditworthiness, and the qualitative/quantitative factors used in analyzing corporate and government issuers.
- Fixed-Income Securitization (ABS/MBS)
  Covers how loans are pooled and tranched into asset-backed and mortgage-backed securities, along with prepayment risk and the cash-flow/risk profile of each structure type.
Derivatives5-8%
- Forward Commitment and Contingent Claim Features
  Defines forwards, futures, swaps, and options, and contrasts the payoff profile of a forward commitment against a contingent claim like an option.
- Arbitrage, Replication, and Cost of Carry
  Explains how no-arbitrage pricing and replication logic underlie derivative valuation, including the relationship between spot price, expected future price, and carry costs.
- Pricing and Valuation of Forwards, Futures, and Swaps
  Covers how forward and futures prices are determined and why they can diverge, plus how swap contracts can be viewed as a series of forward agreements.
- Pricing and Valuation of Options
  Covers the drivers of option value, put-call parity, and using a one-period binomial model to value a derivative under risk-neutral pricing.
Alternative Investments7-10%
- Alternative Investment Features, Methods, and Structures
  Categorizes the alternative asset universe and compares direct, co-investment, and fund-based access methods along with typical ownership/compensation structures.
- Investments in Private Capital: Equity and Debt
  Covers the investment characteristics of private equity and private debt and the diversification benefits they can add to a portfolio.
- Hedge Funds
  Contrasts hedge fund structures and strategies with traditional asset classes and examines their risk, return, and diversification profile.
- Introduction to Digital Assets
  Covers the basics of distributed ledger technology and how digital assets differ from traditional asset classes in risk, return, and portfolio role.
Portfolio Management8-12%
- Portfolio Risk and Return (Parts I & II)
  Builds the mean-variance framework, the capital allocation and capital market lines, and shows how combining a risk-free asset with a risky portfolio shapes the efficient frontier and beta.
- Basics of Portfolio Planning and Construction
  Covers writing an investment policy statement, setting risk/return objectives, and translating client constraints (liquidity, horizon, taxes, ESG preferences) into an asset allocation.
- The Behavioral Biases of Individuals
  Distinguishes cognitive errors from emotional biases and discusses how investor behavior can produce market patterns that classical theory doesn't fully explain.
- Introduction to Risk Management
  Introduces a risk governance framework, financial and non-financial risk sources, and the tradeoffs among methods for measuring and modifying risk exposure.

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About the CFA Level I exam

Passing score: CFA Institute does not publish a fixed passing percentage. The Minimum Passing Score (MPS) is a criterion-referenced score set using a modified Angoff standard-setting process: a panel of charterholders independently judges, question by question, the probability that a 'just-qualified' candidate would answer correctly, and the compiled results are the primary (not final) input to the MPS, which is ultimately approved by the CFA Institute Board of Governors. The MPS is maintained from one administration to the next through equating unless a significant change prompts a reset.
Prerequisites: To enroll in the CFA Program a candidate must meet one of: (1) a completed bachelor's (or equivalent) degree from an accredited institution, (2) be in the final year of a bachelor's degree program with the Level I exam window falling within 23 months of expected graduation, or (3) have a combination of professional work experience and/or higher education totaling at least 4,000 hours accrued over a minimum of 36 consecutive months. Candidates must also hold a valid international travel passport and agree to abide by the CFA Institute Code of Ethics and Professional Conduct Program.
Format: 180 multiple-choice questions (three answer choices: A, B, or C) split into two 135-minute sessions (2 hours 15 minutes each), computer-based, with an optional break between sessions; total seat time approximately 4.5 hours
Level: Level I of III sequential exams required for the CFA charter
Who it's for: Aspiring and early-career investment professionals (equity/credit analysts, portfolio management associates, risk and research staff) seeking the foundational body of knowledge for the CFA charter. It also draws career-changers entering investment management who need a broad, rigorous grounding in finance, accounting, and quantitative methods.

CFA Level I exam FAQ

How many questions are on the CFA Level I exam?

180 multiple-choice questions (90 per session, two sessions)

What is a passing score on the CFA Level I?

CFA Institute does not publish a fixed passing percentage. The Minimum Passing Score (MPS) is a criterion-referenced score set using a modified Angoff standard-setting process: a panel of charterholders independently judges, question by question, the probability that a 'just-qualified' candidate would answer correctly, and the compiled results are the primary (not final) input to the MPS, which is ultimately approved by the CFA Institute Board of Governors. The MPS is maintained from one administration to the next through equating unless a significant change prompts a reset.

What is the format of the CFA Level I exam?

180 multiple-choice questions (three answer choices: A, B, or C) split into two 135-minute sessions (2 hours 15 minutes each), computer-based, with an optional break between sessions; total seat time approximately 4.5 hours

Are there prerequisites for the CFA Level I?

To enroll in the CFA Program a candidate must meet one of: (1) a completed bachelor's (or equivalent) degree from an accredited institution, (2) be in the final year of a bachelor's degree program with the Level I exam window falling within 23 months of expected graduation, or (3) have a combination of professional work experience and/or higher education totaling at least 4,000 hours accrued over a minimum of 36 consecutive months. Candidates must also hold a valid international travel passport and agree to abide by the CFA Institute Code of Ethics and Professional Conduct Program.

Who should take the CFA Level I?

Aspiring and early-career investment professionals (equity/credit analysts, portfolio management associates, risk and research staff) seeking the foundational body of knowledge for the CFA charter. It also draws career-changers entering investment management who need a broad, rigorous grounding in finance, accounting, and quantitative methods.