Free CFA Level II Practice Questions

B is correct. A creation unit is a large, standardized block of ETF shares (typically 25,000 to 100,000 shares, though the exact size varies by ETF) that serves as the unit of exchange in the creation/redemption process. Only authorized participants (APs) — typically large broker-dealers or market makers — can create or redeem shares in creation unit increments by exchanging the underlying securities (or cash) with the ETF issuer.

C is incorrect because individual investors cannot create ETF shares. They buy and sell existing shares on the secondary market (exchange). The creation process is reserved for authorized participants and occurs in large blocks, not single shares.

A is incorrect because the total number of ETF shares outstanding is not fixed — it changes continuously as APs create new shares or redeem existing ones. This open-ended structure is a key feature that keeps the ETF's market price close to its NAV.

B is correct. Backfill bias (also called instant history bias or incubation bias) occurs when a hedge fund begins reporting to a database and its historical performance (before the reporting start date) is added retroactively. Funds typically only begin reporting after they have established a good track record, so the backfilled returns tend to be higher than average. This creates an upward bias in the database's historical returns.

A is incorrect because retroactive revision of reported returns is not what backfill bias refers to. Most databases record returns as reported and do not allow revisions. While reporting fraud could theoretically occur, it is not the same concept as backfill bias.

C is incorrect because stale pricing is a different issue (related to illiquid positions not being marked to market frequently). While stale pricing can affect hedge fund return characteristics (smoothing returns, understating volatility), it is not backfill bias.

AFFO = FFO - Recurring Capital Expenditures - Non-cash Rent Adjustments (straight-line rent)
$$\text{FFO} = 75{,}000{,}000$$ (calculated previously)
$$\text{AFFO} = 75{,}000{,}000 - 12{,}000{,}000 - 3{,}000{,}000 = 60{,}000{,}000$$

AFFO per share: $\frac{60{,}000{,}000}{20{,}000{,}000} = 3.00$

A is correct. AFFO provides a more refined measure of recurring cash flow by deducting maintenance capex and adjusting for non-cash items like straight-line rent.

B is incorrect because 3.15 might result from not deducting the straight-line rent adjustment. Straight-line rent overstates current cash rental income by spreading rent escalations evenly over the lease term.

C is incorrect because 2.75 would result from deducting additional items beyond the standard AFFO calculation or from using a higher maintenance capex figure.