Chartered Financial Analyst (CFA) Practice Exam Level 2

For investments classified as amortized cost, what types of securities does this apply to?

1. Only common stocks

2. Only fixed income securities

3. All types of securities

4. Only mutual funds

The correct answer is: Only fixed income securities

Amortized cost is a method used to account for certain types of financial instruments, specifically those that are expected to be held until maturity. This accounting treatment is most commonly applied to fixed income securities, such as bonds and loans, where the intent is to retain the investment until it matures. Under amortized cost accounting, the security is initially recorded at its purchase price, and over time, its value is adjusted for any principal repayments and the amortization of any premium or discount from the purchase price to face value. This approach is suitable for fixed income securities because it provides a more accurate representation of the value of investments that are expected to accrue interest income over time and where the investor does not intend to sell the security before maturity. Common stocks, on the other hand, do not fall under amortized cost because they do not have a fixed maturity date or fixed income; their value is inherently volatile and subject to market fluctuations. Similarly, mutual funds can invest in a variety of securities, but they are generally not accounted for using amortized cost because their valuations are based on the market value of the underlying assets. Thus, the correct context for amortized cost is indeed fixed income securities.