Free Practice Questions for CFA Institute Sustainable-Investing Exam

Different ESG rating agencies (MSCI, Sustainalytics, Refinitiv, etc.) use different methodologies, leading to low correlation among ratings.

Why C (more difficult for companies) is correct:

Companies struggle to improve ESG scores because rating criteria differ significantly across providers.

Example: A company may score high on MSCI but low on Sustainalytics, making it harder to demonstrate ESG improvement.

Why not A or B?

A is incorrect because inconsistency creates challenges rather than making improvement easier.

B is incorrect because ESG ratings do influence corporate ambition to improve sustainability efforts.

ESG integration at the portfolio level focuses on risk management to protect and enhance financial returns.

Why B (Risk management measures) is correct:

ESG integration aims to reduce exposure to financially material ESG risks (e.g., climate risk, governance failures).

Portfolio managers use ESG data to assess company-specific and systemic risks.

Why not A or C?

A (Credit analysis) applies more to fixed-income investing.

C (Ownership & stewardship) relates to active engagement rather than ESG risk integration.

The carbon offset market allows companies and individuals to purchase carbon credits to compensate for their emissions.

Why C (voluntary and regulated aspects) is correct:

Regulated markets: Compliance-based (e.g., EU Emissions Trading System, California Cap-and-Trade Program).

Voluntary markets: Used by companies seeking to offset their carbon footprints (e.g., via Verra, Gold Standard projects).

Why not A or B?

A (Very transparent) is incorrect—voluntary carbon markets often lack transparency and face greenwashing risks.

B (Rigorous scientific process) is partly true but varies widely between high-quality and low-quality offsets.

Engagement teams focusing on governance issues are often organized by sector because governance practices and challenges can vary significantly across industries, making a sector-based approach more effective. (ESGTextBook[PallasCatFin], Chapter 6, Page 283)

Conduct-related exclusions (Option C) filter out companies based on unethical or controversial business activities, such as:

Gambling, tobacco, weapons, fossil fuels, and human rights violations.

Used in ESG-focused and socially responsible investing (SRI) indices.

Option A (Faith-based exclusions) are religion-specific (e.g., Islamic finance avoiding alcohol or pork-related businesses).

Option B (Idiosyncratic exclusions) refer to custom exclusions tailored to investor preferences, not general ESG norms.

The GRESB framework’s application can be influenced or controlled by majority owners, which may limit its effectiveness in assessing the sustainability of real estate investments if it is not applied rigorously. (ESGTextBook[PallasCatFin], Chapter 8, Page 451)

Scope 3 emissions (Option C) include indirect emissions from supply chains, investments, and consumer use, making finance and technology sectors particularly exposed because:

Finance: Banks and asset managers finance high-emission industries, leading to significant Scope 3 exposure.

Technology: Cloud computing, data centers, and supply chains generate significant Scope 3 emissions (e.g., electronics manufacturing).

Option A (Scope 1 emissions) refers to direct emissions, which are low for finance and tech.

Option B (Scope 2 emissions) involves purchased electricity, which is relevant but not a major exclusion factor.

Environmental risks and opportunities impact both financial forecasts and valuation multiples (Option C) by:

Adjusting revenue and cost projections (e.g., higher carbon taxes or lower energy costs from renewables).

Affecting valuation multiples, as companies with strong ESG performance often receive higher price-to-earnings (P/E) or lower discount rates due to reduced risk.

Option A (Financial forecasts only) ignores the impact on valuation multiples.

Option B (Valuation multiples only) overlooks how environmental risks affect revenue, costs, and profitability.

Human rights violations are most prevalent deep within supply chains, where oversight is weakest.

Why B (Deep in supply chains) is correct:

First-tier suppliers are often audited, while deeper tiers have less transparency.

Forced labor, child labor, and unsafe working conditions are more common in third-tier and informal supply chains.

Example: Textile industry abuses in subcontracted factories.

Why not A or C?

A is incorrect—first-tier suppliers face more scrutiny from brands.

C is incorrect—violations are even more likely in third-tier suppliers and beyond.

The Corporate Governance Committee (Option C) ensures the board:

Has diverse, skilled, and independent directors.

Follows best practices in governance, ethics, and oversight.

Option A (Audit committee) focuses on financial reporting and risk management.

Option B (Compensation committee) oversees executive pay and incentives.

The SASB Materiality Map (Option C) is designed to identify material ESG issues for specific industries and companies, helping investors:

Understand which ESG issues impact financial performance.

Assess and compare ESG risks across sectors.

Option A (Only covers equities) is incorrect because SASB standards apply to multiple asset classes.

Option B (Portfolio-level exposure) is more relevant to ESG rating agencies rather than SASB’s framework.

Investment managers in passive/index tracking strategies (Option C) frequently use proxy voting as a primary tool to influence companies because:

They cannot sell underperforming ESG stocks easily (since they track an index), so they engage through voting and shareholder resolutions.

Major passive fund managers like BlackRock, Vanguard, and State Street use voting to drive ESG changes.

Option A (Real estate) lacks public voting mechanisms—investors engage via direct ownership.

Option B (Private debt) involves debt covenants, not voting rights.

A healthcare company’s ESG-contingent asset (Option C) arises when its data analytics division enables cost-effective healthcare solutions for governments, leading to:

Long-term value creation through cost savings.

A competitive ESG advantage due to social impact.

Option A (Custodian of medical details) is an ESG responsibility but not a contingent asset.

Option B (Lagging recruitment strategies) is an ESG weakness, not an asset.

The 2020 version of the UK Stewardship Code emphasizes reporting on the outcomes from ESG activity, highlighting the practical impact of stewardship efforts rather than just focusing on policies or intentions. (ESGTextBook[PallasCatFin], Chapter 6, Page 276)

Greenhushing occurs when a company is reluctant to publicly share its sustainability achievements or goals due to fears of backlash or misunderstanding from stakeholders. (ESGTextBook[PallasCatFin], Chapter 7, Page 364)