Sustainable-Investing CFA Institute Sustainable Investing Certificate(CFA-SIC) Exam Free Practice Exam Questions (2025 Updated)

According to the Taskforce on Nature-related Financial Disclosures (TNFD), the four realms of nature include land, which is a critical aspect of the natural environment that businesses must consider in their sustainability and risk management strategies.

Step-by-Step Explanation:

TNFD Framework:

The TNFD was established to develop a framework for organizations to report and act on evolving nature-related risks. This framework is intended to help financial institutions and companies manage risks related to biodiversity and natural capital.

The CFA Institute highlights that the TNFD framework is essential for integrating nature-related financial risks into corporate and investment decision-making processes.

Four Realms of Nature:

The TNFD identifies four realms of nature that are critical for understanding and managing nature-related risks:

Land

Oceans

Freshwater

Atmosphere

These realms encompass the major natural systems that support life on Earth and are crucial for maintaining biodiversity and ecosystem services.

Significance of Land:

Land is a fundamental realm as it encompasses terrestrial ecosystems, forests, and agricultural areas. It is crucial for biodiversity, carbon sequestration, and providing resources for human activities.

The CFA Institute notes that sustainable land management practices are vital for mitigating risks related to deforestation, habitat loss, and soil degradation, which can have significant financial and environmental impacts.

Integration into ESG Strategies:

Companies and investors are increasingly recognizing the importance of integrating land-related risks into their ESG strategies. This includes assessing the impacts of their operations on land use, biodiversity, and ecosystem health.

The TNFD framework provides guidance on how to assess and report on land-related risks, helping organizations to enhance their sustainability practices and improve transparency.

Formal corporate governance codes are most likely to be found in all major world markets. These codes provide a framework for best practices in corporate governance and are widely adopted to enhance transparency, accountability, and investor confidence.

Global Adoption: Major markets around the world have established formal corporate governance codes to guide companies in implementing effective governance practices. These codes are often developed by regulatory bodies, stock exchanges, or industry associations.

Standardization of Practices: Corporate governance codes help standardize governance practices across markets, making it easier for investors to assess and compare companies. They cover key areas such as board composition, executive remuneration, and shareholder rights.

Regulatory Compliance: Compliance with governance codes is often mandatory or strongly encouraged, with companies required to disclose their adherence to these standards. This promotes consistency and enhances the integrity of the market.

Under the CICERO "Shades of Green" framework, a Yellow rating (Option A) indicates:

Lack of sufficient data to determine climate impact.

Potential misalignment with long-term sustainability goals.

Option B (Light Green) means the project supports climate-friendly solutions but is not transformational.

Option C (Medium Green) means the project is aligned with long-term climate goals but has areas for improvement.

Externalities are the positive or negative impacts of an asset that are not reflected in its financial costs.

Why A (Impact on the environment) is correct:

Infrastructure assets (e.g., roads, dams, power plants) create environmental and social externalities, such as:

Air pollution from transportation projects.

Habitat destruction from hydroelectric dams.

Noise pollution from airports.

Why not B or C?

B is incorrect—technical issues (e.g., equipment failure) are not classified as externalities.

C is incorrect—externalities originate from the asset itself, not external factors.

Impact investing involves investments aimed at generating a measurable positive social or environmental impact alongside financial returns, such as funding low-cost community housing. (ESGTextBook[PallasCatFin], Chapter 8, Page 451)

ESG portfolio optimization involves setting upper and lower bounds for ESG-related variables (Option C) to balance financial performance with ESG impact. For example:

Carbon footprint constraints: Ensuring portfolio emissions stay within a target range.

Sector exposure limits: Avoiding excessive concentration in high-emission industries.

Option A is incorrect because optimization is dynamic and does not apply rigid decisions.

Option B is incorrect because ESG optimization does not necessarily accept lower active risk—it depends on investor preferences.

Fiduciary duty (Option A) is the primary driver for ESG investment in pension plans. Trustees are legally obligated to act in the best interests of beneficiaries, which includes considering ESG factors that affect long-term risk-adjusted returns.

Option B (Loss aversion) is a behavioral bias, but pension ESG investment is based on financial materiality rather than loss avoidance.

Option C (Personal ethics of members) may influence individual choices, but pension plans follow fiduciary principles rather than personal beliefs.

GHG emissions are categorized into three scopes:

Scope 1: Direct emissions from a company’s owned facilities and vehicles.

Scope 2: Indirect emissions from purchased electricity, heating, or cooling.

Scope 3: Indirect emissions from the value chain, including leased assets, supply chain, employee commuting, and business travel.

Why C (Scope 3) is correct:

Leased assets are not directly owned but still contribute to a company’s carbon footprint.

Why not A or B?

A (Scope 1) applies to owned assets, not leased ones.

B (Scope 2) applies to purchased electricity, not leased buildings or vehicles.

The Inflation Reduction Act (IRA) of 2022 is the largest U.S. investment in climate action, focusing on clean energy incentives, tax credits, and subsidies.

Why A (Clean energies) is correct:

The IRA allocates $369 billion toward energy security and climate change initiatives, with the majority going to clean energy technologies such as:

Renewable energy (solar, wind, geothermal)

Energy storage systems

Hydrogen energy and biofuels

Why not B or C?

B (Clean transport) receives significant investment (EV tax credits, charging infrastructure) but is not the largest category.

C (Clean electricity) benefits indirectly, but the IRA prioritizes energy sources rather than distribution.

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)

Stewardship codes share similar principles across different regions, emphasizing long-term value creation, accountability, and the active role of shareholders in corporate governance. (ESGTextBook[PallasCatFin], Chapter 6, Page 276)

There is a relatively high correlation (Option C) between sovereign ESG scores and credit ratings because:

Countries with strong governance, environmental policies, and social stability tend to have higher credit ratings.

Weak ESG performance (e.g., corruption, political instability, climate risk) negatively affects sovereign creditworthiness.

Option A (Relatively low) is incorrect because major rating agencies (S&P, Moody’s, Fitch) integrate ESG factors into sovereign risk assessments.

Option B (Close to zero) is incorrect because ESG factors are material financial risks in sovereign credit ratings.

The performance impact of excluding certain sectors (such as tobacco or coal) can be more easily measured by comparing the portfolio's returns to a benchmark, showing the drag or enhancement due to this exclusion. (ESGTextBook[PallasCatFin], Chapter 7, Page 319)

The UN Guiding Principles on Business and Human Rights (UNGPs) (Option C) are based on the "Protect, Respect, and Remedy" framework, which outlines:

State duty to protect human rights.

Corporate responsibility to respect human rights.

Access to remedies for victims of human rights violations.

Option A (CHRB) assesses company performance but is not the foundation of this framework.

Option B (OECD MNE Guidelines) also address corporate responsibility but are broader than human rights.

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.

Quantitative ESG analysis involves numerical, measurable data that can be compared across companies and time periods.

Why A (Issuer-reported carbon emissions) is correct:

Carbon emissions data (Scope 1, 2, and 3) is measurable and numeric, often reported in metric tons of CO₂ equivalent (MTCO₂e).

This data can be used in financial models to assess climate risk.

Why not B or C?

B (Executive compensation policies) are qualitative, as linking pay to ESG goals involves policy assessments rather than hard data.

C (Investments and policies credibility) involves subjective judgment rather than numerical data.

Many climate-conscious pension funds employ fossil fuel exclusion strategies to align with low-carbon investment goals.

Why B (Exclude fossil fuel investments) is correct:

Many pension funds divest from coal, oil, and gas due to regulatory, reputational, and financial risks.

Example: Norwegian Sovereign Wealth Fund and CalPERS have divested from coal companies.

Why not A or C?

A (Accept lower returns) is incorrect—climate-focused funds aim for competitive risk-adjusted returns.

C (Investing in high-risk sovereign debt) is unlikely, as these countries face climate risks that could weaken financial stability.

The European Green Deal’s primary goal is to make the EU climate neutral by 2050 (Option A), meaning:

Net-zero greenhouse gas emissions by 2050.

Massive investment in renewable energy and clean technology.

Option B (55% emission reduction by 2030) is an intermediate milestone, not the main goal.

Option C (€372 billion mobilization) refers to the EU Recovery Plan but is not the core objective.

Traditional ESG research providers (Option C) like MSCI, Sustainalytics, and Refinitiv offer:

Comprehensive ESG ratings, data, and analytics.

Coverage of large-cap and mid-cap companies worldwide.

Option A (Highly automated) applies more to alternative providers (e.g., AI-driven ESG analytics).

Option B (Focus on small companies) is incorrect because large ESG providers mostly cover public, large-cap companies.

Both Enron and WeWork faced governance failures due to excessive control and influence by their CEOs (Jeffrey Skilling for Enron, Adam Neumann for WeWork).

Why C (CEO dominance) is correct:

Enron’s CEO misled investors through fraudulent accounting practices.

WeWork’s CEO (Adam Neumann) had unchecked authority, leading to unethical corporate decisions that ultimately resulted in a failed IPO.

Why not A or B?

A (Auditor lapses) is relevant for Enron (Arthur Andersen scandal) but not a key factor in WeWork’s collapse.

B (Related-party deals) occurred at WeWork (e.g., CEO leasing buildings to his own company) but was not a central issue in Enron’s collapse.

Engagement (Option B) is the active process of fund managers interacting with investee companies to:

Encourage ESG improvements.

Address material risks impacting long-term value.

Option A (Monitoring) is passive observation, not action.

Option C (Corporate sustainability) applies to company policies, not investor actions.

Engagement (Option B) is a key component of responsible stewardship, with the objective of preserving and enhancing long-term value in investee companies. Investors engage with companies on ESG issues such as climate risk, diversity, and governance to improve performance and reduce long-term risks.

Option A is incorrect because smaller asset owners often rely on collaborative engagement or delegate stewardship activities to investment managers rather than engaging directly.

Option C is incorrect because reactive engagement (triggered by share price declines) is generally less effective than proactive, long-term engagement strategies focused on sustainability improvements.

Impact investing seeks to generate positive, measurable social or environmental outcomes alongside financial returns.

Why A (impact investing) is correct:

Impact investors explicitly aim for measurable ESG outcomes, such as reducing carbon emissions or improving social equity.

Example: Funds investing in affordable housing, renewable energy, or microfinance.

Why not B or C?

B (Best-in-class) refers to selecting the top ESG performers, not necessarily requiring measurable ESG outcomes.

C (Exclusions-based) avoids certain sectors but does not actively generate ESG impact.

The ISSB (International Sustainability Standards Board) aims to standardize sustainability reporting by aligning it with financial reporting timelines.

Why B (published with financial statements) is correct:

ISSB requires sustainability disclosures to be integrated with financial reporting to improve transparency.

Why not A?

Sustainability disclosures are not yet universally required to be audited—this remains an evolving requirement, unlike financial statements, which must be audited.

Active ownership refers to investors using their rights (voting, engagement, resolutions) to influence corporate behavior.

Why C (Proxy voting with an agenda) is correct:

Active owners use proxy voting to push ESG policies (e.g., climate risk disclosures, executive compensation reforms).

Example: BlackRock and Vanguard vote on shareholder resolutions to demand climate risk reporting.

Why not A or B?

A (Negative screening) is a passive strategy, not active ownership.

B (Disinvestment) is sometimes used but is not the main strategy of active ownership.

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)

ESG ratings can be noisy due to variations in methodology, data sources, and subjective judgments by rating agencies, leading to inconsistencies across ratings for the same company. (ESGTextBook[PallasCatFin], Chapter 7, Page 364)

The Semite, Bhagwat, and Yankee (2018) study found that board diversity, particularly in thought and experience, helps reduce stock return volatility by:

Enhancing risk management through better decision-making.

Reducing governance failures by avoiding groupthink.

Encouraging long-term investment strategies that contribute to stable financial performance.

Why not A or C?

A is incorrect because diverse boards do not necessarily reduce R&D investment; in fact, some studies suggest they may promote more innovative decision-making.

C is incorrect because greater homogeneity (lack of diversity) often leads to poor governance outcomes, not higher profitability.

A lower terminal growth rate due to ESG risks (Option A) results in:

A lower valuation in a discounted cash flow (DCF) model.

Higher expected regulatory costs, operational risks, or reputational issues reducing future cash flows.

Option B (Same valuation) is incorrect because ESG risks impact long-term growth assumptions.

Option C (Higher valuation) is incorrect—ESG risks increase discount rates, lowering present value.