CFA brainscape

Question 1

Residual Dividend Model

Answer 1

1. Calc cap needs
2. Pick cap structure
3. Calc new cap needs from equity
4. (Earnings - equity cap investment needed) = div

Question 2

5 reasons to repurchase shares

Answer 2

1. Tax advantage
2. Share price support / signaling
3. Added flexibility (vs. div)
4. Offsetting dilution from employee stock options
5. Increasing financial leverage , change cap structure

Question 3

Is it good to repurchase shares

Answer 3

1. earnings yld = EPS / stock price
2. EPS after buyback = (earnings - cost of borrowing) / (existing shares - buy back shares)
3. Is New EPS > old EPS, then repurchase good
4. Good if borrowing cost < earnings yld

Question 4

1. Div payout ratio
2. Div coverage ration
3. FCFE coverage ratio

Answer 4

1. Div payout ratio = divs / NI
2. Div coverage ratio = NI / divs
3. FCFE coverage ratio = FCFE / (divs + repurchases)

Question 5

3 Investor div preference theories

Answer 5

1. MM’s div irrelevance
2. ‘Bird in the hand’
3. Tax aversion

Question 6

2 Goals of corporate governance

Answer 6

1. Eliminate/reduce conflicts of interest, especially between management and shareholders
2. Use company’s assets in best interest of investors and shareholders

Question 7

4 Elements of a good corporate governance system (core attributes)

Answer 7

1. Defined rights of shareholders/stakeholders
2. Defined ovesight responibilities of managers/directors
3. Fair treatment between managers/directors/shareholders
4. Transparency of operations, risk, performance

Question 8

Corporations: proportion of all businesses, proportion of revenue

Answer 8

20% of businesses
90% of revenue

Question 9

Board of directors risk as agents of shareholders

Answer 9

1. Lack of independence
2. Personal relationships w/management
3. Director has business relationship with firm
4. Interlinked boards
5. Over compensation

Question 10

Good corp governance traits for board (8/14)

Answer 10

1. > 75% BOD are independent
2. Chairman & CEO split
3. Good qualifications
4. Annual, non-staggered elections
5. BOD self assessments
6. BOD only meetings (no mng)
7. Independent audit cmmtt
8. Independent nominating cmmtt

Question 11

Good corp governance traits for board (6/14)

Answer 11

9. Compensation cmmtt (?)
10. Independent BOD legal consel
11. Statement of governance policies
12. Disclosure & transparency
13. Insider transactions approved by BOD
14. Responsiveness to shareholder proxy votes

Question 12

4 risks from bad corporate goverance

Answer 12

1. Financial disclosure risk
2. Asset risk
3. Liability risk
   4.

Question 13

M&A | merger

Answer 13

one company buys ALL of another company
acquirer and target

Question 14

2 dimensions of M&A

Answer 14

1. Forms of integration: how companies physically come together
2. Type of merger: how the companies’ businesse activities relate to each other

Question 15

M&A | 3 forms of integration

Answer 15

1. Statutory merger: one company ceases to exit
2. Subsidiary merger: parent + subsidiary
3. Consolidation: both companies cease to exist >> completely new company

Question 16

M&A | 3 types of mergers

Answer 16

1. Horizontal: similar businesses
2. Vertical: along supply chain (raw materitals/backwards, consumer/forwards)
3. Conglomerate: separate industries

Question 17

Reasons for M&A

Answer 17

1. Synergy
2. Rapid growth
3. Market power
4. Gain unique capabilities
5. Diversification
6. Bootstrapping EPS
7. Personal benefits to mng
8. Tax benefits
9. Hidden value
10. Int’l business goals

Question 18

M&A | Bootstrapping

Answer 18

1. Increasing EPS by M&A wo/ increase in earnings
2. High PE co. buys low PE co.
3. No new economic value
4. EPS increase b/c per dollar of mkt cap you get more earnings

Question 19

M&A and industry life cycle

Answer 19

1. prioneer/dev: congomerate, horizontal
2. rapid growth: conglomerate, horizontal
3. mature: horizontal, vertical
4. stabilization: horizontal
5. decline: all 3

Question 20

2 technical forms of acquisition

Answer 20

1. Stock purchase
2. Asset purchase

Question 21

M&A | Stock purchase and asset purchase

Answer 21

SP|AP - 1. Payment: sharehoder|company

2. Approval: maj of shareholders|company unless > 50% of assets
3. Taxes: shareholder pay cap gains| co. pays cap gains
4. Liabities: buyer assumes liabilities|does not assume liabilities
5. Notes: buy 100% of co. | buy some assets

Question 22

M&A | Anti-trust & HHI

Answer 22

HHI past merger|Change|Anti-trust action - 1. < 1000 | doesn’t matter | no action

2. 1000-1500 | > 100 | possible
3. > 1500 | > 50 | yes

Question 23

M&A | Post offer defense mechanism

Answer 23

1. Just say no
2. Litigation
3. Greenmail
4. Share repurchase
5. Leveraged recapitalization
6. Crown jewel defense: possibly legal
7. Pac-man
8. White knight: winner’s curse
9. White squire

Question 24

Herfindahl - Hirschmann Index

Answer 24

1. If change > 100, then anti-trust issue
2. HHI = ∑ (MS x 100)2 from 1 to n, MS = mkt share, n = firms in industry
3. < 1800 is competitive

Question 25

M&A| Discounted cash flow (DCF) analysis steps

Answer 25

(similar to FCFE), Calc FCF: 1. Decide on FCF mode 2. Dev pro forma financial estimates 3. calc FCF using estimates 4. discount FCF using WACCadjusted 5. Determine terminal value then discount 6. Add all PV FCF together

Question 26

M&A| Discounted cash flow (DCF): calc FCF

Answer 26

NI + Net interest after tax | unlevered NI +- deferred tax change | net op profit less adj taxes (NOPLAT) + non-cash charges (NCC) +- ∆NWC - cap ex| FCF, NWC = CA(- cash) - CL(- ST debt)

Question 27

M&A|Discounted cash flow (DCF): 2 terminal value methods

Answer 27

1. Constant growth: term val = FCFT(1+g) / (WACCadj - g) 2. Market multiple: term val = FCFT x (P/FCF), P = projected price

Question 28

M&A| 3 valuation of target company methods

Answer 28

1. Discounted cash flow (DCF) analysis 2. Comparable company analysis 3. Comparable transaction analysis

Question 29

M&A| Comparable transaction analysis for target valuation

Answer 29

Similar to comparable company analysis, but only mergers 1. Find comparable companies that were acquired 2. Calc relative value metrics based on deal price 3. Create descriptive metrics (avg, median, etc)

Question 30

M&A | Empirical results

Answer 30

1. Target get 30% premium 2. Acquirers: ST ↓1-3%, LT after 3yrs ↓ 4% and 60% underperform peer group

Question 31

PE | committed vs paid-in capital

Answer 31

committed = promised paid-in (invested) = actually received

Question 32

Convertible bonds: premium payback period

Answer 32

``` PPP = mkt conv permium / favorable income diff fid = (coupon - (conv ratio x div))/conv ratio ```

Question 33

PE | corporate governance of PE firm

Answer 33

1. key man clause 2. performance disclosure & confidentiality 3. clawback 4. distribution waterfall 5. tag along - drag along 6. no-fault divorce: fire GP w/75% of LP 7. removal for cause: fire GP 8. investment restrictions 9. co-investment

Question 34

PE | distribution waterfall

Answer 34

1. deal by deal 2. total return: a.paid back \> committed capital b. paid back \> invest capital

Question 35

PE | 6 ways to determine NAV

Answer 35

1. at cost - adj for later financing 2. at min of cost or mkt 3. revaluing with each new financing 4. at cost with no adj until exit 5. discount factor for restricted securities 6. illiquidity discounts to comparable public firms

Question 36

PE | type of investors in PE

Answer 36

qualified investors

Question 37

PE | PE risks

Answer 37

1. liquidity 2. unquoted 3. competitive environment 4. agency 5. capital 6. regulatory 7. tax 8. valuation 9. diversification 10. market

Question 38

PE | PE costs

Answer 38

1. transaction 2. investment vehicle fund setup 3. administrative 4. audit 5. management (2/20) 6. dilution 7. placement (up to 2%)

Question 39

PE | gross IRR v. net IRR

Answer 39

gross: portfolio co. \> PE firm net: PE firm \> LPs

Question 40

PE | quantitative performance measures

Answer 40

1. PIC (paid in capital) - cap utilizied by GP 2. DPI\*(distributed to PIC) - LP's realized return: aka cash-on-cash return 3. RVPI\*(residual value to PIC) - LP's unrealized return 4. TVPI\*(total value to PIC) - DPI + RVPI \* net of mng fee & carried interest

Question 41

Fixed Asset Turnover

Answer 41

Activity Ratio Rev / Avg Net Fixed Assets Rev/Ass Avg Net Fixed Assets = Fixed Assets - Dep

Question 42

Common Equity Accounts (Balance Sheet)

Answer 42

Common stock Add paid-in capital Treasury stock Non-control subsidiary Retained earnings Accum other comp income

Question 43

Common Asset Accounts (Balance Sheet)

Answer 43

Cash Acc Rec Inv PPE Prepaid exp Investments (bonds) Intangible DTA Pension

Question 44

Receivables turnover ratio

Answer 44

Activity ratio Rev / Avg acc rec Rev / Ass

Question 45

Common Liability Accounts (Balance sheet)

Answer 45

Acc pay Accru exp Unearned rev Debt Captial leases Pension DTL

Question 46

Operating cash flow | Direct vs Indirect Method

Answer 46

Direct: redo income statement based on cash not accrual subtract out CFI p/l Indirect: start with accrual income statement and net income and adjust for cash basis subtract CFI p/l

Question 47

Current Ratio

Answer 47

Liquidity ratio Current Assets / Current Liabilities

Question 48

Cash to Income Ratio

Answer 48

Performance ratio CFO / Operating Income

Question 49

Cash return on equity ratio

Answer 49

Performance ratio CFO / Avg total equity

Question 50

EBIT

Answer 50

Operating profit

Question 51

Multi-step income statement format

Answer 51

Rev - COGS = Gross Profit - SGA - Dep = Op Profit - Int = EBT - taxes = EAT - p/l discont ops = Net Income

Question 52

Operating Cash Flow (CFO)

Answer 52

Cash flow that affects net income

Question 53

Number of days of payables

Answer 53

Activity ratio : 365 x avg acct pay / purchases : 365 x liab / exp

Question 54

total asset turnover

Answer 54

activity ratio : rev / avg assets : rev / asset

Question 55

harmonic mean

Answer 55

n / (1/x1 + 1/x2 + 1/x3)

Question 56

geometric mean

Answer 56

[(1 + r1) x (1 + r2) + (1 + r3)] ^ 1/n : less than arithmetic mean

Question 57

three statistical frequencies

Answer 57

absolute, relative, cumulative

Question 58

NOIR

Answer 58

nominal (no particular order), ordinal (ordered), interval (diff equal), ratio (true zero)

Question 59

Holding period yield/return

Answer 59

HPY/HPR : = (end value - begin value) / begin value = (P1 - P0 + D1) / P0 = [BDY x (t/360)] / [1 - BDY x (t/360)]

Question 60

money weighted return v. time weighted return

Answer 60

MWR uses cash flows and IRR : TWR calcs return for each period then multiplies the geometric mean

Question 61

annual percentage rate APR

Answer 61

no compounding : lower than APY : calculator CPT I/Y then multiply by # of periods

Question 62

annual percentage yield APY

Answer 62

yes compounding : higher than APR : ( end value / begin value ) ^ # periods

Question 63

bond equivalent yield BEY

Answer 63

semi-annual rate (compunded if necessary) x 2

Question 64

money market yield / CD equivalent yield

Answer 64

MMY = HPY x (360/dtm) = 360 x BDY / [360 - (dtm x BDY)]

Question 65

effictive annual yield (EAY)

Answer 65

EAY = (1 + HPY) ^ (365/t) - 1

Question 66

bank discount yield (BDY)

Answer 66

'= ( face - price ) / face x 360 / dtm

Question 67

standards of professional conduct

Answer 67

(7) professionalism, integrity of cap mkts, duties to clients, duties to employers, analysis+recommendations+actions, conflict of interest, responsibilities of CFA

Question 68

standards / resposibilities to CFA

Answer 68

1. conduct 2. referencing CFA

Question 69

standards / conflicts of interest

Answer 69

1. disclosure 2. priority or transactions 3. referral fees

Question 70

standards / analysis, recommendations, actions

Answer 70

1. diligence + reasonable basis 2. comms w clients + prospects 3. record retention

Question 71

standards / duties to employers

Answer 71

loyalty, outside compensation, surprise well

Question 72

standards / duties to clients

Answer 72

loyalty, fair dealing, suitability, performance presentation, confidentiality

Question 73

standards / integrity of markets

Answer 73

material non-public info, market manipulation

Question 74

standards / professionalism

Answer 74

1. knowledge of law 2. independence + objectivity 3. misrepresentation 4. misconduct

Question 75

code of ethics

Answer 75

(6) act w integrity w/public,clients,employer, client/profession above self, use care when managing money, practice + encourage, promote integrity of mkts, maintain + improve self

Question 76

important Z values

Answer 76

2. 59 = 0.5%, 2. 33 = 1%, 1.96 = 2. 5%, 1.65 = 5%, 1.28 = 10%

Question 77

GIPS

Answer 77

(9) fundamentals of compliance, input data, calculation methodology, composite construction, disclosures, presentation + reporting, real estate, private equity, wrap fee / separately managed accounts (SMA) portfolios

Question 78

coefficient of variation

Answer 78

standard deviation / mean = s / Xbar

Question 79

diluted EPS

Answer 79

(NI - pref div) + (conv pref divs) + (conv debt int)x(1 - tax) / (weight avg shares) + (conv pref shares) + (conv debt shares) + (stock opt shares)

Question 80

basic EPS

Answer 80

NI - pref divs / weighted avg shares

Question 81

Dupont equation - original

Answer 81

ROE = return on equity = NI/sales x sales/assets x assets/equity = net profit margin x asset turnover x leverage ratio

Question 82

Dupont equation - extended

Answer 82

ROE = return on equity = NI/EBT x EBT/EBIT x EBIT/sales x sales/assets x assets/equity = XXX

Question 83

common size cash flow ratios

Answer 83

basing cash flow statement on % of sales : X/sales

Question 84

common size balance sheet ratios

Answer 84

basing balance sheet accts on % of assets : X/total assets

Question 85

common size income statement ratios

Answer 85

basing income statement accts on % of sales : X/sales

Question 86

return on equity ROE

Answer 86

net income / avg equity

Question 87

return on total capital

Answer 87

net income / (avg debt + avg equity)

Question 88

return on assets w interest ROA

Answer 88

(net income + (int x ( 1 - tr )) / avg assets

Question 89

return on assets no interest ROA

Answer 89

net income / avg assets

Question 90

pre-tax margin

Answer 90

EBT / sales

Question 91

EBITDA

Answer 91

Sales - COGS - SGA

Question 92

Bayes Formula

Answer 92

P(A | B) = P(B | A) x P(A) / P(B)

Question 93

price index vs return index

Answer 93

price index = includes just price, no divs or int : return index = includes div and int

Question 94

portfolio variance

Answer 94

o^2 = Wa^2 x Oa^2 + Wb^2 x Ob^2 + 2WbWaCovab = Wa^2 x Oa^2 + Wb^2 x Ob^2 + 2WbWaPabOaOb

Question 95

correlation coefficient

Answer 95

Pab = Covab / (Oa x Ob) : Pab x Oa x Ob = Covab : -1 \<= 1

Question 96

covariance

Answer 96

Covab = Pab x Oa x Ob = E[(Ai - Abar)(Bi - Bbar)] : range is pos to neg infiniti

Question 97

covariance of A and A

Answer 97

Covaa = Oa^2

Question 98

fact

Answer 98

P(A) = P(AB) + P(ABc) where A can only occur if B or Bc, B and Bc are mutually exclusive and exhaustive

Question 99

probability addition rule

Answer 99

P(A or B) = P(A) + P(B) - P(AB)

Question 100

probability multiplication rule

Answer 100

P(AB) = P(A|B) x P(B) = P(B"A) x P(A)

Question 101

skewness

Answer 101

Sk = 1/n x E(Xi - Xbar)^3 / s^3, s=sample std dev : norm dist = 0, right skew \> 0, left skew \< 0

Question 102

kurtosis

Answer 102

K = 1/n x E(Xi - Xbar)^4 / s^4, s=sample std dev : leptokurtic (more) \> 3, norm dist = 3, platykurtic (less) \< 3

Question 103

sharpe ratio

Answer 103

S = Ri - Rf / O, O = std dev of portfolio

Question 104

chebyshev's inequality

Answer 104

percentage of observations that lie within k std devs, regardless of distribution, is at least \>= 1 - 1/K^2 for k \> 1

Question 105

variance

Answer 105

O^2 = E(Xi - Xbar)^2 / n if Xbar is pop mean OR

Question 106

mean absolute deviation

Answer 106

MAD = E | Xi - Xbar | / n

Question 107

variance of binomial random variable

Answer 107

O^2 = n x p x (1 - p)

Question 108

probability of x successes in n binomial trials

Answer 108

p(x) = n! / [(n - x)! x!] \* p^x \* (1 - p)^(n - x)

Question 109

VAR on bonds

Answer 109

VAR looks at both how changes in yield affects bond/portfolio values and how yield volatility affects bond/portfolio values

Question 110

price value of basis point

Answer 110

= duration \* .0001 \* notional : it's the $ change / 1 bp change

Question 111

bond valuation with duration and convexity

Answer 111

= ( - duration x Δy ) + ( convexity x Δy^2) x 100, where Δy = change in yield in decimal form

Question 112

portfolio duration

Answer 112

= W1D1 + W2D2 + … + WnDn, where W is $ portion of whole portfolio

Question 113

Macaulay Duration

Answer 113

weighted average of time until cash flows arrive, where weights are % of total bond value that cash flow represents : does not work with embedded options :

Question 114

Modified Duration

Answer 114

Macaulay Duration / (1 + YTM) : does not work with embedded options

Question 115

effective duration

Answer 115

(V- - V+) / (2 x V x Δy), where Δy is in decimal form

Question 116

forward rate notation

Answer 116

length of loan 'f' years until loan starts : 1 f 2 \>\> one year loan that starts in 2 years

Question 117

option adjusted spread

Answer 117

z spread if the bond had no options : used to compare to option free bonds : if no options then z spread = OAS

Question 118

z spread v. YTM spread

Answer 118

steeper spot curve \>\> greater diff between z and YTM spreads : upward sloping spot \>\> z \> YTM : downward sloping z \< YTM : earlier principal paid \>\> wider diff between z and YTM

Question 119

z spread, zero volatility spread

Answer 119

the identical yield that must be added to each risk free spot rate to correctly value a risky bond

Question 120

5 bond related rates

Answer 120

(5) coupon rate, current yield, YTM (= IRR), spot rates, forward rates

Question 121

arbitrage free bond valuation approach

Answer 121

use spot rates : value each cash flow : make sure it sums to bond value : arb by b/s pieces and s/b whole

Question 122

what is YTM like

Answer 122

IRR

Question 123

spot rate

Answer 123

the correct discount rate for a single cash flow in the future

Question 124

arbitrage CDO vs balance sheet CDO

Answer 124

arb CDO done for profit by arb diff between cash inflow and outflow : balance sheet CDO done to reduce risk on balance sheet from loans

Question 125

what debt maturities are exempt from SEC regulation

Answer 125

\<= 270 days

Question 126

what is more risky? Revenue or general obligation bonds

Answer 126

revenue

Question 127

stripped mortgage backed securities & risk

Answer 127

PO wins from prepayment : IO losses from prepayment

Question 128

3 maturity cycles for T-bills

Answer 128

30 day, 90 day, 180 day

Question 129

effect of yield levels on duration and reinvestment risk

Answer 129

Yield down \> duration up, reinvestment down : yield up \> duration down, reinvestment up

Question 130

different coupon structures

Answer 130

zero, step-up, deferred, regular, floating

Question 131

list of fixed income risk

Answer 131

(12) interest rate, yield curve, call, prepayment, reinvestment, credit, liquidity, exchange rate, unexpected inflation, volatility, event, sovereign

Question 132

bond interest rate sensitivity

Answer 132

maturity longer \> duration up : coupon up, call, put, yield up \> duration down

Question 133

Is duration calced with %Δyield or Δyield

Answer 133

Δyield

Question 134

variation margin

Answer 134

in a futures account, the amount of margin needed to be added when margin falls below maintenance and needs to be increased to initial

Question 135

3 types of options

Answer 135

financial, futures, commodity

Question 136

features futures for T-bills, T-bonds, stock index

Answer 136

T-bills - $1mm denominations : T-bonds - $100k denominations : stock index - S&P most popular ($250 x index value)

Question 137

forward rate agreement terminology

Answer 137

when the loan begins 'by' when it ends 'FRA' : 2 by 5 FRA starts in 60 days and ends in 150 days and loan length is 90 days (150 - 60)

Question 138

how are forward contract prices determined for discount bonds, coupon bonds, FRAs

Answer 138

discount - % off of face (eg 4% \>\> (1 + (96% x dtm/360)) x notional : coupon - YTM : forward rate agreement - cash settle, based on rate when loan would BEGIN in the future but discounted by length of loan because the profit wouldn't occur until the end of the loan

Question 139

forward rate agreement

Answer 139

pl = (realized rate - forward rate) x (dtm/360) x notional / (1 + (realized rate x (dtm/360))

Question 140

cumulative distribution function (cdf)

Answer 140

aka 'distribution function : sum of probabilities for the outcomes up to and including a specified outcome

Question 141

of cells in top triangle in matrix

Answer 141

n x (n-1) / 2

Question 142

combination formula

Answer 142

nCr = n! / ( (n-r)! x n! ) = 'n choose r' : calc n [2nd][nCr] r

Question 143

permutation formula

Answer 143

of permutations of r objects from n objects (order counts) : = n! / (n-r)! : calc n {2nd][nPr] r

Question 144

label n items with k labels with ni items per label

Answer 144

n! / (n1! x n2! x … x nk!)

Question 145

multiples' of equity valuation models

Answer 145

1) P/E, P/CF, P/S, P/BV : 2) EV/EBITDA

Question 146

enterprise value

Answer 146

all a firm's outstanding securities (debt + equity) minus cash and short term investments

Question 147

justified P/E

Answer 147

a PE not based on stock price but some other valuation model

Question 148

discounted cash flow : equity valuation models

Answer 148

dividend discount - Gordon constant growth V = D1/(k-g), multi-stage : Free cash flow V = E (FCFEi /(1 + r)^i

Question 149

Gordon constant growth rate model

Answer 149

V = D1 / ( k - g)

Question 150

infinite return model

Answer 150

E X / (1 + r)^i = X / i

Question 151

3 equity valuation models

Answer 151

discounted cash flow model : multiplier model : asset based model

Question 152

equity valuation model - asset based

Answer 152

asset - liabilities - pref stock, where assets and liabilities are valued at fair value

Question 153

5 external effects on industries

Answer 153

(5) macroeconomic, technology, demographic, governmental, social

Question 154

3 types of market efficiency

Answer 154

weak - incorp all past info, no tech analysis : semi-strong - incorp all past + public, includes weak and no fundamental analysis : strong - incorp all past, public and private, includes weak, semi-strong and no active analysis

Question 155

5 index weighting types

Answer 155

(5) price, equal, market cap, float adj mkt cap, fundamental

Question 156

index - total return vs price return

Answer 156

price does not include cash flows (div + int), just index price : total includes all cash flows

Question 157

complete market efficiency

Answer 157

operational efficiency + informational efficiency = allocational efficiency

Question 158

3 types of secondary markets

Answer 158

quote driven - investors w dealers (OTC) : order driven - rules match buyers and sellers (exchanges) : brokered - brokers locate counter parties

Question 159

margin call price

Answer 159

P0 x (1 - initial margin %) / (1 - maintenance margin %) : think of cap structure margin loan = debt, cash = equity, losses go to equity, when equity = maint margin % of capital then margin call

Question 160

call money rate

Answer 160

interest rate charged on margin loan

Question 161

3 functions of the market

Answer 161

allocate capital efficiently, determine returns that put savings and borrowings in equilibrium, allow entities to save, borrow, manage risk, trade assets now and in the future

Question 162

Markowitz portfolio theory

Answer 162

CAPM

Question 163

IPS - investment guidelines

Answer 163

permitted asset types, leverage

Question 164

IPS - (7) investment constraints

Answer 164

(7) risk, return, time horizon, tax situation, liquidity, legal, unique (RRTTLLU)

Question 165

(9) IPS contents

Answer 165

description of client, state of purpose, state of duties/responsibilities, procedures, investment objectives, investment constraints, investment guidelines, eval of performance, appendices

Question 166

Beta

Answer 166

B = Cov(im)/o^2m = corr(im)/o^2m : B is the slope of the least squares line of Ri-Rf vs Rm-Rf : E(Ri) = Rf + B[E(Rm) + Rf)]

Question 167

Jensen's Alpha

Answer 167

a of portfolio = (Rp - Rf) - Bp(Rm - Rf) : % of the SML line : associated with SML

Question 168

Treynor's value

Answer 168

(Rp - Rf) / Bp : associated with the SML

Question 169

CML vs SML statistics

Answer 169

CML - Sharpe Ratio, M^2 : SML - Treynor, Jensen's alpha

Question 170

M squared risk measure

Answer 170

m^2 = (Rp - Rf)Om/Op - (Rm - Rf) : similar to sharpe ratio but % terms : associated with CML

Question 171

slope of capital markets line (CML line)

Answer 171

is the Sharpe ratio = Rm - Rf / om

Question 172

security market line (SML)

Answer 172

systemic risk : E(Ri) vs systemic risk, where systemic risk = Cov(im) : E(Ri) = Rf + Cov(im)/o^2m x [E(Rm) + Rf]

Question 173

capital market line (CML)

Answer 173

total risk : optimal capital allocation : E(Rp) = Rf + [(E(Rm) + Rf) / om] x op

Question 174

fact

Answer 174

concept of systemic risk applies to individual securities as well as portfolios

Question 175

capital allocation line

Answer 175

line of optimal portfolios of risk free + risky assets : theoretically all investors have the same risky asset and CAL

Question 176

minimum variance portfolio

Answer 176

for a given expected return, the portfolio (weights) with the lowest std dev : global min var portfolio = portfolio with the minimum std dev of all portfolios

Question 177

portfolio variance of two assets

Answer 177

O^2p = WaO^2a + WbO^2b + 2WaWbCov(ab) : O^2p = WaO^2a + WbO^2b + 2WaWbCorr(ab)OaOb

Question 178

covariance

Answer 178

Cov(ab) = E (Xa - Xbar a)(Xb - Xbar b) / n - 1 : Cov(ab) = PabOaOb

Question 179

variance

Answer 179

O^2 = E (Xi - Xbar)^2 / n, if population, O^2 = E (Xi - Xbar)^2 / n - 1, if sample

Question 180

money weighted rate of return

Answer 180

= IRR

Question 181

3 types of lines of credit

Answer 181

uncommitted, committed, revolving

Question 182

Receivables - factoring

Answer 182

selling off the receivables through securitization : factor = the buyer of the security

Question 183

acc pay management - cost of trade credit

Answer 183

COTC = (1 + % discount/(1-%discount))^(365/# days paid past discount)

Question 184

BDY vs MMY vs BEY

Answer 184

BDY = (F - P) / F x 360/dtm : MMY = (F - P) / P x 360/dtm : BEY = (F - P) / P x 360/dtm, this is not the normal BEY!

Question 185

BDY vs MMY

Answer 185

Only difference is divisor is face for BDY and price for MMY

Question 186

operating cycle in days formula

Answer 186

days of inventory + days of receivables, this is part of the cash conversion cycle

Question 187

effect of share repurchase on book value

Answer 187

If P \> BV, decrease in BV : If P \< BV, increase in BV

Question 188

effect of share repurchase on EPS

Answer 188

If E/P = cost of borrowing, no effect on EPS : if E/P \> cost of borrowing, EPS will increase : if E/P \< cost of borrowing, EPS will decrease

Question 189

breakeven quantity of sales

Answer 189

Qbe = (fixed op cost + fixed financial cost) / (unit price - variable cost per unit) : contribution margin = (unit price - variable cost per unit)

Question 190

degree of total leverage

Answer 190

DTL = DOL x DFL = %ΔEBIT / %Δsales x %ΔEPS / %ΔEBIT =%ΔEPS / %Δsales = Q ( P - V) / (Q (P - V) - F - I) = (S - TVC) / ((S - TVC) - F - I)

Question 191

degree of financial leverage

Answer 191

DFL = %ΔEPS / %ΔEBIT = EBIT / (EBIT - I) ???

Question 192

degree of operation leverage

Answer 192

DOL = %ΔEBIT / %Δsales = ΔEBIT/EBIT / Δsales/sales = Q(P-V) / (Q(P-V) - F) = (S - TVC) / ((S - TVC) - F)

Question 193

cost of capital - 3 ways to calculate common equity

Answer 193

CAPM approach, Kc = Rf - B[E(Rm) - Rf + country risk] : Div discount model, Kc = D1/P0 + g, P0 = D1 / (k -g), g = growth rate = RR X ROE : Bond yield + risk premium (3-5%)

Question 194

cost of capital - pure play method with B

Answer 194

2 step Beq a \>\> Bass a \>\>\> Beq b : Bass a = Beq a / [1 + (1 -t)debt/equity], then Beq b = Bass a [1 + (1 - t)debt/equity]

Question 195

leverage - 2 types of risk

Answer 195

business risk (sales and operating), financial

Question 196

leverage - business risk

Answer 196

sales, operating

Question 197

marginal cost of capital break point

Answer 197

BP = amount of capital at which the components cost of cap changes / weight of component in capital structure

Question 198

cost of capital - country risk

Answer 198

CRP = sovereign yld spread x (O of developing equity mkt / O of developing bond mkt in foreign currency)

Question 199

cost of capital - pref stock

Answer 199

Kp = Dp / P, Dp = pref div, P = mkt price of pref stock

Question 200

fact

Answer 200

cost of capital - WACC = MCC

Question 201

NPV IRR PI commonality

Answer 201

if one is true, all true - NPV \> 0, IRR \> RRR, PI \> 1

Question 202

profitability index (PI)

Answer 202

PI = PV of future cash flows / CF0 = NPV/CF0 + 1

Question 203

credit - 4 Cs and 4 other measures

Answer 203

character, collateral, capacity, covenants, scale & diversification, operational efficiency, margin stability, leverage & coverage

Question 204

'debt' in ratios exludes…

Answer 204

non-interest bearing liabilities - acc pay, acc liabilities, DTL

Question 205

pension costs

Answer 205

service cost, interest cost, expected return on plan assets, actuarial p/l, prior service costs

Question 206

2 types of capital leases

Answer 206

sales - PV \> carrying value, lease rec = PV of lease payments, PV = rev, carrying value = COGS, int = CFO, principal = CFI (same as all amortizing loans) : direct financing/capital - no profit recog, lease rec created, int = CFO, principal = CFI

Question 207

lease payment cash flows and income statement

Answer 207

cash flow - int is CFO, prin is CFI : income state for cap lease - depreciation is op exp, int is int exp

Question 208

finance/capital lease

Answer 208

is a financial purchase : add to both ass and liab w/dep & int for lessee, for lessor int = CFO, prin = CFI

Question 209

operating lease

Answer 209

rental, no balance sheet, rev = PV of cash flow, COGS = carrying value, PV \> carrying, for lessor int = CFO, prin = CFI

Question 210

lease is a capital lease if…

Answer 210

GAAP, any of these are true - title transferred, bargain purchase option, lease period \>= 75% of asset life, PV of lease \>= 90% of fair value

Question 211

bond issuing costs

Answer 211

GAAP - capitalized as asset (deferred charge), expensed over life of bond, BOND + CHARGE = PROCEEDS: IFRS - reduce bond liability by costs \>\> increases effective rate

Question 212

bonds on the balance sheet

Answer 212

present value of cash flows using effective rate (YTM) : effective rate = mkt rate at purchase : premium - expense + amort = coupon (this reduces liab), discount - exp = coupon + amort (this increases liab)

Question 213

what happens to internally generated intangible assets

Answer 213

All expensed except - IFRS - dev costs past R&D capitalized, IFRS&GAAP - software dev past initial stage caped for all uses, GAAP - all software for internal use

Question 214

intangible assets have two characteristics

Answer 214

finite/indefinite, identifiable/unidentifiable

Question 215

inventory period costs

Answer 215

abnormal waste, storage, admin, selling are expensed not capitalized

Question 216

summary of income statement

Answer 216

Net sales - COGS = gross profit - op exp = op profit (EBIT) - interest = EBT - taxes = EAT - below the line items adj for taxes = net income +/- other comp income - pre div = income available to common

Question 217

financial leverage

Answer 217

assets / equity

Question 218

ratio pairs

Answer 218

rec turnover \> days of sales outstanding, pay turnover \> number of days of pay, inv turnover \> days of inventory on hand

Question 219

types of ratios

Answer 219

activity, performance, liquidity, solvency/coverage, profitability, valuation

Question 220

cash flow per share

Answer 220

CFO - pref div / weighted avg shares

Question 221

income statement - single step vs multi-step

Answer 221

single step - rev and costs aggregated separately, multi - includes gross profit (COGS)

Question 222

interest coverage ratio

Answer 222

coverage : CFO + int paid + taxes paid / interest paid

Question 223

cash ratio

Answer 223

cash + mkt securities / curr liab

Question 224

financing cash flow

Answer 224

cash flow that affects capital structure, issuing/repaying debt, issuing/buying back stock, etc

Question 225

investing cash flow

Answer 225

cash flow from purchasing/disposing of long term assets and certain investments (like leases)

Question 226

cash flow to revenue ratio

Answer 226

CFO / net revenue

Question 227

inventory turnover ratio

Answer 227

COGS / avg inv : exp / asset

Question 228

quick ratio

Answer 228

liquidity : cash + mkt securities + rec / curr liab : acid test

Question 229

debt liability interest expense

Answer 229

market rate at purchase x balance sheet value of liab at beginning of period

Question 230

deferred taxes

Answer 230

DTL is a liab that is what your balance sheet says you SHOULD have paid : DTA is what you should NOT have paid : income tax expense = taxes payable + DTL - DTA : ite is internal, itp is what the govt wants

Question 231

cash return on assets

Answer 231

performance : CFO / avg assets

Question 232

defensive interval

Answer 232

liquidity : cash + mkt securities + rec / daily expenditures

Question 233

debt coverage ratio

Answer 233

coverage : CFO / total debt

Question 234

DDB depreciation

Answer 234

double declining : 2 x (cost - accum dep) / useful life

Question 235

fact

Answer 235

cost & production - when MP max, MC min : when AP max, AVC min and MP intersects AP

Question 236

fact

Answer 236

cost - MC intersects AVC and ATC at each curves minimum point

Question 237

costs - AFC, AVC, ATC

Answer 237

AFC = TFC / Q, AVC = TVC / Q, ATC = AFC + AVC

Question 238

marginal cost (MC)

Answer 238

ΔTC / ΔQ

Question 239

market concentration - Herfindahl-Hirschman Index (HHI)

Answer 239

sum of squared % mkt share of 50 largest firms : \> 1800 not competitive

Question 240

market concentration - 4-firm concentration ratio

Answer 240

sum of % of industry sales of four largest firms : \>40 not competitive

Question 241

fact

Answer 241

gov't multiplier is GREATER than autonomous tax multiplier \>\> balanced budget multiplier is positive

Question 242

Ricardo-Barro effect

Answer 242

bigger gov't deficit ? People to save more in prep for higher future taxes \> people buy the gov't debt with savings \> no crowding out effect

Question 243

Phillips curve

Answer 243

Inflation vs UE : long term is 100% elastic, short term slopes down

Question 244

equation of exchange

Answer 244

MV = PY

Question 245

Federal Reserve money multiplier

Answer 245

1 + c / r + c, c = currency / deposits, r = required reserve ratio

Question 246

debt payment ratio

Answer 246

coverage ratio : CFO / cash for long term debt repayment

Question 247

reinvestment ratio

Answer 247

coverage ratio : CFO / cash paid for long term assets

Question 248

payable turnover ratio

Answer 248

activity ratio : purchases / avg acc pay : exp / ass

Question 249

days of sales outstanding

Answer 249

365 / rec turnover : 365 x avg acc rec / sales

Question 250

income statement - unusual or infrequent items v. extraordinary items

Answer 250

unusual or infrequent - included in continuing ops and reported before taxes : extraordinary - unusual and infrequent, reported after taxes (net of taxes), not allowed in IFRS

Question 251

cash flow - taxes

Answer 251

GAAP - all taxes in CFO : IFRS each tax goes to its section, CFO/CFI/CFF

Question 252

cash flow - interest & dividends

Answer 252

GAAP/IFRS : int rec CFO - CFO/CFI, int paid CFO - CFO/CFF, div rec CFO - CFO/CFI, div paid CFF - CFO/CFF

Question 253

items on cash flow statement come from…

Answer 253

1) income statement items 2) changes in balance sheet accounts

Question 254

change of accounting method or estimate requires

Answer 254

method - retro : error - retro : estimate - pro

Question 255

comprehensive income

Answer 255

net income + other comp income (unreal pl from currrency, pension adj, hedges, unreal pl from avail for sale securities), NO DIVS (pref or common) included

Question 256

held to maturity

Answer 256

debt, reported at amort cost (initial proceeds), amort cost = face - unamort discount or + unamort premium, fair value ignored subsequently, realized pl on income statement

Question 257

available for sale securities

Answer 257

debt & equity, reported on balance sheet at fair value, unrealized pl reported in other comp income, realized pl on income statement

Question 258

trading securities

Answer 258

debt & equity, reported on balance sheet at fair value, unrealized pl reported in income statement, realized pl on income statement

Question 259

gross revenue reporting vs net revenue reporting

Answer 259

gross = all rev + all costs, net = rev - costs : can use gross if primary obligator, bear investment + credit risk, able to choose supplier, latitude to establish price

Question 260

installment sales

Answer 260

revenue is recognized 1) immediately - very certain payment 2) as cash comes in - % rev = % profit 3) cost recovery - profit when accum cash \> accum cost

Question 261

IASB vs FASB

Answer 261

IASB more emphasis on going concern : FASB - relevance, reliability, IASB - comparability, understandability : FASB0 bi adj of asset values upwards

Question 262

accounting boards & standards

Answer 262

FASB \> GAAP : IASB \> IFRS

Question 263

flow of accounting information

Answer 263

journal entries (in a general journal) \> general ledger \> initial trial balance (end of period) \> adjusted trial balance \> financial statements

Question 264

main accounting equation

Answer 264

A = L + E : A = L + contributed cap + beginning retain earn + revenue - expenses - dividends

Question 265

4 types of revenue and expense accruals

Answer 265

unearned rev (L), accrued exp (L), accrued rev (A), prepaid exp (A)

Question 266

are financial statement notes audited

Answer 266

yes

Question 267

McCallums monetary fed rul

Answer 267

something to do with monetarism and MV = PY

Question 268

Taylor's fed funds rate rule

Answer 268

Fed funds rate = 2% + actual inflation + .5\*(actual inflation - 2%) + .5(output gap)

Question 269

technology efficiency vs economic efficiency

Answer 269

``` technology = fewest inputs economic = lowest cost ```

Question 270

economic profit

Answer 270

includes explicit & implicit opportunity cost

Question 271

normal profit of an individual

Answer 271

an individual's opportunity cost

Question 272

opportunity cost

Answer 272

the return on a resource that could have been earned in its next most valuable use

Question 273

marginal benefit & marginal cost

Answer 273

``` marginal benefit (MB) = demand curve marginal cost (MC) = supply curve ```

Question 274

price elasticity of supply

Answer 274

%Δ quantity supplied / %Δ price of good

Question 275

inelastic vs elastic

Answer 275

inelastic \< 1 elastic \> 1 perfect inelastic = 0 perfect elasticity = infinity

Question 276

income elasticity of demand

Answer 276

%Δ quantity demanded / %Δ income normal necessity 0-1 normal luxury \> 1 inferior \< 0

Question 277

elasticity & greatest total revenue

Answer 277

when elasticity = -1, P\*Q = max; total revenue test: if ΔPup \> Δ(P\*Q)up, then demand is inelastic ΔPup \> Δ(P\*Q)down, then demand is elastic

Question 278

cross elasticity of demand

Answer 278

%ΔQ / %ΔPsubstitute if positive \> substitute if negative \> compliment

Question 279

price elasticity of demand

Answer 279

%ΔQ / %ΔP where %Δ = (Xt - X0) / [(Xt - X0)/2] vertical demand line = inelastic horizontal demand line = elastic

Question 280

elasticity

Answer 280

%ΔX / %ΔY

Question 281

technical analysis - change in polarity

Answer 281

breached resistence \> support and vice versa

Question 282

technical analysis - non price based

Answer 282

1. put/call ratio 2. VIX 3. margin debt 4. short interest ratio 5. flow of funds 6. mutual fund cash position 7. equity issuance

Question 283

technical analysis oscillators

Answer 283

1. rate of change, Pt - P0 2. relative strength, Pup/Pdown 3. moving avg, 2 moving avg lines 4. stochastic, Pt vs high/low prices in last X days

Question 284

technical analysis - moving average and Bollinger bands

Answer 284

1. moving avg = avg of last X closing prices 2. Bollinger bands = std dev of X closing prices around moving avg

Question 285

technical analysis - chart

Answer 285

1. bar chart 2. candlestick chart 3. point and figure chart 4. volume chart

Question 286

parametric and non-parametric

Answer 286

1. parametric: more assumptions regarding distribution of population 2. non-parametric: few assumptions about population (Spearman rank correlation test)

Question 287

variance testing - equality of 2 normally dist populations

Answer 287

are the two variances the same? both normal, independent : F test statistic, F = s1^2/s2^2, where s1^2 \> s2^2 and df = n1 - 1 and n2 - 1 (2 dfs)

Question 288

variance testing - variance of norm dist population

Answer 288

is variance same as null hypo variance? normal, Chi-square statistic : X2n-1 = (n-1) x s^2 / O2o, where O2o = null hypo value and df = n-1

Question 289

mean difference test

Answer 289

are the means of two pops diff? both normal, DEPENDENT, remember returns of 2 steel companies : t statistic = (dbar - pop mean) / std error of d, where dbar = 1/n\*E di, where di = difference in means

Question 290

equality of pop means test with unknown but assumed unequal variances

Answer 290

are the pop means the same? Both norm, independent : t stat = (x1bar - x2bar) / (s1^2/n1 + s2^2/n2)^1/2 where df is really complicated

Question 291

equality of pop means test with unknown but assumed equal variances

Answer 291

are the pop means the same? Both norm, independent : t stat = (x1bar - x2bar) / (sp^2/n1 + sp^2/n2)^1/2 where sp^2 = ((n1 -1)s1^2 + (n2-1)s2^2) / (n1 + n2 -2)

Question 292

hypothesis test p-value

Answer 292

probability of obtaining a test statistic that rejects the null hypothesis when it is true, use Z table to find it

Question 293

critical value

Answer 293

z,t,X,F value (eg 1.96)

Question 294

power of hypothesis test

Answer 294

probabilty of correctly rejecting the null hypothesis when it is false : often decreases when alpha is small : = 1 - P(type II error)

Question 295

hypo test - type I and type II error

Answer 295

1. type 1: reject the null when true = significance level = alpha 2. type II: failure to reject null when false

Question 296

test statistic

Answer 296

(sample statistic - null hypo value) / standard error

Question 297

hypopothesis testing procedure (7)

Answer 297

1. state hypothesis 2. select test statistic 3. specify sig level 4. state decision (rejection) rule 5. collect sample and calc sample statistic 6. make a decision re hypo 7. make a decision based on test results

Question 298

z vs t test statistic

Answer 298

1. normal, known var = z 2. normal, unknown var = t, non-norm, known 30 z 3. non-norm, unknown: 30 t

Question 299

the 2 n-1s

Answer 299

sample variance and degrees of freedom

Question 300

roys safety first criterion (SF ratio)

Answer 300

max (E(Rp) - Rl) / Op OR min P(Rp\

Question 301

continuous compounding formula

Answer 301

e^r where r is rate of return (eg 0.06)

Question 302

working capital turnover

Answer 302

activity ratio = rev / (avg curr ass - avg curr liab)

Question 303

days of inventory on hand

Answer 303

365 / inventory turnover = 365 x avg inv / COGS

Question 304

bond sinking fund provisions

Answer 304

1. repayment of principle through series of repayments 2. cash payment: borrower pays cash \> trustee \> retires at par 3. delivery of securities: borrower buys bonds \> trustee \> retires those bonds (worse when bonds over par)

Question 305

free cash flow to equity

Answer 305

= CFO - FCI + net borrowing

Question 306

free cash flow to firm

Answer 306

= CFO - FCI + int exp(1 - t) = NI + non cash charges + int exp(1-t) - FCI - working capital

Question 307

investing and financing ratio

Answer 307

coverage ratio : CFO / cash outflows from investing and financing activities

Question 308

bonds - calls & puts

Answer 308

1. call: good for issuer/borrower, call protection \> currently calleable, refundable vs non-refundable, rates down 2. put: good for lender/buyer, rates up

Question 309

bullet vs amortizing security

Answer 309

1. bullet: principle repaid at end 2. amortizing: principle paid along side interest

Question 310

what happens when a bold is sold inbetween coupon payments

Answer 310

1. cum coupon (normal) = seller will receive accrued interest for buyer up to sale date 2. dirty price (full price) = clean price + accured int, if bond is in default trades without accrued interest : ex-coupon - next coupon goes to seller

Question 311

dividend payment ratio

Answer 311

coverage ratio = CFO / dividends paid

Question 312

cash flow stucture

Answer 312

Operating + investing + financial = change in cash balance + beginning cash balance = ending cash balance

Question 313

cash conversion cycle

Answer 313

days of sales outstanding + days of inventory on hand - days of payables

Question 314

split rate corporate tax

Answer 314

corporate retained earnings are taxed at a higher rate than earnings paid out as dividend

Question 315

old prudent man vs new prudent investor rule

Answer 315

1. total return old: income + preserve principle, new: income + cap growth 2. risk old: no risk, new: risk vs return 3. portfolio old: each investment by itself, new: investment part of portfolio 4. security restrictions old: yes, new: no 5. delegation of duty old: no, new: duty to delegate

Question 316

new prudent investor: main points

Answer 316

1. economic conditions 2. inflation + deflation 3. investments + tax liability 4. investment effect on portfolio 5. total return (income + cap growth) 6. other resources of beneficiary 7. liquidity, income, cap preservation 8. special relationship of assets to beneficiary

Question 317

PE | NAV after distribution

Answer 317

= NAVbefore - carried int - distributions

Question 318

PE | VC post money value

Answer 318

= PV(exit value) = pre + inv

Question 319

PE | VC ownership calc at time of investment

Answer 319

1. f = inv/post = PV(inv)/exit value 2. VC shares / other shares = f / 1-f 3. price = inv / VC shares

Question 320

PE | adjusting discount rate for probability of failure

Answer 320

r\* = (1+r / 1-q) - 1, r\* = adj, r = unadj

Question 321

EV | residual income model

Answer 321

1. aka economic profit for equity 2. = NI - equity charge, equity charge = equity x rr 3. equity charge measures shareholders opportunity cost

Question 322

cash flow accrual ratio

Answer 322

1. NI - CFO - CFI = accrual 2. accrual / net op assets = cash flow accrual ratio

Question 323

\*\* EV | Four Valuation Models\*\*

Answer 323

1. dividend discount (DDM) 2. free cash flow (FCF) 3. market multiple models 4. residual income model

Question 324

EV | economic value added

Answer 324

1. EVA = NOPAT - (wacc x invested cap) 2. inv cap = NWC + fixed assets = book debt + book equity 3. NOPAT = EBIT(1-t) 4. EVA = economic profit to debt + equity

Question 325

ABS | early amort trigger

Answer 325

* protects lender from credit quality decline * eg. 3 months avg excess spread = 0 \>\> trigger

Question 326

ABS | CDO

Answer 326

• 3 layers senior: variable rate: 70-80% of CDO mezzanine: fixed rate subordinate (equity tranche) • pool contains mix of variable + fixed rate but not in same proportion as investor layers. Swaps are used to adjust

Question 327

ABS | Cash flow CDO

Answer 327

* goal is to repay senior + mezz * 3 phases 1) ramp up: 1-2 mo: put together portfolio 2) reinvest: reinvest payments 3) paydown: 3-5 yrs: get paid * if 'coverage test' is passed then mezz and equity get paid interest, otherwise all to senior * principal \>\> senior \>\> mezz \>\> equity

Question 328

ABS | Market Value CDO

Answer 328

more freedom to manager than cash flow CDO

Question 329

ABS | Synthetic CDO

Answer 329

* contract, not asset * senior + junior 'sections' * junior pays in as protection for senior * then sell a credit default swap (CDS) on a notional amount tied to some other instrument * derivative: after junior is depleted, senior is on the hook

Question 330

ABS | CDO motivations

Answer 330

1. arbitrage (majority) 2.balance sheet ◎ sell an asset without selling it and same with buying

Question 331

Mortgages | SMM & prepayment calculation

Answer 331

prepayment(m) = SMM(m) x (mortgage balance at beginning of month - scheduled principal repayment)

Question 332

Mortgages | prevailing mortgage rates

Answer 332

1. spread between current rate and original mortgage rate 2. path of mortgages ◎ refinancing burnout when rates go up and down and everyone has refied already

Question 333

Mortgages | 3 factors of prepayment

Answer 333

1. prevailing mortgages rates 2. housing turnover 3. characteristics of mortgage

Question 334

Mortgages | 2 types of prepayment risk

Answer 334

1. contraction risk ◎ negatie convexity (call) ◎ reinvestment risk 2. extension risk

Question 335

Mortgages | CMO

Answer 335

collateralized mortgage obligation ◎ tranches

Question 336

Mortgages | CMO tranche types

Answer 336

1. sequential pay tranche 2. accrual tranche 3. planned amort class tranche 4. support tranche

Question 337

Mortgages | principal pay down window

Answer 337

• in a CMO, the time it takes to pay down the principal in a particular tranche

Question 338

Mortgages | Z - tranche

Answer 338

* aka accrual tranche * last tranche to receive principal * interest goes to paying off other tranches. Z-tranche balance increases (accrues) * Z or Accrual bond

Question 339

ABS | CDO debt includes:

Answer 339

1. junk bonds 2. MBS & ABS (structured) 3. emerging mkt bonds 4. corp loans made by commercial banks 5. special situation loans

Question 340

Mortgages | PAC tranche

Answer 340

• 'planned amortization class' • amorted based on sinking fund schedule • initial PAC collar: prepay speed • guaranteed lower PSA schedule ◎ min of 2 payment speeds • PAC window: principal repay time • a prepay collar

Question 341

Mortgages | support tranche

Answer 341

* paired with a PAC tranche * more guaranteed PAC \>\> more risky the support * support takes excess or provides when too little * if support is paid off then PAC no longer supported \>\> 'busted' PAC

Question 342

Mortgages | effective collar

Answer 342

a PAC's PSA range

Question 343

Mortgages | PAC I and PAC II

Answer 343

• PAC I is normal PAC • PAC II (aka scheduled tranche) ◎ support for PAC I ◎ also has a schedule ◎ higher prepay risk, but more prepay protection than support wo/schedule

Question 344

Mortgages | why were CMO's set up?

Answer 344

to redistribute contraction & extension risk

Question 345

Mortgages | PAC I, PAC II, Support prepay risk

Answer 345

PAC I PAC I PAC I PAC I PAC II PAC II Support (no schedule)

Question 346

Mortgages | pass through

Answer 346

the worst basic MBS with no bells or whistles

Question 347

Mortgages | stripped MBS

Answer 347

1. principal only (PO) ◎ prepay good 2. interest-only strips (IO) ◎ prepay pad

Question 348

Mortgages | IO, PO, pass through: price volatility

Answer 348

price vol (PO,IO) \> price vol (pass through)

Question 349

Mortgages | 3 factors of agency underwriting standards

Answer 349

1. max loan to value (LTV) 2. payment to income 3. loan amount

Question 350

Mortgages | agency v non-agency CMO path

Answer 350

* agency: whole loan \>\> pass through \>\> CMO * non-agency: whole loan \>\> whole loan CMO

Question 351

Credit | treasuries used to create the theoretical spot rate curve

Answer 351

1. all on the run ◎ most accurate priced issues ◎ large maturity gaps after 5 yrs 2. most on-the-run, some off ◎ reduces maturity gap ◎ repo mkt may distort prices 3. all treasuries ◎ includes all information 4. treasury strips (zero coupon) ◎ reduce maturity gap, rate = spot rate ◎ less liquid premium, diff taxes

Question 352

Credit | par coupon curve

Answer 352

on-run-run yld curve

Question 353

Credit | what does duration measure?

Answer 353

bond price sensitivity to parallel changes in interest rates

Question 354

Credit | 3 factors that affect treasury securities returns

Answer 354

1. changes in interest rate levels (90%) 2. slope changes (8.5%) 3. curvature changes (1.5%)

Question 355

Volatility

Answer 355

* var = Σ (X1 - Xbar)^2 / T - 1 * sd = sqrt(var) * Xt = ln(Yt / Yt-1) * Xbar = avg yld from 1 \> T and is optional * \*sqrt(time) to change time period (day \> annual = \*16)

Question 356

Credit | what does bond yld volatility mean?

Answer 356

* if annual vol = .1 and yld = .08 * then 69% prob that yld will be .08 +- .008 a year from now

Question 357

Bonds | 3 spread measures

Answer 357

1. nominal yield: YTMbond - YTMgovt 2. Z-spread ◎ spread at each spot rate so that CFpv = Po ◎ includes cost of imbedded option ◎ Z is constant across all spot rates ◎ exp: 104.12 = 8/(1+.04+Z) + 108/(1+.05+Z)... 3. OAS: spread once option cost is removed = Z - opt cost

Question 358

Bonds | backward induction

Answer 358

* used to calc Po of bond * start calcing at nodes N (end of tree) back node 0

Question 359

Bonds | option value

Answer 359

* Pcall = Pnon-call bond - Pcall bond * Pput = Pput bond - Pnon-put bond

Question 360

Bonds | OAS

Answer 360

* aka option-adjusted spread * rate that must be added to all of the non-option spot rates so that CFpv = Po * rate that once added makes the binomial tree arbitrage free * removes cost of embedded option

Question 361

Credit | S&P's debt service coverage

Answer 361

= (free op cash flow + interest) / (interest + annual principal repayment)

Question 362

Credit | free operating cash flow

Answer 362

= FCFF - int(1- tr) • does not add back in interest exp as does FCFF

Question 363

Credit | operating cash flow

Answer 363

= CFO = NI + dep + decrease non-cash assets + increase non-cash debt +- non-cash charges

Question 364

CF

Answer 364

= NI + dep +- other non-cash charges • aka earning plus non-cash charges • aka funds from operations (credit term)

Question 365

Credit | financial ratios

Answer 365

1. current (ST solvency) 2. acid test (ST solvency) 3. LT dept-cap (capitalization: financial leverage) 4. total debt-cap (capitalization) 5. EBIT - int (coverage) 6. EBITDA - int (coverage) • all ratios are better when higher

Question 366

Asset Manager Code of Professional Conduct (AMCPC)

Answer 366

1. loyalty to clients 2. investment process and actions 3. trading 4. risk management, compliance, support 5. performance & valuation 6. disclosures

Question 367

Asset Manager Ethics Responsibilities

Answer 367

1. always act ethically & professionally 2. acit in the best interest of the client 3. act in an objective and independent manner 4. perform actions using skill, competence and diligence 5. communicate accurately with clients on a regular basis 6. comply with legal and regulatory reqs regarding capital mkts

Question 368

AMCPC | Loyalty to Clients policies (3B1 p 123)

Answer 368

1. align incentives (no undue risk) 2. client confidential info 3. AML 4. def of a token gift

Question 369

AMCPC | Investment Process and Actions (3B1 p 124)

Answer 369

1. never manipulate mkt prices 2. deal fairly when doing ARA 3. reasonable basis 4. diff levels of service 5. explainable strategies 6. ability to cash out 7. IPS

Question 370

AMCPC | Trading (3B1 p 125)

Answer 370

1. no insider trading 2. priority of transactions 3. soft dollars use 4. best execution 5. equitable share allocation

Question 371

AMCPC | Risk management, Compliance, Support (3B1 p 125)

Answer 371

1. Policies/procedures for AMCPC, SPC, regs, law 2. firm-wide risk system 3. compliance officer 4. portfolio info is correct & reviewed by 3rd party 5. record retention 7 yrs 6. sufficient, qualified staff 7. disaster recovery plan

Question 372

AACPC | Performance & Valuation (3B1 p 126)

Answer 372

1. see GIPS 2. 3rd party valuations

Question 373

AMCPC | Disclosure (3B1 p 127)

Answer 373

Absolutely EVERYTHING

Question 374

3 Behavioral models

Answer 374

1. Barnewall 2 way model 2. Bailard, Biehl, Kaiser 5 way model 3. Pompain model

Question 375

Behavior models | Barnewall 2 way model

Answer 375

2 investor categories: active and passive

Question 376

Behavior models | Bailard, Biehl, Kaiser 5 way model

Answer 376

• 2 investeror dimensions: ◎ confidence: confident (C) to anxious (A) ◎ method of action: careful (F) to impetuous (I) • 5 investor categories: ◎ straigt arrow (middle) ◎ Individualist (CF) ◎ Adventurer (CI) ◎ Guardian (AF) ◎ Celebrity (AI)

Question 377

Behavior models | Pompian model

Answer 377

• 4 step assesment • 2 dimensions: risk tolerance / investment style • 4 Behavior Investor Types (BITs): ◎ passive preserver ◎ friendly follower ◎ independent individualist ◎ active acumulator

Question 378

Behavior models | Pompian model - 4 step assessment

Answer 378

1. active/passive 2. risk tolerance scale 3. behaviorial biases 4. classify investor in BITS

Question 379

Behavior models | Pompian model - BITs

Answer 379

Behavior Investor Types: Risk tolerance (low \> high) & Investment style (conservative \> aggressive): ◎ Least: Passive preserver (emotional: bad) ◎ Moderate low: Friendly follower (cognative: good) ◎ Moderate high: Independent individualist (cognative: good) ◎ Most: Active accumulator (emotional: bad)

Question 380

Behavior models | Pompian model biases - Passive preserver

Answer 380

* Emotional: endowment, loss aversion, status quo, regret aversion * Cognative: mental accouting, anchoring and adjustment

Question 381

Behavior models | Pompian model biases - Friendly follower

Answer 381

* Emotional: regret aversion * Cognative: availability, hindsight, framing

Question 382

Behavior models | Pompian model biases - Independent individualist

Answer 382

* Emotional: overconfidence, self-attribution * Cognative: conservatism, availability, confirmation, representativeness

Question 383

Behavior models | Pompian model biases - Active accumulator

Answer 383

* Emotional: overconfidence, self-control * Cognative: illusion of control

Question 384

Client / Adviser success measure

Answer 384

1. Adviser understands long term financial goals of client 2. Adviser maintains consistent approach with client 3. Adviser acts as client expects 4. Both client and advisor benefit

Question 385

Analyst behavioral biases

Answer 385

1. overconfidence 2. way management presents information 3. biased research

Question 386

Analyst behavioral biases | self calibration

Answer 386

* Mitigate overconfidence * accurately remembering forecasts and accurate self-evaluations

Question 387

Analyst behavioral biases | Company management influence

Answer 387

1. framing 2. anchoring and adjustment 3. availablity

Question 388

Investment committee behavioral biases

Answer 388

* Often no better than individual * All individual + social proof bias: person follows the group * To counteract, need independence

Question 389

Excess return anomolies that are not

Answer 389

* Excess return before, but not after expenses * Excess return with too low associated risk

Question 390

Behavioral bias | Disposition effect

Answer 390

more willing to sell winners than losers

Question 391

Behavioral bias | Biases creating excess returns

Answer 391

1. Momentum effect ◎ Herding 2. Bubble and crash: panic buying/selling 3. Value vs Growth ◎ Halo effect

Question 392

Behavioral bias | Biases that contribute to overconfidence

Answer 392

1. illusion of knowledge 2. self-attribution 3. representativeness 4. availability 5. illusion of control 6. hindsight

Question 393

Behavioral bias | Methods to avoid bias

Answer 393

1. seek counter evidence/opinions 2. defined systematic decision process 3. verifiable data 4. correct framing 5. documenting decisions 6. bayes formula

Question 394

Behavioral bias | Quantitative indication of bubbles/crashes

Answer 394

* Bubble: 2 std dev from mean price * Crash: 30% drop in a few months

Question 395

Behavioral bias | Bubble/Crash biases

Answer 395

1. overconfidence 2. confirmation 3. self-attribution 4. hindsight 5. regret aversion 6. disposition effect

Question 396

Behavioral finance | macro vs micro

Answer 396

* macro: mkt deviaition from traditional finance theory * micro: individuals' decision making process deviation from traditional finance (REM: rational economic men)

Question 397

Rational economic men (REM)

Answer 397

The rational actor assumption in traditional finance theory

Question 398

Bayes formula

Answer 398

P(A|B) = P(B|A) \* P(A) / P(B)

Question 399

Behavioral finance | Utility theory

Answer 399

• Foundation of traditional finance theory • diminishing marginal utility return ◎ \>\> concave risk averse utility function ◎ \>\> convex indifference curves

Question 400

Behavioral finance | Satisfice

Answer 400

* sufficient satisfaction, but not optimal, are sufficient * satis+ficent = satisfice

Question 401

Behavioral finance | Decision theory

Answer 401

• associated with traditional finance theory • process of making optimal decision when decision maker is informed, math able, rational (REM)

Question 402

Behavioral finance | Bounded rationality

Answer 402

* associated with behavioral finance theory * Knowledge and cognative limitations of decision maker * Satisfice * More constrained that prospect theory

Question 403

Behavioral finance | Prospect theory

Answer 403

* associated with behavioral finance theory * similar to bounded theory * risk aversion is replaced by loss aversion * 2 phases: Editing phase, then Evaluation phase

Question 404

Behavioral finance | Prospect theory : Editing phase

Answer 404

First three steps 1. Codification: gain/loss & prob 2. Combination: Combines similar outcomes 3. Segregation: separation of risk-free and risky aspect of each outcome

Question 405

Behavioral finance | Prospect theory: Evaluation phase

Answer 405

1. assign weights and prob ◎ weights and prob are based on behavioral biases ◎ \>\>gains \< losses, large prob \< tail events 2. calc expected utility

Question 406

IPS | Situational profiling and risk tolerance

Answer 406

1. source of wealth ◎ active (entrepreneurial) vs passive (steady accum & inherit) 2. measure of wealth ◎ perceived wealth vs needs \>\> percieved risk tolerance 3. stage of life ◎ foundation, accumulation, maintenance, distribution

Question 407

IPS | Situational profiling: Source of wealth

Answer 407

* Active: more risk tol, but possible business risk vs investment risk difference * Passive: less risk tol

Question 408

IPS | Situational profiling: Stage of life

Answer 408

1. Foundation (mod risk) 2. Accumulation (highest risk) 3. Maintenance [retirement] (low-mod risk) 4. Distribution: old wealthy giving to others (low - high risk)

Question 409

Traditional finance assumes investors have 3 traits

Answer 409

1. risk aversion: min risk; risk is volatility 2. rational expectations: unbiased view of the world 3. asset integration: all investments are correlated

Question 410

Traditional vs Behavioral investor traits

Answer 410

1. risk aversion vs loss aversion 2. rational expectations vs biased expectiations 3. asset integration vs ass segregation

Question 411

IPS | 4 Personality types

Answer 411

1. cautious: low risk, indecisive, difficult 2. methodical: conservative, lots of data 3. confident, decisive 4. spontaneous: high portfolio turnover, chase fads, doubt self and others

Question 412

IPS | for exam, IPS = O&C (objectives & constraint section of IPS)

Answer 412

\*only front of card\*

Question 413

IPS | IPS benefits to clients

Answer 413

1. id's and documents objectives/constraints 2. dynamic in response to changes w/client or mkt 3. easy to understand 4. education about self and investing 5. understand manager's actions 6. transferable across managers

Question 414

IPS | IPS benefits to manager

Answer 414

1. knowledge of client 2. guidance for investment decisions 3. resolution of disputes (signed documentation)

Question 415

IPS | RRTTLLU breakdown by O&C

Answer 415

* O: RR * C: TTLLU

Question 416

IPS | arrving at RRTTLLU

Answer 416

TTLLU \>\> risk \>\> return

Question 417

IPS | SAA must conform to IPS

Answer 417

\*only front of card\*

Question 418

IPS | RRTTLLU abbrev for notes in test

Answer 418

* return: rn * risk: rs * time horizon: tm * taxes: tx * liquidity: lq * legal: ll * unique: u

Question 419

IPS | calcing returns with inflation

Answer 419

add inflation in initially so that you include the inflated numbers when calcing taxes

Question 420

IPS | are residences included in investment calculations?

Answer 420

no

Question 421

IPS | remember to watch for...

Answer 421

* pre vs after tax * real vs nominal

Question 422

IPS | Return objective: 2 categories

Answer 422

required vs desired return

Question 423

IPS | Risk objective: 2 categories

Answer 423

* ability (time horizon, wealth & outflow) vs willingness to take risk * always state conclusion * if they differ, pick conservative choice

Question 424

IPS | assessing clients' preferences

Answer 424

look at actions as well as statements

Question 425

IPS | 4 Risk objective factors

Answer 425

1. time horizon 2. critical goals/expenditures 3. liquidity needs 4. portfolios proportion of overall wealth

Question 426

IPS | Time horizon constraint assessment

Answer 426

1. state: ◎ number of stages ◎ each stage objective ◎ # yrs in each stage 2. other involved people (eg giving/receiving inheritance) 3. multi-generational horizon 4. retirement time horizon default: 20-25 yrs

Question 427

IPS | 4 Tax constraint: tax types

Answer 427

1. income 2. capital gains 3. wealth transfer 4. personal property (eg car, house)

Question 428

IPS | 4 Tax mitigation strategies

Answer 428

1. Tax deferral (eg cap gain investment, loss harvesting, low turnover) 2. Tax avoidance: tax free securities 3. Tax reduction: investments with lower tax rates (eg cap gains vs income) 4. Wealth transfer timing: (eg. no sales)

Question 429

IPS | Complicated tax situation

Answer 429

state that tax situation is complex and manager should seek qualified tax advice

Question 430

IPS | 5 Liquidity constraints

Answer 430

1. ongoing, known expense (or in return jbj) 2. emergnecy reserves (if requested) 3. one-off, infrequent outflows (college falls under time horizon) 4. one off positive inflows 5. illiquid assets: restricted from sale, illiquid (eg house)(or in unique), large tax cost (or in unique or tax)

Question 431

IPS | Legal: 2 common issues

Answer 431

1. Trust: revocable vs irrevocable 2. Family foundation

Question 432

IPS | Legal: notes

Answer 432

1. If no big legal issues state there are none beyond normal Code & Standards responsibilities 2. manager must follow the trust document; weigh needs of different stakeholders 3. mention other legal issues or lack of 4. if complex issues, state manager will seek qualified expert advice

Question 433

IPS | Unique constraints

Answer 433

1. Special investment concerns (eg social) 2. Special instructions (liquidate holdings) 3. Restrictions on sales 4. Forbidden asset / asset classes 5. Assets outside of portfolio (eg. houses) 6. Bequests 7. Unattainable objectives

Question 434

IPS | General notes

Answer 434

* State what is there and what is NOT there * Complex issues, seek qualified expert * Re-state all the facts * point out conflicting factors

Question 435

Strategic Asset Allocation (SAA)

Answer 435

is the mix of asset classes that will meet the IPS objectives and constraints

Question 436

IPS & SAA | important return is pre or after tax?

Answer 436

after tax

Question 437

SAA process

Answer 437

1. eliminate portfolios that violate stated or appropriate constraints 2. assess return to risk ranking ◎ sharpe ratio ◎ most often you will never need to get to this stage bc/only one portfolio remains

Question 438

SAA portfolio elimination process

Answer 438

1. excess/insufficient cash equivalents 2. hold/fail to hold assets specified in constraints 3. violates risk constraints 4.generate insuffient return (after-tax) 5.inappropriate asset classes or weightings (even if not specificed) ◎ 60 equity/40 bond&cash is default ◎ do not ignore home ownership \>\> too much real estate holdings • address concentration issues (eg. low-basis inheritance, former employer stock)

Question 439

IPS & SAA | monte carlo simulation pro/cons vs deterministic method

Answer 439

• Pros: 1. path dependency 2. better display of risk/return by providing multiple possible outcomes 3. better tax analysis 4. better display of short-term & long-term performance (eg more ST vol, but better LT return) 5. better analysis of multi-period effects 6. can look at different points in timeline (major decision/event points) • Cons: 1. if simplistic model of returns is used 2. if generalized asset class returns are used rather than specific investments (w/costs) 3. if simplistic tax model is used

Question 440

Taxes | 3 types of taxes

Answer 440

1. income 2. wealth: assets and asset transfers 3. consumption: sales & VAT

Question 441

Taxes | marginal tax rate

Answer 441

tax rate paid on the last dollar of income

Question 442

Taxes | how US taxes work in regards to different tax rates over a single income

Answer 442

* every one pays same rate on 1st dollar * each dollar after is taxed on whichever tax rate basket that dollar falls into * for example: $20K income: first $8,350 is taxed at 10%, remaining is taxed at 15% * the overall rate (avg tax rate) is the weighted average of the different rates \* the amount taxed at that rate

Question 443

Taxes | 2 most common tax regimes

Answer 443

``` #1: common progressive (progressive, light on all investment) #2: LIght capital gains tax (progressive, light on cap gains) ```

Question 444

Taxes | accrual taxes

Answer 444

• paid periodically (eg annually)

Question 445

Taxes | FVIF - accrual tax

Answer 445

FVIF = [1 + R\*(1 - T)]^N R = pre-tax return ◎ or FVIF = (1 + Rart)^N T = tax rate N = number of investment periods • = after-tax value of each dollar invested

Question 446

Taxes | accrual (annual) tax drag % is less/more than tax rate

Answer 446

more, due to effect on compounding

Question 447

Taxes | tax drag

Answer 447

* gain lost to taxes * stated as a dollar value or %

Question 448

Taxes | FVIF - deferred tax

Answer 448

``` FVIF = [(1 - T) \* (1 + R)^N + T\*B] R = investment return N = # periods T = tax rate B = % of original investment ALREADY taxed ```

Question 449

Taxes | Tax drag: deferred vs accrual

Answer 449

* accrual $ and % \> deferred * deferred is constant % of total gain (horizon and return do not affect it) and equal to tax rate * accrual $ and % grow with return and horizon

Question 450

Taxes | FVIF - wealth based

Answer 450

``` FVIF = [(1 + R) \* (1 - T)]^N R = investment return N = # periods T = tax rate ```

Question 451

Taxes | wealth tax attributes

Answer 451

* tax drag \> tax rate * horizon increase \>\> greater $ and % tax drag * return increase \>\> greater $ lower % tax drag

Question 452

Taxes | accrual tax attributes

Answer 452

* tax drag \> tax rate * horizon or return increase \>\> greater $ and % tax drag

Question 453

Taxes | deferred tax attributes

Answer 453

constant % tax drag regardless of horizon or return • tax drag % = tax rate

Question 454

Taxes | annual return after realized (cummulative) taxes sans deferred taxes

Answer 454

Rart = R(1 - Trealized) = R[1 - (PiTi + PdTd + PcgTcg)] Pi, Pd, Pcg = % of gain attributed to interest, div, realized cap gains Ti, Td, Tcg = tax rate on interest, div, realized cap gains

Question 455

Taxes | Tax loss harvesting

Answer 455

* using investment loses ot offset investment gains * main gain reducing tax bill in near term and those saving can be invested

Question 456

Taxes | HIFO

Answer 456

* Highest In (basis), First Out * allowed by some govts * Also LIFO if you believe taxes will rise

Question 457

Taxes | trading activity and taxes

Answer 457

usually the frequent trader falls under a higher tax rate, which leads to lower returns, especially over longer horizons and higher return rates

Question 458

Taxes | year end sales

Answer 458

* if gain, wait until next year * if loss, sell this year to harvest the loss

Question 459

Taxes | Mean variance optimization

Answer 459

Optimizing portfolio allocation should be done on an after tax basis using equivalent after-tax returns and risk on an after tax basis

Question 460

Taxes | effective unrealized cap gains tax rate adjusting for annual taxes

Answer 460

Tecg = Tcg\*[1 - (Pi + Pd + Pcg)] / [1 - (PiTi + PdTd + PcgTcg)]

Question 461

Taxes | FVIF - all taxes

Answer 461

FVIFt = (1 - Tecg) \* (1 + Rart)^N + Tecg - (1-B)\*Tcg • Tecg = effective cap gains adj for annual taxes • Rart = return after realized taxes

Question 462

Taxes | accrual equivalent (after tax) return

Answer 462

Rae = (ending balance after all taxes / beginning balance)^N N = number of periods • as horizon or amount deferred increases Rae approaches pre-tax return

Question 463

Taxes | accrual equivalent tax rate

Answer 463

Tae = 1 - (Rae / Rpre-tax)

Question 464

Taxes | tax deferred account (TDA)

Answer 464

* pre-tax income * entire balance when withdrawn * FVIFtda = (1 + R)^N \* (1 - Tfuture)

Question 465

Taxes | tax-exempt account (TEA)

Answer 465

* not Tea (equivalent accrual tax rate) * after-tax income * no tax upon withdrawl * FVIFtea = (1 + R)^N \* (1 - Tnow)

Question 466

Taxes | TDA vs TEA

Answer 466

* if Tfuture \< Tnow, then TDA is better * if Tfuture \> Tnow, then TEA is better * if Tfuture = Tnow, then no difference * if $ amounts are restricted and equal then compare FV's of each, but remember to include extra taxed $ for TDA

Question 467

Taxes | FVIF

Answer 467

Future Value Interest Factor

Question 468

Taxes | List of FVIF's

Answer 468

1. tax deferred acct 2. tax exempt acct 3. all taxes 4. accrued annual tax 5. wealth tax 6. deferred cap gains

Question 469

Taxes | FVIF - deferred capital gains

Answer 469

FVIFcgt = (1 - Tcg)\*(1 + R)^N + Tcg \* B • Tcg = cap gains tax rate • B = cost basis PERCENT • R = annual return

Question 470

Taxes | Taxes and investment risk (volatility)

Answer 470

after tax risk = stan dev \* (1 - T) • govt absorbs part of variability • tax exempt accts (TDA & TEA): investor bears all risk

Question 471

Taxes | asset location

Answer 471

type of acct asset is located (eg tax advantaged acct)

Question 472

Taxes | tax alpha

Answer 472

value created by effective tax management

Question 473

Taxes | Taxes and trading behavior

Answer 473

1. Traders: high turn-over, ST cap gains \>\> bad 2. Active investors: med-turn-over, LT cap gains \>\> so-so 3. Passive investors: LT cap gains over many years \>\> good 4. Exempt investors: hold assets in tax-exempt accts

Question 474

Estate

Answer 474

Every thing a person owns • financial • real estate (aka immovable property) • collections (eg art) • businesses • non-tangible (eg trademarks, patents

Question 475

Estate planning

Answer 475

Planning of transfer of person's estate to other during lifetime or at death

Question 476

Will

Answer 476

* aka testament * legal doc that states rights of others to person's estate

Question 477

Probate

Answer 477

• Legal process that takes place at death • court determines ◎ will validity ◎ decedent's property inventory ◎ claims against decedent ◎ distributes property according to will

Question 478

Intestate

Answer 478

Dying without a valid will

Question 479

Avoiding probate

Answer 479

• There are ways to avoid probate ◎ joint ownership w rights of survivorship ◎ living trusts ◎ retirement plans ◎ life insurance

Question 480

Estate | gifts

Answer 480

* aka lifetime gratuitous transfer or inter vivos transfer * given while living * subject to gift taxes; who pays is up to govt law

Question 481

Estate | wealth transfer methods

Answer 481

1. gifts 2. bequests

Question 482

Estate | bequests

Answer 482

* testamentary gratuitous transfer * given after death * estate taxe (paid by grantor/transferor); inheritance tax (paid by recipient); who pays is up to govt law * taxes can vary based on relationship to decedent

Question 483

Roman law

Answer 483

civil law system based on old Roman law; top down system where laws are handed down from legislative body

Question 484

English law

Answer 484

common law system; bottom up; judges create precedents that are applied in future cases

Question 485

Estate | forced heirship

Answer 485

* children or spouse have a right to a portion of parent's estate * all assets are usually included

Question 486

Estate | community property rights

Answer 486

* each spouse entitled to half of the estate earned during mariage * gift and inheritence can be held separately * part of forced heirship

Question 487

Estate | separate property rights

Answer 487

* each spouse owns their property separately * common in civil law countries

Question 488

Human capital

Answer 488

* aka net employment * PV of net employment income over lifetime

Question 489

Individual balance sheet

Answer 489

* Assets: all tangible and intangible assets including human capital and any other future income * Liabilities: all current and future liabilities incurred by living life plus any required reserve fund (Core capital) * Equity is anything left over (Excess capital)

Question 490

Core capital

Answer 490

equals liabilities on Individual Balance Sheet • sum product of expected annual spending x prob of living that long

Question 491

Excess capital

Answer 491

equals equity on Individual Balance Sheet

Question 492

Mortality table

Answer 492

death table (fun) • combined prob: prob either one is alive next year • real annual spending: living exp for coming year • exp real spending: real annual spending \* combined prob • present value:PV of real annual spending • total: PV of core capital required to meeting exp THROUGH the given year (row) • 0 prob to live past 100 in table

Question 493

monte carlo simulation advantage

Answer 493

gives a distribution of outcomes vs just a mean

Question 494

longevity risk

Answer 494

* risk of running out of money in retirement prior to death (ruin) * generally, retiree should spend \<= 3% of assets to have 95% confidence of not outliving assets

Question 495

Estate | giver and givee terms before and after death

Answer 495

* before death: donor, recipient * after death: testator, beneficiary

Question 496

Estate | return and tax rate symbols

Answer 496

* Rg, Tig = investment return and annual tax rate of recipient * Re, Tie = investment return and annual tax rate of giver * Te = estate tax rate paid by the estate * Tg = gift tax rate paid by either giver, receiver

Question 497

Estate | relative value of gift / bequest

Answer 497

``` RV = FVgift / FVbequest ◎ = (1 - Tg)\*(1 + Rg\*(1 - Tig))^N / (1 - Te)\*(1 + Re\*(1 - Tie))^N F = future vale ```

Question 498

Estate | relative value of gift when donor pays gift tax

Answer 498

* add in + Tg\*Te due to reduced estate taxes * RVg = (1 - Tg + Tg\*Te)\*(1 + Rg\*(1 - Tig))^N / (1 - Te)\*(1 + Re\*(1 - Tie))^N

Question 499

Estate | relative value: generation skipping

Answer 499

``` RV = 1 / 1 - T T = wealth transfer tax ```

Question 500

Estate | calcing generation skipping

Answer 500

1. calc excess above core capital requirements for giver and next generation 2. give excess to third generaiton