CFA Level 1 Flashcards

Question

What is the slope of the Security Market Line?

Answer 1

The slope is the Market Risk Premium. SML is a graphical representation of CAPM so Beta is the X-axis and the expected return is the Y-axis. The intercept is the risk free weight.

Answer 2

By obtaining better information, education and advice

Answer 3

You can't. You can only acknowledge their presence and adapt to it.

Answer 4

It allocates the total risk tolerance (based on 1 or many risks) to different components. This hopefully leads to investments in assets with the highest returns per unit of risk

Answer 5

1. First degree (or perfect price discrimination), each consumer is charged the maximum he is willing to pay 2. Prices varies across different units sold. Quantity discounts on bulk purchases 3. Prices varies across different consumer groups. Discounts for students and seniors, this is the most common price discrimination.

Answer 6

Neutral rate = trend growth + inflation target If the central bank's policy rate is below the neutral rate, then it is expansionary. If above contractionary and if equal then it is neutral.

Answer 7

GDP = C + I + G + (X-M) C = Consumer spending I = Gross Private Domestic Investment G = Goverment expenditures on finished goods and services X = Exports M = Imports

Answer 8

S = I + (G-T) + (X-M)

Answer 9

The statement distinguish on non-current vs current assets and liabilities

Answer 10

debt-to-capital = Total Debt / (Total Debt + Shareholder's Equity)

Answer 11

Financial Leverage = Average Total Assets / Average Shareholder's Equity

Answer 12

It is the ratio of the percentage change in demand for a percentage change in price. If abs(elasticity) > 1 then it is elastic, small price changes have big impact on demand

Answer 13

Many and good substitutes makes the demand very elastic. If there are no substitutes you demand is inelastic, you will pay much more since you have no alternative.

Answer 14

It is the ratio of percentage change in demand to the percentage change of income

Answer 15

* Normal goods have positive income elasticity => an increase in income increases demand * Inferior goods have negative income elasticity => an increase in income decreases demand. Like instant noodles, bought by poor students but not by rich people.

Answer 16

* **Substitutes** have positive cross price elasticity. If you increase the price of good X the demand of price Y will go up. People buy Y instead of X. * **Complements** have negative cross price elasticity. If you increase the price of good X, the demand of good Y will decrease. Think like gasoline cars and gas, if the price of gas goes up, people will buy less gasoline cars and more electic car instead

Answer 17

It is a good for which a higher price makes the good desirable. I.e., Gucci bag. The higher price means status. The price elasticity is positive, the higher price the higher quantity (up to a limit of course)

Answer 18

The GDP deflator is a price index that can be used to convert nominal GDP into real GDP, taking out the effects of changes in the overall price level. GDP deflator = Nominal GDP_t / Real GDP_t Where Real GDP_t uses the prices as of the base year but the production as of year t

Answer 19

A captail consumption allowance (CCA) measures the depreciation of physical capital from the production of goods and services over a period. CCA can be thought of as the amount that would have to be reinvested to maintain the productivity of physical capital from one period to the next. It is used in calculating GDP: GDP = National Income + CCA + statistical discrepancy

Answer 20

The AD curve illustrate the negative relationship between the price level and the level of real output demanded by consumers, businesses, and government.

Answer 21

1. The wealth effect 2. The interest rate effect 3. The real exchange rate effect When plotting the AD Curve, AD is on the x-axis and price level on the y-axis

Answer 22

A decrease in the price level increases the purchasing power of existing nominal wealth so that consumers will demand more goods and services.

Answer 23

The interest rate effect refers to the changes that occur in behaviors such as spending and borrowing after a change in the interest rate. When the interest rate decreases, individuals and businesses well generally borrow more money and invest and spend, increasing the AD. And vice versa. If price level goes up interest rates will go up to combat inflation and then AD will go down.

Answer 24

When the domestic price level increases, the real price increases for foreigners which reduces demand for export. So (X-M) will become lower and hence the Y (AD Curve) will also decrease. Y = C + I + G + (X-M)

Answer 25

The aggregate supply (AS) curve describes the relationship between the price level and the quantity of real GDP supplied, when all other factors are kept constant. That is, it represents the amount of output that firms will produce at different price levels.

Answer 26

It is the AS curve in the very short run. It is horizontal since firms will adjust its output without changing price by adjusting labor hours and intensity of use of plant and equipment,

Answer 27

When output prices increase, the price level increases, but firms see no change in input prices in the short run. Firms respond by increasing output in anticipation of greater profits from higher output prices. The result is an upward-sloping SRAS curve. So the higher output prices, the higher output.

Answer 28

All input costs can vary in the long run, and the LRAS curve in is perfectly inelastic (it is vertical, no change in price level will impact the output). In the long run, wages and other input prices change proportionally to the price level, so the price level has no long-run effect on aggregate supply. We refer to this level of output as potential GDP or full-employment GDP.

Answer 29

GDP = C + I + G + (X-M) * Increased consumer spending * Increased business expectations (invest more) * Expansionary monetary policy / expansionary fiscal policy (increase G)

Answer 30

* Labor productivity * Lower input prices * Taxes and government subsidies

Answer 31

* Increase in supply and the quality of labor * Increase in the supply of natural resources * Technology

Answer 32

1. **Frictional unemployment**, when you quit to seek new opportunities. It always exist 2. **Structural unemployment**, it is caused by long-run changes in the economy that eliminate some jobs while generating other type of jobs for which the unemployed workers are not qualified. 3. **Cyclical unemployment** is caused by changes in the general level of economic activity | Structural and frictional unemployment is always present

Answer 33

Unemployment rate = Number of people unemployed / labor force Labor force is the sum of unemployed + employed. Those who are voluntarily unemployed are not part of labor force

Answer 34

It is a person who is employed part-time but wants a full-time position or being stuck at ICA with an engineering degree. IT IS NOT UNEMPLOYED!

Answer 35

Participation ratio = labor force / working age population

Answer 36

Early in an expansion when hiring prospects begin to improve, the number of discouraged workers who re-enter the labor force is greater than the number who are hired immediately.

Answer 37

It is the price index with constant (old) basket of goods and services | Laspeyers -> Paasche -> Fischer

Answer 38

It is the price index that uses the current consumption weights. | Laspeyers -> Paasche -> Fischer

Answer 39

It is the price index that is the geometric mean of Laspeyers and Paasche index. | Laspeyers -> Paasche -> Fischer

Answer 40

Inflation can result from an initial decrease in aggregate supply caused by an increase in the real price of an important factor of production, such as wages or energy. Cost-Push Inflation is when e.g. wages increase so that the supply decreases which causes the price level to increase.

Answer 41

Demand-pull inflation can result from an increase in the money supply, increased government spending or any other change that increases aggregate demand. In demand-pull inflation the economy is already at full-employment equilibrium so when the demand increases, the GDP will increase to an unsustainable level. Unemployment falls bnelow its natural rate and put upward pressure on real wages which reduces SRAS and a new equlibrium is found at a higher price level

Answer 42

Demand-pull inflation can result from an increase in the money supply, increased government spending or any other change that increases aggregate demand. In demand-pull inflation the economy is already at full-employment equilibrium so when the demand increases, the GDP will increase to an unsustainable level. Unemployment falls bnelow its natural rate and put upward pressure on real wages which reduces SRAS and a new equlibrium is found at a higher price level

Answer 43

* **GDP** = The total value of goods and services produced **within** a country's borders * **GNP** = The total value of goods and services produced by the labor and capital of a **country's citizen** (regardless where they produce it, Canada, US, doesn't matter)

Answer 44

A country has an **absolute advantage** if it can produce a good at a lower resource cost than the other country.

Answer 45

A country has **comparative advantage** if it the opportunity cost for producing a good is lower than the other countries. By specilization the total output among to countries can increase!

Answer 46

It includes the **current account**, which mainly measures the flows of goods and services; the **capital account**, which consists of capital transfers and the acquisition and disposal of non-produced, non-financial assets; and the **financial account**, which records investment flows.

Answer 47

The current account focus on the flow of goods and services. Like raw materials, manufactured goods and services like transportation.

Answer 48

The capital account includes financial assets. It measures the net change of assets and liabilities during a particular year. It includes purcases of rights to natural resources.

Answer 49

It include gold, foreing currencies. For a country with a trade deficit, it must be balanced by a net surplus in the capital and financial accounts.

Answer 50

Comprehensive Income incldues all items that impact owners' equity. Some of these items are included in the calculation of Net Income and some in "Other Comprehensive Income". When comprehensive income is presented in two statements, the statement of comprehensive income begins with the profit or loss from the income statement and then presents the components of OCI.

Answer 51

1. Foreign currency translation adjustments (translating subsidaries' balance sheet assets and liabilities at current exchange rates) 2. Unrealized gains or losses on derivatives for hedges 3. Unrealized holding gains and losses on available-for-sale securities (US GAAP) 4. Certain costs of a company's defined benefit post-retirement plans

Answer 52

1. The first approach is to express each line item of cash inflow (outflow) as a percentage of total inflows (outflows) of cash 2. The second approach is to express each line item as a percentage of net revenue.

Answer 53

Free cash flow is the excess of operational cash flow over capital expenditures

Answer 54

FCFF is the cash flow available to the firm's supplier of debt and equity capital FCFF = NI + NCC + Int(1-Tax rate) - FCInv - WCInv FCFF = CFO + Int(1-Tax rate) - FCInv | We need to add back the interest paid since that belongs to debt supplie ## Footnote CFO = NI + NCC - WCInv where WCInv is working capital expenditures

Answer 55

FCFE is the cash available to the company's common shareholders FCFE = CFO - FCInv - Net debt repayment

Answer 56

**Dividens paid** is a financing activity Interest received, interest paid, dividends received and taxes paid are all operation

Answer 57

* **Financing:** Dividends paid & Interest paid * **Investing:** Interest received & Dividends received | All four can also be operating. IFRS allows for more flexibility

Answer 58

RoE = RoA * Financial Leverage (Net Income / Assets) * Assets / (Equity)

Answer 59

RoE = Net profit margin * Total asset turnover * Financial leverage = Net Income / Sales * Sales / Assets * Assets / Equity

Answer 60

Net profit margin = Net Income / Sales = (Net Income / EBT) * (EBT / EBIT) * (EBIT / Sales) | Tax burden * Interest Burden * EBIT margin (operating profit margin ## Footnote Tax & Interest burden is the lower the quotient, the higher burden

Answer 61

In inflationary environment, FIFO will give higher gross profit. COGS for LIFO will be higher and hence result in lower gross profit

Answer 62

The LIFO reserve is the amount by which LIFO inventory is less than FIFO inventory. The LIFO reserve will increase when prices are rising and inventory quantities are stable or increasing.

Answer 63

If a firm is liquidating its inventory, or if prices are falling, the LIFO reserve will decline. Management could use a LIFO liquidation (draw down inventory) to artificially inflate current period earnings | LIFO liquidation is a decrease in the quantity of inventory

Answer 64

In IFRS and US GAAP (except for LIFO ) the investory is reported on the balance sheet at the lower of cost or net realizable value (NRV) | NRV is expected sales price - cost of selling ## Footnote LIFO is the lowest of cost or market (replacement cost)

Answer 65

**IFRS**The inventory is written down to the Net Realizable Value and the loss is recognized on the income statement. If the value increases, the values can be written up by reducing COGS in the income statement. Inventory can never be written up more than what was previously done. **US GAAP** - No write-up is allowed under US GAAP. | This doesn't apply for LIFO in US GAAP

Answer 66

Quick ratio = (Cash + Short-term marketable securities + receivables) / current liabilities | The quick ratio is one ratio to assess a company's liquidity position

Answer 67

Cash ratio = (Cash + Short-term marketable securities) / current liabilities | The cash ratio is one ratio to assess a company's liquidity position

Answer 68

Current ratio = current assets / current liabilities | The Current ratio is one ratio to assess a company's liquidity position

Answer 69

An asset is impaired if: carrying value > recoverable amount Recoverable amount = max(fair value less cost to sell, value in use) where value in use is the present value of future cash flows. The loss is then carrying value - recoverable amount | Assets must be tested for impairment anually. Fair value is market price

Answer 70

Determining (1) and calculating (2) is different in US GAAP 1. carrying value > undiscounted cash flow 2. carrying value - fair value (or pv of cash flows) | Assets must only be tested for impairment if it is likely

Answer 71

Yes, when a firm constructs an asset the interest that accrues during the construction period is capitalized and then part of the depreciation the following years. | The treatment is similar under IFRS and US GAAP

Answer 72

In IFRS, you are allowed to capitalize development costs, but not reseach costs. | A firm must show that it can complete the asset.

Answer 73

Under US GAAP, research and development costs are generally expensed as incurred. For software that you **intend to sell**, you can capitalize development costs when you can show **technological feasibility**. | A firm must show that it can complete the asset.

Answer 74

When the income tax expense is greater than taxes payable due to **temporary differences** | E.g., accelerated depreciation is used on calculating tax return

Answer 75

Income tax expense = change in DTL + taxes payable | For DTA it is **-**change in DTA. So if DTA increase income tax is lower

Answer 76

V_Lev = V_unlev + tD | Value levered = Value unlevered + marginal tax rate * debt debtTaxshield

Answer 77

The cost of equity is a linear function of the company’s debt-to-equity ratio with an adjustment for the tax rate

Answer 78

DOL = % change in operating income / % change in units sold DOL = Q(P-V) / (Q(P-V) - F) | Q(P-V) is the contribution margin ## Footnote DOL is different depending on the numbers of units produced

Answer 79

DFL = % change in net income / % change in operating income DFL = [Q(P-V) - F] / [Q(P-V) - F - C] | C is fixed financing cost

Answer 80

DTL = % change in net income / % change in units sold DTL = DOL * DFL DTL = Q(P-V) / [Q(P-V) - F - C]

Answer 81

A market order instructs the broker to execute the trade immediately at the best possible price

Answer 82

A limit order places a minimum execution price on sell orders and a maximum execution price on buy orders. For example, a buy order with a limit of $6 will be executed immediately as long as the shares can be purchased for $6 or less.

Answer 83

They are not executed unless the stop price has been met

Answer 84

If the market price goes below 45, then the shares will be sold

Answer 85

**Depository receipts **(DRs) represent ownership in a foreign firm and are traded in the markets of other countries in local market currencies. A bank deposits shares of the foreign firm and then issues receipts representing ownership of a specific number of the foreign shares. ## Footnote The depository bank acts as a custodian and manages dividends, stock splits, and other events.

Answer 86

If the firm is involved with the issue, the depository receipt is a **sponsored** DR; otherwise, it is an **unsponsored** Depository Recipt.

Answer 87

Global depository receipts (GDRs) are issued outside the United States and the issuer's home country | Most GDRs are traded on the London and Luxembourg exchangesUSD is common

Answer 88

American depository receipts (ADRs) are denominated in U.S. dollars and trade in the United States.

Answer 89

Committed capital (e.g., for private equity funds) is how much money in total that LPs have committed to the fund’s future investments. Management fees are based on committed capital in PE. | LP stands for limited partners who are the investors.

Answer 90

1. Embryonic - high prices, high risk 2. Growth, rapidly increasing demand, low 3. Shakeout, slowing growth, intense competition 4. Mature, little or no growth, industry consolidation 5. Decline, negative grotwh, excess capacity

Answer 91

1. Overcollateralization (collateral value greater than the par value) 2. Cash reserve fund - money set aside to make up for credit losses 3. Excess spread account, the yield promised on the bonds are lower than the promised yield on the assets supporting the ABS. 4. Tranches with different seniority of claims

Answer 92

1. Surety bonds, issued by insurance companies to make up any shortfall 2. Bank guarantees, serve the same purpose 3. Letters of credit from financial institutions, a promise to lend money to the issuing entity if it does not have enough cash

Answer 93

Bond equivalent yield is just 14%. So it disregards the compounding. So the Bond Equivalent Yield for a semi-annual pay bond is less than the real annual return from holding the bond till maturity since (1+2x) < (1+x)^2 | EAR takes compounding into account, that doesn't BEY do

Answer 94

A forward rate shows the yield for future periods. E.g, the rate of interest on a 1-year loan that would be made two years from now is a forward rate. A forward yield curve shows the future rates for bonds or money market securities for the same maturities for annual periods in the future. ## Footnote (1 + S3)^3 = (1 + S1)(1 + 1y1y)(1 + 2y1y)

Answer 95

The 3-year spot rate is the YTM for a zero-coupon bond that matures in three years. So: (1 + S3)^3 = (1 + S1)(1 + 1y1y)(1 + 2y1y) You will earn that YTM for the next three years

Answer 96

The 3-year spot rate is the YTM for a zero-coupon bond that matures in three years. So:

Answer 97

A forward rate agreement (FRA) is a derivative contract that has a future **interest rate,** rather than an asset, as its underlying. The point of entering into an FRA is to lock in a certain interest rate for borrowing or lending at some future date ## Footnote The long pays the fixed rate and the short the floating rate

Answer 98

In the weak-form efficient market hypothesis, security prices fully reflect all past market data

Answer 99

In a semi-strong-form efficient market, prices reflect all publicly known and available information, including historic market prices.

Answer 100

In a strong-form efficient market, security prices fully reflect both public and private information. A market that is strong-form efficient is, by definition, also semi-strong- and weak-form efficient.

Answer 101

A **G-spread** is the yield over a government bond. Should be the same maturity

Answer 102

An alternative to using government bond yields (**G-spread**) as benchmarks is to use rates for interest rate swaps in the same currency and with the same tenor as a bond. Yield spreads relative to swap rates are known as interpolated spreads or I-spreads. I-spreads are frequently stated for bonds denominated in euros.

Answer 103

The G and I-spreads assume that the spot yield curve is flat. One can fix this with the **zero-volatility spread** or **Z-spread**.

Answer 104

The **Z-spread** is the constant add-on to each benchmark spot rate that if used in discounting would equal the market price of the bond. It is the appropriate yield curve spread.

Answer 105

An option-adjusted spread (OAS) is used for bonds with embedded options. The OAS is the spread to the government spot rate curve that the bond would have if it were option-free. **IT IS ADJUSTED FOR THE OPTION** Hence, option value = Z-spread - OAS

Answer 106

Option value = Z-spread - OAS

Answer 107

1. In a **call market**, trades can be arranged only when the market is **called** at a particular time and place. I a call market, one price clears the market for the stock. 2. In contrast in a **continuous trading market**, trades can be arranged and executed anytime the market is open.

Answer 108

1. In **quotedriven markets,** customers trade with dealers (very common for bonds, OTC markets) 2. In **order-driven markets**, an order matching system run by an exchange, a broker, or an alternative trading system uses rules to arrange trades. Often trades with complete strangers. 3. In **brokered markets**, brokers arrange trades between their customers (real estate, large blocks of stocks, tänk ECM SEB)

Answer 109

Both Ordinal and Nominal are categorical data. 1. Ordinal -> the categories can be logically ordered, like credit ratings 2. Nominal -> cannot be organised in a logical order, like different sectors (energy vs utilities).

Answer 110

For a given set of projects, the greater a firm's reliance on debt financing, the greater its equity beta

Answer 111

1. We adjust the beta from a comparable company (or group of companies) for its leverage and tax rate. We unlever it to get asset beta 2. We adjust the comparable company's asset beta (re-lever it) based on the financial leverage and the marginal tax rate of the target company. So unlever - then relever

Answer 112

Beta_asset = Beta_equity x [1 / (1 + [1-t]D/E)] So the higher D/E or Tax rate, the lower will the unlevered Beta be. | Asset beta = unlevered, equity beta = levered

Answer 113

equity beta=asset beta * [1 + (1-t) x D/E]

Answer 114

Beta = cov(Rp, Ra) / var(Rp) where Ra is the return on the asset and Rp is the return on the market portfolio. A company having a Beta of 1.2 implies that if stock market increases by 10% the company’s share price will increase by 12%

Answer 115

A fiduciary call is what is on the right side of the put-call-parity. It is c + X / (1+Rf)^t.

Answer 116

A protective put is a share of stock together with a put option on the stock.

Answer 117

c + X / (1 + Rf)^T = S + p It is based on the payoffs of two portfolio combinations: a fiduciary call and a protective put.

Answer 118

Put-call-forward parity is derived with a forward contract rather than the underlying asset itself. We subsite F0 / (1+Rf)^t for S in the original put-call-parity. F0 / (1 + Rf)^T + p0 = c0 + X / (1 + Rf)^T

Answer 119

1. Unit of account (you express prices in omney) 2. You can use it to store value over time 3. It serves as a medium of exchange, you can buy stuff with it

Answer 120

Y = A x f(L,K) 1. A is the total factor productivity (change in technology) 2. L is the labor size 3. K is the amount of capital available

Answer 121

growth in potential GDP = growth in technology + W-L (growth in labor) + W-C(growth in capital) W-L are and W-C are the labor's share of national income and capital's percentage of national income | growth potential GDP=growth in labor force+growth in labor productivity

Answer 122

The peak phase of a business cycle represents the **highest level of economic output** (real GDP) reached during that cycle. Inflation pressure that built during the expansion may continue into the early part of the contraction that follows the peak. Employment declines first after the peak, it is a lagging indicator.

Answer 123

No, the LRAS is perfectly inleastic, it is vertical. Because in the long run input prices change in proportion to the price level, so even if the price level goes up, the input prices will also raise and the supply will be thesame. | x is ouput, y is price. LRAS reflect the potential GDP.

Answer 124

Items that can move the LRAS to the right (incresed output) include: 1. Increased supply of labor 2. Better technolology (can also move SRAS to the right) 3. Natural resources

Answer 125

The term “credit cycle” refers to cyclical fluctuations in interest rates and credit availability. Credit cycles tend to be longer than business cycles and they can cause asset price bubbles if the credit availability is too high

Answer 126

Yes, maximimzing profit at MR = MC is **applicable for all firms**!

Answer 127

The **Fischer effect** says that: nominal interest rate = real interest rate + expected inflation It states that in an economy, the **real interest rate is stable** and that changes in nominal interest rates result from changes in expected inflation.

Answer 128

**M x V = P x Y** M is the quantity of money V is the velocity of circulation of money in the economy P is the price level Y is the real output Thus, the amount of money used to purchase goods and services in an economy, M × V, is equal to the money value of this output, P × Y. If you increase the money supply, while velocity and output are constant, all you’re doing is creating inflation (or increasing P).

Answer 129

In the theory of the firm, price searchers are those firms that set their own selling price, such as a monopoly firm. A price taker, on the other hand, is a firm that takes the price as it is set by the market forces of demand and supply.

Answer 130

As X-M and use in the formula: S = I + (G - T) + (X - M)

Answer 131

You can use the **total probability rule** to calculate the unconditional probability: P(A) = P(A|S) + P(A|S^C) where S and S^C are mutually exclusive and exhaustive.

Answer 132

P(AB) = P(A|B) * P(B) The probability that both events will occur

Answer 133

P(A or B) = P(A) + P(B) - P(AB) The probability that at least one of the two events will occur.

Answer 134

Start with P(AB) = P(BA) and then use the **multiplication rule of probability**: P(A) * P(A|B) = P(B) * P(B|A) and P(A) = P(B) * P(B|A) / P(A|B)

Answer 135

**Marketable securities** are securities that can easily be sold.

Answer 136

You apply two times the straight-line rate, so if the asset's life is 10 years, then you assume 1/10+ * 2 depreciation rate. And you also do not take the residual value into account, but rather just stop when residual value has been reached. **DDB depreciation** = (2 / useful life) * (cost - accumulated depreciation)

Answer 137

All costs incurred until an asset is ready for use must be capitalized, including the invoice price, applicable sales tax, freight and insurance costs incurred delivering equipment, and any installation costs ## Footnote Cmpanies generally must capitalise interest costs associated with acquiring or constructing an asset that requires a long period of time to get ready for ts intended use

Answer 138

variance = p1 * (R1- Rmean)^2 + p2 * (R2- RMean)^2 + p3 * (R3- Rmean)^2

Answer 139

Revenue recognition standards require that firm **conclude that they will not have to reverse any cumulative revenue recognized**. So if it is likely they will receive a bonus in a project, likely is not enough, they have to be certain!

Answer 140

They tend to change the government budget deficit in an opposite direction to economic growth. For xample, during a recession, tax receipts will fall, and government expenditures on unemployment insurance payments will increase. They do not require any vote from legislators.

Answer 141

odds = p / (1-p) so if p is small, then odds will also be small. If the probability is 1 / 8, then the odds is (1 / 8) / (7 / 8) = 1 / 7, the odds is one-to-seven.

Answer 142

1. **Real personal income** is a coincident indicator with turning points that tend to coincide with business cycle turning points. 2. **The unemployment rate** is a lagging indicator, here suggesting an expansion has been underway for some time. (previously discouraged workers enter the workforce) 3. **Building permits** are a leading indicator because builders may seek permits in anticipation of an economic expansion that has not begun yet.

Answer 143

For a firm using FIFO, gross profit is the same whether the firm uses a periodic or perpetual inventory system. For a firm using LIFO or average cost, gross profit can be different depending on the choice of inventory system.

Answer 144

In a periodic inventory system, inventory values and COGS are determined at the end of the accounting period. No detailed records of inventory are maintained. FIFO COGS and ending inventory are the same whether a perpetual or periodic system is used.

Answer 145

In a perpetual inventory system, inventory values and COGS are updated continuously. Inventory purchased and sold is recorded directly in inventory when the transactions occur.

Answer 146

Permutation is used if ordering matters, so it will be larger. In combination, the order doesn't matter: Permutation = n! / k! Combination = n! / (k! * (n-k)!)

Answer 147

Stratified random sampling uses a classification system to separate the population into smaller groups based on one or more distinguishing characteristics. So each strata is sampled from!

Answer 148

**Cluster sampling** is also based on subsets of a population, but in this case we are assuming that each subset (cluster) is representative of the overall population with respect to the item we are sampling. So we do not need to sample from all clusters (as we do in **stratified random sampling**)

Answer 149

1. Expansion (real GDP is increasing) 2. Peak (real GDP stops increasing and starts decreasing) 3. Contraction, real GDP is decreasing 4. Trough, real GDP stops decreasing and begins increasing

Answer 150

Firms try to keep enough inventory on hand to meet sales demand but do not want to keep too much of their capital tied up in inventory. As a result, the ratio of inventory to sales in many industries trends toward a normal level in times of steady economic growth.

Answer 151

1. Peak -> sales growth begins to slow and unsold inventories accumulate, the quotient increase 2. Trough -> sales growth starts to increase and inventory doesn't catch up so quotient decrease then firms will start producing inventories so the quotient reaches its normal level

Answer 152

1. Peak -> sales growth begins to slow and unsold inventories accumulate, the quotient increase 2. Trough -> sales growth starts to increase and inventory doesn't catch up so quotient decrease then firms will start producing inventories so the quotient reaches its normal level

Answer 153

This is a test of the value of a single variance and is based on a test statistic with a performed via the chi-square distribution. Chi-square assumes that the population is normally distributed. (so does F-statistic) | F-test is for testing equality of variances from two populations

Answer 154

The hypotheses concerned with the equality of the variances of two populations are tested with an F-distributed test statistic. | Chi-square is used for 1 variance (population variance)

Answer 155

The hypotheses concerned with the equality of the variances of two populations are tested with an F-distributed test statistic. | Chi-square is used for 1 variance (population variance)

Answer 156

Factoring refers to the sale of receivables without recourse; that is, the risk that the firm's customers will not pay, or will not pay in a timely manner, is borne by the factor, who purchases the receivables. One company sells its receivables to another company. The other company nows bears the risk of the customers not paying.

Answer 157

Flotation costs are the fees charged by investment bankers when a company raises external equity capital. Flotation costs can be substantial and often amount to between 2% and 7% of the total amount of equity capital raised, depending on the type of offering. Flotation costs are a cash outflow that occurs at the initiation of a project and affect the project NPV by increasing the initial cash outflow.

Answer 158

CAPM shows the required return given the stocks Beta (its systematic risk). If the expected return calcualted by an analyst is greater, then you should buy the stock.

Answer 159

**Abandonment options** are similar to put options (the option to sell an asset at a given price in the future). They allow management to abandon a project if the present value of the incremental cash flows from exiting a project exceeds the present value of the incremental cash flows from continuing the project.

Answer 160

**Expansion options** are similar to call options (the option to buy an asset at a given price in the future). Expansion options allow a company to make additional investments in future projects if the company decides they will create value.

Answer 161

**Flexibility options** give managers choices regarding the operational aspects of a project. The two main forms are **price-setting** and **production flexibility** options. * Price-setting options allow the company to change the price of a product. For example, the company may raise prices if demand for a product is high, in order to benefit from that demand without increasing production. * Production-flexibility options may include paying workers overtime, using different materials as inputs, or producing a different variety of product.

Answer 162

**Fundamental options** are projects that are options themselves because the payoffs depend on the price of an underlying asset. For example, the payoff for a copper mine is dependent on the market price for copper. If copper prices are low, it may not make sense to open a copper mine, but if copper prices are high, opening the copper mine could be very profitable.

Answer 163

**Fundamental options** are projects that are options themselves because the payoffs depend on the price of an underlying asset. For example, the payoff for a copper mine is dependent on the market price for copper. If copper prices are low, it may not make sense to open a copper mine, but if copper prices are high, opening the copper mine could be very profitable.

Answer 164

**Matrix pricing** is a method of estimating the required yield-to-maturity (or price) of bonds that are currently not traded or infrequently traded. The procedure is to use the YTMs of traded bonds that have credit quality very close to that of a nontraded or infrequently traded bond and are **similar in maturity** and coupon, to estimate the required YTM. | You use linear interpolation of the maturities to find a suitable YTM

Answer 165

The **sustainable growth rate** is the rate at which equity, earnings, and dividends can continue to grow indefinitely assuming that ROE is constant, the dividend payout ratio is constant, and no new equity is sold. **sustainable growth** = **g** = (1 − dividend payout ratio) × ROE

Answer 166

Operational efficiency

Answer 167

If security prices reflect all the information associated with fundamental value in a timely fashion, then the financial system is informationally efficient | Operational efficiency contributes to informational efficiency.

Answer 168

In informationally efficiently markets, capital is allocated to its most **productive use**. That is, they are **allocationally efficient**

Answer 169

The portfolio duration is simply the weighted average of the individual bond's duration. One limitation of this approach is that for portfolio duration to "make sense" the YTM of every bond in the portfolio must change by the same amount. Hence it assume a parallel shift in the yield curve. | Use the full price of the bonds

Answer 170

A **clawback clause **gives LPs the **right to recover** the performance fees from the GP. For instance, if a GP pays itself an incentive fee on profit not yet fully earned, the clawback clause allows an investor to claw back past incentive fee accrual and payments. Clawback is usually applicable when the GP closes successful deals early and incurs losses after some time within the life of a fund.

Answer 171

In **deal-by-deal** (also called American) waterfall, performance fees are accumulated** on per deal methods**. This makes the GP receive payments before LPs get their rates of return (hurdle rate) on the fund and initial investments. In whole-of-fund waterfall, the **GP does not receive any profit** until LPs are paid their hurdle rate and initial investments. | Deal-by-deal more profitable for GPs.

Answer 172

"Top-heavy" refers to a capital structure that includes a high percentage of **secured bank debt**. A firm with a top-heavy capital structure may be limited in its access to additional bank borrowing, which increases the likelihood of default if the firm encounters financial distress.

Answer 173

****In the event of a default, a borrower with a nonrecourse loan is not liable for the loan amount, the property is simply returned to the lender. With a nonrecourse loan, the lender has more risk in the event of default so interest rates will be higher.

Answer 174

Catch-up clauses benefit the general partners, allowing them to collect all gains after the hurdle rate is met until they have collected their specified incentive percentage of the initial gains

Answer 175

The security market line is basically a representation of CAPM so x-axis is the Beta (systematic risk). The slope is the market risk premium. The y-axis is the required return for the asset and the intercept is the risk free rate.

Answer 176

The capital allocation line **(CAL)** is the line of possible portfolio risk and return combinations given the risk-free rate and the risk and return of a portfolio.

Answer 177

The capital market line **(CML)** is the optimal CAL for all investors. With respect to capital market theory, any point above the CML is not achievable and any point below the CML is dominated by and inferior to any point on the CML.

Answer 178

When one company acquires another, the purchase price is allocated to all the identifiable assets (tangible and intangible) and liabilities acquired, based on fair value. If the purchase price is greater than the acquirer’s interest in the fair value of the identifiable assets and liabilities acquired, **the excess amount is recognized as an asset, described as goodwill**

Answer 179

Under U.S. GAAP, debt securities acquired with the intent to hold them until they mature are classified as held-to-maturity securities and measured at amortized cost. Amortized cost is equal to the original issue price minus any principal payments, plus any amortized discount or minus any amortized premium, minus any impairment losses. **Subsequent changes in market value are ignored.**

Answer 180

Available-for-sale securities are debt securities that are not expected to be held to maturity or traded in the near term. Any unrealized gains and losses are recognized in other comprehensive income as a part of shareholder's equity.

Answer 181

Trading securities (also known as held-for-trading securities) are debt securities acquired with the intent to sell them over the near term. The unrealized gains and losses are recognized in the income statement. | All equity securities holdings are treated in the same manner ## Footnote Except equity securities that give a company significant influence over a firm

Answer 182

The central principle is that a firm should recognize revenue when it has **transferred a good or service to a customer**. This is consistent with the familiar accrual accounting principle that revenue should be recognized when earned.

Answer 183

For long-term contracts, revenue is recognized based on a firm's **progress toward completing** a performance obligation. Progress toward completion can be measured from the input side (e.g., using the percentage of completion costs incurred as of the statement date). Progress can also be measured from the output side, using engineering milestones or percentage of the total output delivered to date.

Answer 184

**Justified P/E** is the P/E calculated using a DDM-model: P/E = (D/E) / (K-G) This is also a leading P/E ratio because the earnings should be the expected earnings next period. If one would just previous periods Earnings, then we get trailing P/E | D/E is the expected dividend payout ratio

Answer 185

The quotation is **price current / base currency** so in 1.25 USD/EUR, then EUR is **base** and USD is **price**

Answer 186

In a **direct quote**, the price currency is the investors currency: price currency / base currency

Answer 187

real exchange rate = nominal exchange rate * (CPI base / CPI price)

Answer 188

forward = spot * (1+interest price) / (1 + interest base)

Answer 189

The **forward discount** or **forward premium** for a currency is calculated relative to the spot exchange rate. The forward discount or premium for **the base currency** is the percentage difference between the forward price and the spot price. Example: Forward 7 USD / SEK Spot 6 USD / SEK SEKs forward premium is 7/6 - 1 = 16.6%

Answer 190

**Matrix pricing** is a method used to estimate the yield-to-maturity (**YTM**) for bonds that are not traded or infrequently traded. The yield is estimated based on the yields of traded bonds with the same credit quality. If these traded bonds have different maturities than the bond being valued, linear interpolation is used to estimate the subject bond's yield.

Answer 191

The **ex-dividend date** is the first day on which a share purchaser will not receive the next dividend. The ex-dividend date is one or two business days before the holder-of-record date, depending on the settlement period for stock purchases. **If you buy the share on or after the ex-dividend date, you will not receive the dividend**

Answer 192

1. Fundamentals of Compliance. 2. Input Data and Calculation Methodology. 3. Composite and Pooled Fund Maintenance. 4. Composite Time-Weighted Return Report. 5. Composite Money-Weighted Return Report. 6. Pooled Fund Time-Weighted Return Report. 7. Pooled Fund Money-Weighted Return Report. 8. GIPS Advertising Guidelines.

Answer 193

A composite is a grouping of **discretionary portfolios** representing a similar investment strategy, objective, or mandate. A composite must include **all portfolios (current and past)** that the firm has managed in accordance with this particular strategy. The firm should identify which composite each managed portfolio is to be included in before the portfolio's performance is known. All discretionary portfolios must be included in one, and only one, composite.

Answer 194

The annual (effective) yield for bond with its YTM stated for a periodicity of n, and n compounding periods per year, is: (1 + YTM / n)^n - 1 The greater the periodicity (number of payments per year) the great annual (effective yield) | YTM is often stated as it does not take the compounding into account

Answer 195

The current yield is the annual cash payment / bond price | It is also called income yield or running yield

Answer 196

The margin used to calculate the bond coupon payments the quoted margin (numerator) and we call the margin required to return the FRN to its par value the required margin (also called the discount margin) (denominator)

Answer 197

PV = FV * (1 - DAYS/YEARS * DR) OR DR = YEAR/DAYS * (FV - PV / FV) | Since the denominator is FV the discount rate **understates** the return

Answer 198

AOR = FV / (1 + DAYS/YEAR * AOR) AOR = YEAR/DAYS * (FV - PV)/PV | AOR is in the denoiminator

Answer 199

That is called a Bond equivalent yield.

Answer 200

PVBP = (PV^- - PV^+) / 2 | Easy to derive using the ApproxModDur

Answer 201

ApproxModDur = (PV_- - PV_+) / (2 x delta_yield x PV_0)

Answer 202

EffDur = (PV_- - PV_+) / (2 x delta_curve x PV_0) It assess the interest rate risk of a bond by estimating the percentage change in price given a change in a benchmark yield curve—for example, the government par curve.

Answer 203

The **money duration** of a bond is a measure of the price change in units of the currency in which the bond is denominated. The money duration can be stated per 100 of par value or in terms of the actual position size of the bond in the portfolio. MoneyDur = AnnModDur × PVFull | PVFull is the full price of the bond, including accrued interest

Answer 204

**Modified duration** is a measure of the percentage price change of a bond given a change in its yield-to-maturity.

Answer 205

%PVFull = - AnnModDur * deltaYield + 1/2 x AnnConvexity x deltaYield ^2

Answer 206

ApproxCon = [PV- + PV+ - (2 x PV0)] / (deltaYield^2 * PV0)

Answer 207

No, putable bonds do always have positive convexity.

Answer 208

Yes, typically at lower yields since when interest rates fall, the incentive for the issuer to call the bond at par increases, therefore itsprice will not rise as quickly as the price of a non-callable bond, its price might actually drop as the likelihood that the bond will be called increases.

Answer 209

The value of the put option grows when the interest rates grow since the price of bonds fall and the value of being able to sell at PAR is of course higher then Put option always trades at **higher** prices than non-putable bonds

Answer 210

The value of the call option grows when the interest rates fall since the price of the bond will approach par so it will be more likely for the issuer to buy back the bonds. Call option always trades at **lower** prices than non-callable bonds

Answer 211

Key rate duration is a measure of a bond’s sensitivity to a change in the benchmark yield curve at **specific maturity segments**. Key rate durations can be used to measure a bond’s sensitivity to changes in the shape of the yield curve.

Answer 212

Bonds with an embedded option do not have a meaningful internal rate of return because future cash flows are contingent on interest rates. Therefore, **effective duration** is the appropriate interest rate risk measure, not modified duration. | Option-pricing models are used to produce inputs to effective duration

Answer 213

1. Angel investing -> capital provided at the idea stage 2. Seed-stage financing -> support product development, marketing. **First stage for VC** 3. Early-stage financing -> companies moving towards operation, to start production / sales | VC = Venture capital

Answer 214

1. **Trade sale** refers to the sale of a company to a strategic buyer, like a competitor to create synergies. Not a sale to another private equity copany, that is a secondaary sale! 2. **IPO - inital public offering**, the company starts selling its shares (including some or all of those held by the private equity firm) to public investors 3. **Recapitalization** describes the steps a firm takes to increase or introduce leverage. Not a true exit strategy, but might allow the private equity firm to extract cash 4. **Secondary sales** represents the sale to another private equity firm. 5. **Write-off/liquidation** occurs when a transaction has not gone well

Answer 215

The **Ethical Decision-Making Framework** is designed to facilitate decision-making and avoid making decisions that have unanticipated ethical consequences. The four steps are: 1. **Identify**: relevant facts, stakeholders and duties owed, ethical principles, conflicts of interest 2. **Consider**: Situational influences, additional guidance, alternative actions 3. **Decide and act** 4. **Reflect**: Was the outcome as anticipated? Why or not?

Answer 216

1. Perfectly competitive markets. **It is well-defined and is positively sloped.** 2. Monopolistic competitive markets, it is not well-defined. 3. Oligopoly, not well-defined. 4. Monopoly, not well-defined. The supply curve of a firm should measure the quantity that the firm is willing and able to supply at different price levels. And the firms should produce the quantity where MR = MC and unfortunately, the marginal revenue and marginal cost do not include this information.

Answer 217

**Monopoly**: 1. A monopoly is a profit maximizer. 2. Monopolies are price makers. 3. Price discrimination: monopolies can change both the price and quality of their products. 4. There are very high barriers to entry for other firms.

Answer 218

**Oligopoly**: 1. Only a few firms operate in the market. 2. Profit maximization is a condition in this market. 3. Barriers to entry are high. 4. Firms make abnormal profits in the long-run.

Answer 219

**Monopolistic Competition**: 1. There are many producers and consumers in the market 2. Producers are price searchers, the demand curve is downward-sloping 3. Consumers assume that there are non-price differences among the products of competitors. Companies spend money on product differentiation/influential advertising 4. Few barriers to entry and exit exist.

Answer 220

**Perfect Competition**: 1. There exist a very large number of buyers 2. There exist a very large number of sellers willing to supply their products at given market prices 3. No single seller or producer is large enough to influence the market price. 4. Homogeneous products: the products being sold in this market are perfect substitutes for one another. Their quality and characteristics don’t vary from one another. 5. Perfect information: every consumer and producer is aware of the market prices and the utility derived from the use of any of the products. 6. There are no entry barriers.

Answer 221

1. Face a downward-sloping demand curve 2. Have at least two identifiable groups of customers with different price elasticities of demand for the product 3. Be able to prevent the customers paying the lower price from reselling the product to the customers paying the higher price

Answer 222

**Indirect mehtod** It starts with Net income and then makes adjustments for non-cash items, non-operating items, and net changes in operating accruals. **Direct method** In the direct method, each cash inflow and cash outflow related to cash receipts and payments are shown, while the impact of accruals is eliminated. Main components are: * Cash from customers * Cash operating expenses * Cash paid for interest / taxes CFI and CFF is identical under both methods.

Answer 223

1. Capacity - the borrower's ability to repay its debt obligations in time. 2. Collateral (emphasized for lower credit quality companies) - valuing the companies asset 3. Covenants - the terms and conditions the borrowers and lenders agree to as part of a bond issue. 4. Character - the management's integrity and commitment to repay the loan. Track record? Prior treatment of bondholders?

Answer 224

A **recessionary gap** is when real GDP is below full employment GDP because of a decrease in aggregate demand.

Answer 225

**Classical economists** believed that unemployment would drive down wages, as workers compete for available jobs, which in turn would increase SRAS and return the economy to its full employment level of real GDP

Answer 226

Keynesian economists believe that increasing aggregate demand through **government action** is the preferred alternative. Both **expansionary fiscal policy** (increasing government spending or decreasing taxes) and **expansionary monetary policy** (increasing the growth rate of the money supply to reduce interest rates) are methods to increase aggregate demand and return real GDP to its full employment (potential) level.

Answer 227

An **inflationary gap** is when real GDP is above full employment GDP because of an increase in aggregate demand.

Answer 228

* The Code contains high-level aspirational ethical principles that drive members and candidates to create a positive and reputable investment profession. * The Standards contain practical ethical principles of conduct that members and candidates must follow to achieve the broader industry expectations.

Answer 229

* Act with integrity, competence, diligence, respect, and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets. * Place the integrity of the investment profession and the interests of clients above their own personal interests. * Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions, and engaging in other professional activities. * Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession. * Promote the integrity and viability of the global capital markets for the ultimate benefit of society. * Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals.

Answer 230

**Neoclassical school** economists believe shifts in both aggregate demand and aggregate supply are primarily driven by changes in **technology** over time. They conclude that the economy will by itself revert to the full-employment equilibrium.

Answer 231

**Keynesian school** economists believe business cycle fluctuations are due to swings in the level of optimism of those who run businesses. They also believe that wages are "downward sticky," reducing the ability of a decrease in money wages to increase short-run aggregate supply and move the economy from recession (or depression) back toward full employment. Instead one must use expansionary fiscal or monetary policy.

Answer 232

**Monetarists** believe the variations in aggregate demand that cause business cycles are due to variations in the **rate of growth of the money supply**, likely from inappropriate decisions by the monetary authorities. They suggest the central bank should follow a **policy of steady and predictable increases in the money supply**.

Answer 233

The **Austrian school** believe business cycles are **caused by government intervention** in the economy.

Answer 234

**New Classical** school economists introduced **real business cycle theory** (RBC). RBC emphasizes the effect of real economic variables such as changes in technology and external shocks, as opposed to monetary variables, as the cause of business cycles. New Classical thinks that **policymakers should not try** to counteract business cycles because expansions and contractions are efficient market responses to real external shocks.

Answer 235

s-error = s / sqrt(n) where s^2 = sum(X-Xmean)^2/(n-1) | Standard error is the adjusted standard deviation of the sample

Answer 236

R2 = RSS / SST Where RSS is regression sum of square. So R2 is the percentage of total variation explained by the independent variable.

Answer 237

F = MSR/MSE where MSR = RSS and MSE = SSE / (n-1) We test the significance of the slope coefficient (in CFRA we only care about simple linear regression) hence this is equivalent to a t-test. | RSS = Regression sum of square SSE = Error sum of square

Answer 238

df = n - 2 t = (estimated beta value - b0) / standard error

Answer 239

Type 1 error is when you reject the null even though it was true

Answer 240

Type 2 error is when you fail to reject the null even though it was false

Answer 241

The power is the probability of not doing a type 2 error, or in other words, the probability of rejecting the null when it should be rejected (it is false) 1 - P(type 2 error)

Answer 242

1. **Transaction demand**, for buying goods and services 2. **Precautionary demand**, to meet unforeseen future needs; 3. **Speculative demand**, to take advantage of investment opportunities.

Answer 243

Due to the biases from product quality and new goods and substitution, CPI overstates the rate of inflation. As a result, increases in wages that are based on CPI will more than compensate for actual increases in the cost of living. - Price increases due to quality, not really more expensive - New goods are usually more expensive in the beginning - Hedonic pricing (SCB gör detta, hur snabb är processorn) may solve the quality issue - Fischer index can solve the substitution bias

Answer 244

Reasons commonly cited by governments for imposing capital restrictions include: 1. reducing the volatility of domestic asset prices 2. maintaining control of exchange rates 3. keeping domestic interest rates low 4. protecting strategic industries from foreign ownership.

Answer 245

The more elastic both import demand and export demand are,** the more likely currency depreciation is to narrow a trade deficit**

Answer 246

If the ratio of operating cash flow to net income is less than 1.0 consistently we can assume that the **company is reporting higher earnings than are likely to be supportable by its operating performance.** | NOT GOOD, CFO = Net Income + Non-Cash expenses - increase in working cap

Answer 247

The two major types of risk affecting a firm are business risk and financial risk.

Answer 248

Business risk is the uncertainty regarding the operating income of a company.

Answer 249

Financial risk refers to the uncertainty caused by the fixed cost associated with borrowed money.

Answer 250

The cost of preferred share is Rpref = D / P, the dividend divded by the current price. It is usually higher than the cost of debt, but less than the cost of common shares. You do not get any tax benefit.

Answer 251

Inventory turnover is how fast you turns over inventory. So the faster you turn it over (higher ratio) the less cash is locked up in inventory Inventory turnover = COGS / average inventory

Answer 252

Externalities refer to the effects that the acceptance of a project may have on other firm cash flows. Cannibalization is one example of an externality and describes when an investment takes customers and sales from other parts of the company. Positive externalities are when synergies are created.

Answer 253

* With a **soft hurdle rate**, a hedge fund charges an incentive fee on all profits, but only if the fund's rate of return exceeds a stated benchmark. * With a **hard hurdle rate**, a hedge fund charges an incentive fee only on the portion of returns that exceed a stated benchmark. So soft are more desirable for GPs (the hedge funds) since they will get higher incntive fee if the hurdle rate is met

Answer 254

With a high water mark, a fund's value must exceed its highest previous value (high water mark) before the fund may charge an incentive fee.

Answer 255

The notice period is the amount of time a fund has after receiving notice of a redemption request to fulfill the redemption request. A notice period is typically 30 to 90 days.

Answer 256

A **lockup period** is a minimum length of time before an investor may redeem shares or make withdrawals.

Answer 257

Sampling error is the difference between a sample statistic (such as the mean, variance, or standard deviation of the sample) and its corresponding population parameter (the true mean, variance, or standard deviation of the population). For example, the sampling error for the mean is as follows: sampling error of the mean = sample mean – population mean = x – µ

Answer 258

1. Opportunities (weak internal controls, inadequate oversight from the board of directors) 2. Motivation (analyst expectiations, previous earnings guidance by management, i.e., they have pressure to deliver) 3. Rationalization (management tell themselves a story to justify it)

Answer 259

Demand curves are not observable so a monopolist must search for the profit maximizing price. Because demand information is not perfect, a monopolist is a price searcher.

Answer 260

For all financial securities, dividend and interest income and realized gains and losses (actual gains or losses when the securities are sold) are recognized in **the income statement**. Doesn't matter if it is held-for-trading or whatever.

Answer 261

LIFO - Whether prices are increasing or decreasing LIFO provides a better estimate of cost of sales. If prices are stable, there is no difference between LIFO and FIFO estimates of inventory or cost of sales. The most useful estimates of inventory and cost of sales are those that best approximate current cost.

Answer 262

FIFO - Whether prices are increasing or decreasing FIFO provides a better estimate of inventory values. If prices are stable, there is no difference between LIFO and FIFO estimates of inventory. The most useful estimates of inventory and cost of sales are those that best approximate current cost.

Answer 263

Shortfall risk refers to the **probability** that a portfolio will not exceed the minimum (benchmark) return that has been set by an investor. Roy's safety-first ciriterion is based on the shortfall risk. SFRatio = (E(Rp) - R-L) / std-p

Answer 264

Yes, both demand and supply are more elastic in the long run.

Answer 265

The **power** of a test is the probability of rejecting the null hypothesis when it is false A correct rejection!

Answer 266

Youl can use a contigency table to test for independence between categories in discrete data.

Answer 267

No you will treat it as having **indefinite life** since it can be renewed so cheap. No amortization

Answer 268

* **Accrual accounting** means that financial statements should reflect transactions at the time they actually occur, not necessarily when cash is paid. * **Going concern** assumes the company will continue to exist for the foreseeable future

Answer 269

* **Relevance.** Financial statements are relevant if the information in them can influence users' economic decisions or affect users' evaluations of past events or forecasts of future events. To be relevant, information should have predictive value, confirmatory value (confirm prior expectations), or both. Materiality is an aspect of relevance. * **Faithful representation**. Information that is faithfully representative is complete, neutral (absence of bias), and free from error.

Answer 270

Installment sales are sales in which proceeds are to be paid in installments over an extended period of time This revenue recognition method accounts for when revenue and expense are recognized at the time of cash collection rather than at the time of sale.

Answer 271

Contractionary monetary policy typically results in increased interest rates which typically cause the domestic currency to appreciate.

Answer 272

* **Recognition lag** - Discretionary fiscal policy decisions are made in a political process. Make take time until they realize the economic problems * **Action lag** - The time governments take to discuss, vote on and enact fiscal policy changes * **Impact lag** - The time between the enactment of fiscal policy changes and when the impact of the changes on the economy actually takes place As a result of these lags, fiscal policy changes may result in **pro-cyclical** rather than countercyclical effects. For example, if the economy is in a recession phase, fiscal stimulus may be deemed appropriate. However, by the time fiscal stimulus is implemented and has its full impact, the economy may already be on a path to a recovery driven by the private sector.

Answer 273

A tariff is a **tax imposed on imported goods** imposed by the individual country

Answer 274

A quota is an **import quantity limitation** imposed by the individual country

Answer 275

The J-curve refers to a graph of the effect of currency depreciation on the trade balance over time. **In the short run, a trade deficit may increase** because current import and export contracts may be fixed in foreign currency units over the near term, and only reflect the exchange rate change over time. In the long run, currency depreciation should decrease a trade deficit.

Answer 276

An economic theory that implies that it makes no difference whether a government finances a deficit by increasing taxes or issuing debt.

Answer 277

Only systematic risk is priced. Investors do not receive any return for accepting nonsystematic or diversifiable risk.

Answer 278

Senior managements compensation is set by the board of directors whos own compensation is set by the compensation committee. The latter may also be invloved with the employee benefit plan.

Answer 279

An **investment committee** reviews and reports to the board on management proposals for large acquisitions or projects, sale or other disposal of company assets or segments, and the performance of acquired assets and other large capital expenditures.

Answer 280

The **operating cycle** is the average number of days that it takes to turn raw materials into cash proceeds from sales, is: operating cycle = days of inventory + days of receivables | The **net operating cycle** is equal to the cash conversion cycle.

Answer 281

Only incremental overhead costs related to a project should be included in the analysis

Answer 282

**Negative screening** refers to specific companies or industries from consideration for the portfolio based on their practices regarding ESG. Examples of industries where ESG factors might lead to exclusion are mining, oil extraction and transport, and tobacco.

Answer 283

**Full integration** refers to the inclusion of ESG factors or ESG scores in traditional fundamental analysis, like in estimating future cash flows. To the extent that ESG practices will affect such variables, integrating them into the analysis can help in determining which companies are currently overpriced or underpriced.

Answer 284

**Thematic investing** refers to investing in sectors or companies in an attempt to promote specific ESG-related goals, such as more sustainable practices in agriculture, greater use of cleaner energy sources, improved management of water resources, or the reduction of carbon emissions.

Answer 285

****Engagement/active ownership investing refers to using ownership of company shares or other securities as a platform to promote improved ESG practices. Share ownership is used to initiate or support (through share voting) positive ESG changes.

Answer 286

Investments made with the intention to generate positive, **measurable** social and environmental impact alongside a financial return | Thematic investing doesn't have to be measurable in the same way i THINK

Answer 287

Banks typically need to maintain excess reserves in order to meet regulatory requirements. As a result, a bank must invest in assets that are more conservative than those invested by other types of financial institutions. So **low risk**!

Answer 288

Under a defined-contribution plan, a company contributes an agreed-upon (defined) amount into the plan. The agreed-upon amount is the pension expense. The amount the company contributes to the plan is treated as an operating cash outflow. The only impact on assets and liabilities is a decrease in cash. In any event, the firm makes no promise to the employee regarding the future value of the plan assets. The investment decisions are left to the employee, who assumes all of the investment risk.

Answer 289

In a defined benefit plan, the firm **promises** to **make periodic payments to employees after retirement**. For a defined benefit plan, the net pension asset or net pension liability is a key element for analysis. If the fair value of the plan's assets is greater than the estimated pension obligation, the plan is said to be overfunded and the sponsoring firm records a net pension asset on its balance sheet. If the fair value of the plan's assets is less the firm records a net pension liability.

Answer 290

An analyst should use market values, not book values, to estimate the weights of debt and equity in a firm's capital structure.

Answer 291

A **float-adjusted** market capitalization-weighted index is constructed like a market capitalization-weighted index. The weights, however, are based on the proportionate value of each firm's shares that are **available to investors** to the total market value of the shares of index stocks that are available to investors.

Answer 292

An index that uses fundamental weighting uses weights based on firm fundamentals, such as earnings, dividends, or cash flow. An advantage of a fundamental-weighted index is that it avoids the bias of market capitalization-weighted indexes toward the performance of the shares of overvalued firms. A fundamental-weighted index will actually have a **value tilt**, overweighting firms with high value-based metrics such as book-to-market ratios or earnings yields

Answer 293

One disadvantage is that a given percentage change in the price of a higher priced stock has a greater impact on the index's value than does an equal percentage change in the price of a lower priced stock. Put another way, higher priced stocks have more weight in the calculation of a price-weighted index. Additionally, a stock's weight in the index going forward changes if the firm splits its stock, repurchases stock, or issues stock dividends, as all of these actions will affect the price of the stock and therefore its weight in the index.

Answer 294

The convenience yield associated with holding the underlying asset of a derivative is most accurately described as: the **nonmonetary** benefits of holding the asset.

Answer 295

The **time value** of an option is the amount by which the option premium (price) exceeds the exercise value and is sometimes called the speculative value of the option. This relationship can be written as: option premium = exercise value + **time value** At any point during the life of an option, its value will typically be greater than its exercise value. This is because there is some probability that the underlying asset price will change in an amount that gives the option a positive payoff at expiration greater than the (current) exercise value.

Answer 296

Interpolated spread is using interest rate swaps in the same currency and with the same tenor as a bond as the benchmark. ssuers will use the spread above the swap rate to determine the relative cost of fixed-rate bonds versus floating rates alternatives, such as commercial paper.

Answer 297

**Covered bonds** are similar to asset-backed securities, but the underlying assets (the cover pool), although segregated, remain on the balance sheet of the issuing corporation (i.e., no SPE is created). Special legislation protects the assets in the cover pool in the event of firm insolvency (**they are bankruptcy remote**).

Answer 298

A sponsored DR provides the investor with voting rights. For an unsponsored DR, the depository bank retains the voting rights

Answer 299

A **peer group** is a set of similar companies an analyst will use for valuation comparisons. More specifically, a peer group will consist of companies with similar business activities, demand drivers, cost structure drivers, and availability of capital. An analyst can appropriately include a company in multiple peer groups if the company's business activities are comparable to firms in more than one peer group.

Answer 300

Issuers can classify subsidiaries as restricted or unrestricted. **Restricted subsidiaries'** cash flows and assets can be used to service the debt of the parent holding company. This benefits creditors of holding companies because their debt is pari passu with the debt of restricted subsidiaries, rather than structurally subordinated.

Answer 301

The line of possible portfolio risk and return combinations given the risk-free rate and the risk and return of a portfolio of risky assets is referred to as the capital allocation line (CAL)

Answer 302

The optimal CAL is the CML, it uses the risk free rate and the market portyfolio and is a inear function of portfolio risk, σP .

Answer 303

The **diversification ratio** is calculated as the ratio of the **standard deviation** of an **equally weighted portfolio** of n securities to the average **standard deviation** of all n securities. If the average standard deviation of returns for the n stocks is 25%, and the standard deviation of returns for an equally weighted portfolio of the n stocks is 18%, the diversification ratio is 18 / 25 = 0.72. The lower the better, i.e., the more diversified!

Answer 304

1. **Declaration date**, board of directors approves payment of dividend 2. **Ex-dividend date**, the first day which a share purchaser will not receive the dividend 3. **Holder-of-record date**, the date on which all owners of shares become entitled to recieve dividend 4. **Payment date**, the date when the divided is paied.

Answer 305

Government bond trades typically settle in one day (T + 1) while corporate bond trades typically settle in two or three days (T+ 2 or T + 3). Government and corporate bonds trade primarily in dealer markets.

Answer 306

High industry concentration refers to an industry that has a **small number of firms**, it is concentrated. This often leads to less price competition, higher pricing power, and higher return on invested capital.

Answer 307

Asset-backed securities backed by **credit card receivables** have a lockout period, during which principal repayments are reinvested in additional receivables.

Answer 308

A basis swap involves trading **one set** of floating rate payments for another. So one floating-rate obligation for another.

Answer 309

the two-year into five-year rate So the YTM of a 5-years to matury bond in 2 years.

Answer 310

No, the price in a forward contract does not change over the contract's life

Answer 311

The price in a futures contract can change during the life of a futures contract because gains and losses are settled daily to return the value of the contract to zero

Answer 312

A soft lockup period describes a provision that** allows redemptions** during the lockup period, but with **significant additional fees** for such redemptions.

Answer 313

"Notching" refers to the credit rating agency practice of assigning ratings to debt issues that **differ** from the issuer's credit rating. An issuer credit rating applies to a firm's senior unsecured debt. Debt issues with different seniority or covenants may be notched to a higher or lower issue credit rating. Notching is more common for lower-rated issuers.

Answer 314

Everything above BBB- and Baa3 is investment grade. Everything at Ba1/BB+ or below is non-investment grade

Answer 315

American options can be more valuable than otherwise equivalent European options only **if early exercise has value** to the option holder. For call options, early exercise may be valuable if the **underlying asset provides cash flows**. Early exercise may be valuable for put options, particularly if they are deep in the money.

Answer 316

The difference between a bond's Macaulay duration and the bondholder's investment horizon is referred to as a **duration gap**. A positive duration gap (Macaulay duration greater than the investment horizon) exposes the investor to market price risk from increasing interest rates. A negative duration gap exposes the investor to reinvestment risk from decreasing interest rates.

Answer 317

**Conditional VaR** is the expected value of a loss, given that the loss exceeds a minimum amount.

Answer 318

**Value at risk** is the minimum loss that will occur over a period with a specified probability.

Answer 319

**Pulls on liquidity** accelerate cash outflows. Examples include paying vendors sooner and changes in credit terms that accelerate the required payment of outstanding balances. The cash is pulled out to pay suppliers.

Answer 320

**Drags on liquidity** delay or reduce cash inflows, or increase borrowing costs. Examples include uncollected receivables and bad debts, obsolete inventory (takes longer to sell and can require significant price discounts), and limited short-term credit availability due to economic conditions. There is a delay on the inflow, late receivables

Answer 321

The Sharpe ratio of a portfolio is its excess returns per unit of total portfolio risk. Higher Sharpe ratios indicate better risk-adjusted portfolio performance. Sharpe ratio = [E(R portfolio) - Rf] / σ portfolio | Used in evaluating the performance of a portfolio

Answer 322

The M-squared (M2) measure produces the same portfolio rankings as the Sharpe ratio but is stated in percentage terms.

Answer 323

The Treynor measure is calculated as (R portfolio - Rf) / Beta portfolio it is interpreted as excess returns per unit of **systematic risk**. (Systematic risk = beta) The Treynor measure and Jenson's alpha are calculated with beta, not standard deviation, and are appropriate for analyzing portfolios based on systematic risk.

Answer 324

Jensen's alpha for Portfolio P is calculated as: **αP** = Rp − [Rf + βP(RM − Rf)] So the excess return over the required reutrn by CAPM. The Treynor measure and Jenson's alpha are calculated with beta, not standard deviation, and are appropriate for analyzing portfolios based on systematic risk.

Answer 325

The Solow model or neoclassical model says that growth in potential GDP = **growth in technology** + WL(growth in labor) + WC(growth in capital) The additional growth in potential GDP from "growth in technology" represents the change in **total factor productivity**, the growth of output that is not explained by the growth of labor and capital.

Answer 326

The **legal infrastructure** identifies the laws relevant to and the legal recourse of **stakeholders** when their rights are violated.

Answer 327

The **contractual infrastructure** refers to the contracts between the company and its stakeholders that spell out the rights and responsibilities of the company and the stakeholders.

Answer 328

The **organizational infrastructure** refers to a company's corporate governance procedures, including its internal systems and practices that address how it manages its stakeholder relationships.

Answer 329

**Governmental infrastructure** comprises the regulations to which companies are subject.

Answer 330

**Event-driven strategies** are typically based on a corporate restructuring or acquisition that creates profit opportunities for long or short positions in common equity, preferred equity, or debt of a specific corporation. Event-driven funds are typically long-biased.

Answer 331

**Relative value strategies** involve buying a security and selling short a related security, with the goal of profiting when a perceived pricing discrepancy between the two is resolved.

Answer 332

**Macro strategies** are based on **global economic trends** and events and may involve long or short positions in equities, fixed income, currencies, or commodities.

Answer 333

Equity hedge fund strategies seek to profit from long or short positions in** publicly traded equities** and **derivatives** with equities as their underlying assets.

Answer 334

The money-weighted return applies the concept of **IRR** to investment portfolios. The money-weighted rate of return is defined as the internal rate of return on a portfolio, taking into account all cash inflows and outflows. The beginning value of the account is an inflow, as are all deposits into the account. All withdrawals from the account are outflows, as is the ending value. Then you solve for IRR with PV inflows = PV outlofws | Time-weighted rate of return doesn't account for the timing of cashflows

Answer 335

The money-weighted return applies the concept of **IRR** to investment portfolios. The money-weighted rate of return is defined as the internal rate of return on a portfolio, taking into account all cash inflows and outflows. The beginning value of the account is an inflow, as are all deposits into the account. All withdrawals from the account are outflows, as is the ending value. Then you solve for IRR with PV inflows = PV outlofws | Time-weighted rate of return doesn't account for the timing of cashflows

Answer 336

In many markets, traders can buy securities by borrowing some of the purchase price. They usually borrow the money from their brokers. The borrowed money is called the margin loan, and they are said to buy on margin.

Answer 337

In a **shelf registration**, an entire issue is registered with securities regulators but the bonds are sold to the public **over a period of time** as the issuer needs to raise funds.

Answer 338

In a **serial bond issue**, bonds with multiple maturity dates are issued at the same time.

Answer 339

In a **rights offering**, existing shareholders are given the right to buy new shares at a discount to the current market price. Shareholders tend to dislike rights offerings because their ownership is diluted unless they exercise their rights and buy the additional shares. However, rights can be traded separately from the shares themselves in some circumstances.

Answer 340

A **dividend reinvestment plan** (DRP or DRIP) allows existing shareholders to use their dividends to buy new shares from the firm at a slight discount.

Answer 341

Professional organizations **adopt codes of ethics** that govern their members' behavior. Legal standards are enforced by governments or regulatory agencies.

Answer 342

1. **Client identification** (type and nature of clients, existence of separate beneficiaries, and approximate portion of total client assets) 2. **investment objectives** (return objectives and risk tolerance); 3. **Investor constraints** (liquidity needs, time horizon, tax considerations, legal and regulatory circumstances, unique needs and preferences) 4. **performance measurement benchmarks**

Answer 343

**Brokers**: agents who fill orders for their clients, helping reduce their client’s transaction costs by efficiently matching them with someone else willing to take the other side of their trades. Typ ECM; hittar säljare och köpare och föra dem tillsammans

Answer 344

**Dealers**: fill their clients’ orders by trading with them. Unlike brokers, dealers directly buy from or sell to their clients, hoping to find another client to take the opposite side of the trade.

Answer 345

**Broker-dealers:** describes an entity that is both a broker and a dealer. Broker-dealers have an inherent conflict of interest in that a broker aims to acquire the best price for their clients, but a dealer maximizes their profit by buying from their clients at low prices and selling to their clients at high prices.

Answer 346

The definition of the firm, for purposes of GIPS compliance, must be the corporation, subsidiary, or division that is **held out to clients as a business entity**. If a firm has different geographic locations (e.g., all doing business under the name of Bluestone Advisers), then the definition of the firm should include all the various geographic locations and their clients.

Answer 347

**Not**, attempting to manipulate the price of a derivative by securing a controlling position in the underlying asset, which is a violation of Standard II(B) Market Manipulation.

Answer 348

Recommendations for compliance with Standard III(C) Suitability state that an investment policy statement should be **reviewed at least annually**. The recommendations also note that changes in market conditions or client circumstances may make more frequent updates necessary.

Answer 349

In the short run, real GDP can be less than its full-employment level (a recessionary gap that causes downward pressure on prices) or more than its full-employment level (an inflationary gap that causes upward pressure on prices). In long-run macroeconomic equilibrium, **actual real GDP is equal to potential real GDP** and there is no upward or downward pressure on the price level.

Answer 350

the square root of the mean squared error. sqrt(MSE)

Answer 351

**firms expect demand to increase.** An increase in finished goods inventories relative to sales, however, would be more likely to indicate a decrease in demand that may be caused by obsolete inventory or a business cycle peak.

Answer 352

The forward discount or premium for the **base currency** is the percentage difference between the forward price and the spot price. Spot: USD / EUR 1.312 Forward: USD / EUR 1.320 Forward premium/discount for EUR: 1.320/1.312 - 1 = 0.610%

Answer 353

1. Whereas the financial statements are prepared by management and are its responsibility, the auditor has performed an independent review. 2. Generally accepted auditing standards were followed, **thus providing reasonable assurance that the financial statements contain no material errors** 3. The auditor is satisfied that the statements were prepared in accordance with accepted accounting principles and that the principles chosen and estimates made are reasonable. The auditor's report must also contain additional explanation when accounting methods have not been used consistently between periods.

Answer 354

An unqualified opinion (also known as an unmodified or clean opinion) indicates that the auditor believes the statements are **free from material omissions and errors**

Answer 355

If the statements make any exceptions to the accounting principles, the auditor may issue a qualified opinion and explain these exceptions in the audit report | A material instance of noncompliance with applicable accounting standard

Answer 356

The auditor can issue an adverse opinion if the statements are not presented fairly or are materially nonconforming with accounting standards. | Adverse opinion issued when statements as a whole aren't fairly presente

Answer 357

Not all inventory costs are capitalized; some costs are expensed in the period incurred. These costs, known as p**eriod costs**, include: 1. Abnormal waste of materials, labor, or overhead. 2. Storage costs (unless required as part of production). 3. Administrative overhead. 4. Selling costs / transportation cost to customer

Answer 358

Accrual accounting is a financial accounting method that allows a company to record revenue before receiving payment for goods or services sold and record expenses as they are incurred. The cash flow statement is not prepared using accrual accounting.

Answer 359

Commodity is correct since commodity prices tend to increase with inflation. Stagflation is a period of economic contraction with increasing inflation, typically brought on by a sharp decrease in aggregate supply. Investments in equities tend to perform poorly in an economic contraction due to decreasing profitability of companies. Fixed income investments decrease in price when nominal interest rates increase due to increases in inflation.

Answer 360

The arithmetic mean is statistically the best estimate (expected value) of the next year's return. The geometric mean is used to calculate average annual compound returns. It is the best estimate of future multi-year annual compound returns, but the arithmetic mean is the best estimate of a single year's return.

Answer 361

You get +35,000 in Cash Flow from Investing (CFI)

Answer 362

Current liabilities are obligations due within one year or the company's operating cycle, whichever is longer. With an operating cycle of two years, Magnus should classify as current any liabilities that must be settled in less than two years. So time-frame = max(1-year, operating cycle) | Same goes for **current** assets

Answer 363

1. **Free Trade Areas** - All barriers to import / export goods are removed 2. **Custom unions** - + all counties adopt a common set of trade restrrictions with non-members 3. **Common market** - + All barriers to movement of labor / capital goods are removed 4. **Economic union** - + Member countries establish common institutions and economic policy for the union. The EU is an economic union 5. **Monetary union** - + Members adopt a single currency. The euro zone is a monetary unionen

Answer 364

**Call options** - higher Rf gives higher value since the PV of the exercise you will pay decreases **Put options** - higher Rf gives lower value since the PV of the exercise you will receive decreases

Answer 365

For calls, longer time to maturity increases the value of the call. For puts, the story is generally the same except for deep-in-the-money put options.

Answer 366

In general, there is a value to being able to exercise early for puts since the upside is limited (especially for deep in the money puts - so they ordinarily sell for more than their European counterparts.

Answer 367

c0 >= max(0, S0 - X(1+r)^t) It is same for both american/european

Answer 368

European put: p0 = max(0, X/(1+r)^t - S0) American put: p0 = max(0, X - S0)

Answer 369

F0(t) = S0(1 + r)^t The pay-off for buying at S0 and selling at F0(t) is riskless so: F0(t) / S0 = (1+r)^t If the price deviate then you have an arbitrage opportunity

Answer 370

**Nonbank finance **companies are a source of short-term financing for smaller firms and firms with lower credit ratings. Commercial paper issuance and revolving credit agreements are typically only available to larger corporations with high credit ratings.

Answer 371

No, Modigliani and Miller with taxes implies an optimal capital structure of 100% debt. However, **static trade-off** theory assumes that increasing debt proportions will initially reduce the weighted average cost of capital (because of tax savings), but that at some level of debt financing, increasing expected costs of financial distress will outweigh additional tax savings of greater debt issuance. | Among MM's assumptions is that financial distress does not have a cost.

Answer 372

The best-in-class approach to ESG implementation is an example of positive screening.

Answer 373

**Delta**. This is the sensitivity of derivatives values to the price of the underlying asset.

Answer 374

**Gamma.** This is the sensitivity of delta to changes in the price of the underlying asset.

Answer 375

**Vega**. This is the sensitivity of derivatives values to the volatility of the price of the underlying asset.

Answer 376

**Rho**. This is the sensitivity of derivatives values to changes in the risk-free rate.

Answer 377

You can use the ROIC to determine if a company is creating value for its shareholders. You compare ROIC to its cost of capital. ROIC is defined as: **after-tax net profit** / **average book value of its total capital**

Answer 378

With a core-satellite approach, a majority of the assets are invested passively (in the "core" portfolio) with a smaller proportion in actively managed "satellite" portfolios. This reduces the likelihood of excessive trading and offsetting active positions.

Answer 379

The theory that bearing unsystematic risk will provide no additional expected return assumes that unsystematic risk can be The theory that bearing unsystematic risk will provide no additional expected return assumes that unsystematic risk can be diversified away at no cost.

Answer 380

The real return is greater than the nominal return when the inflation rate is negative

Answer 381

They are calculated from the model inputs. Risk-neutral pseudo-probabilities are calculated using the risk-free rate and the sizes of an up-move and down-move of the underlying asset.

Answer 382

Structured financial instruments are securities designed to **change the risk profile** of an underlying debt security, often by combining a debt security with a derivative. Sometimes structured financial instruments redistribute risk. Examples of this type of structured instruments are asset-backed securities and collateralized debt obligations.

Answer 383

**A credit-linked note** (CLN) has regular coupon payments, but its redemption value depends on whether a specific credit event occurs. If the credit event (e.g., a credit rating downgrade or default of a reference asset) does not occur, the CLN will be redeemed at its par value. If the credit event occurs, the CLN will make a lower redemption payment. Thus, the realized yield on a CLN will be lower if the credit event occurs. | The yield on a CLN is higher than it would be on the note alone

Answer 384

A **capital protected instrument** offers a guarantee of a minimum value at maturity as well as some potential upside gain. An example is a security that promises to pay $1,000 at maturity plus a percentage of any gains on a specified stock index over the life of the security. Such a security could be created by combining a zero-coupon bond with a call option.

Answer 385

**A participation instrument** has payments that are based on the value of an underlying instrument, often a reference interest rate or equity index. Participation instruments do not offer capital protection. One example of a participation instrument is a floating-rate note. With a floating-rate note, the coupon payments are based on the value of a short-term interest rate, such as 90-day LIBOR (the reference rate). When the reference rate increases, the coupon payment increases. Because the coupon payments move with the reference rates on floating-rate securities, their market values remain relatively stable, even when interest rates change.

Answer 386

An **inverse floater** is an example of a **leveraged instrument**. An inverse floater has coupon payments that increase when a reference rate decreases and decrease when a reference rate increases, the opposite of coupon payments on a floating-rate note.

Answer 387

Some bonds are traded on a *when issued* basis in what is called the **grey market**. Such trading p**rior to the offering date** of the bonds provides additional information about the demand for and market clearing price (yield) for the new bond issue.

Answer 388

A type of bonds for which **ownership is not recorded**. Ownership is evidenced simply by possessing the bonds.

Answer 389

**Industry rotation** is an active management strategy of overweighting or underweighting industries, compared to their strategic allocation weights, based on the **stage of the business cycle**.

Answer 390

Contingent convertible bonds are converted automatically to common stock if a specified event occurs. May be issued by banks - often structured so that if the bank's equity capital falls below a given level, they are automatically converted to common stock

Answer 391

**Equity indexes** typically require reconstitution only in response to corporate events, such as mergers or bankruptcies. Commodity indexes, which use futures contracts as their constituent securities, and fixed income indexes require frequent reconstitution as futures contracts expire and bonds mature.

Answer 392

**Baa3/BBB–** - investment grade **Ba1/BB+** - non-investment grade Bonds with ratings of Baa3/BBB– or higher are considered investment grade. Bonds rated Ba1/BB+ or lower are considered noninvestment grade and are often called high yield bonds or junk bonds.

Answer 393

contango if spot price is lower than future opr A commodity market is contango if the futures price is higher than the spot price. | futures price ≈ spot price×(1+risk-free rate)+storage costs−convienceyie

Answer 394

Spot price higher than futures price. When the convenience yield is high, futures prices will be less than spot prices, a situation referred to as backwardation. | futures price ≈ spot price×(1+risk-free rate)+storage costs−convienceyie

Answer 395

In a securitized bond issue with a waterfall structure, the bonds are issued in tranches with varying levels of seniority. Any losses arising from the underlying assets are absorbed first by the tranches with the lowest seniority. Thus, tranches have different levels of default risk and therefore are likely to have different credit ratings. The structure is a form of internal credit enhancement.

Answer 396

A competitive strategy is described as defensive if it is used to maintain a firm's market share and offensive if it is used to gain market share.

Answer 397

**Cost leadership** is a competitive strategy in which a firm attempts to become the lowest-cost producer in the industry. This will enable the firm to offer lower prices than its competitors.

Answer 398

A **differentiation strategy** involves making a product distinctive compared to competing products so that customers will be willing to pay a premium price

Answer 399

Other things equal, convexity is greater for bonds with longer maturities and lower coupon rates.

Answer 400

The **drawdown period** for a private equity fund is the span of time over which the fund will draw down its committed capital and use it to invest in portfolio companies.

Answer 401

**Defensive stocks** (with low betas and low systematic risk) are less sensitive to economic cycles.

Answer 402

**Revenue bonds** are municipal bonds that will be repaid from revenues generated by a specific project such as a toll road.

Answer 403

**Secured bonds** have specific assets pledged as collateral.

Answer 404

**Downside risk measures** may be more appropriate than standard deviation for estimating risk of **hedge funds**, which often have leptokurtic and negatively skewed returns distributions. Standard deviation is typically an appropriate risk measure for publicly traded securities such as REITs and ETFs.

Answer 405

Soft dollars are **commission payments to a brokerage firm that are used, in part, to pay for other services such as research**.

Answer 406

Standard IV(C) Responsibilities of Supervisors explicitly states that speaking to the employee to determine the extent of the violations and receiving assurances that it will not be repeated **is not enough.** Finley must take positive steps to ensure that the violation will not be repeated, including promptly launching an investigation and limiting the employee's activities and/or increasing supervision of the employee until the results of the investigation are known.

Answer 407

In the absence of regulatory requirements, Standard V(C) Record Retention recommends maintaining records supporting investment recommendations and actions and records of investment-related communications with clients for at least seven years. Seven years is a recommendation, not a requirement, so if local regulations says 5 yeras, then 5 years are OK. Records can be maintained in electronic or hard copy format.

Answer 408

The larger part the good represent of your income, the more elastic it is. Toothpatse is not very elastic, you will buy what you always buy.

Answer 409

a frequency polygon is constructed by drawing a point to represent the frequency of a particular interval and connecting that point to the one representing the frequency of the next interval. The result is a shape very much like a histogram constructed from the same data, but with points instead of columns.

Answer 410

Increased government borrowing will tend to increase interest rates, and firms may reduce their borrowing and investment spending as a result, decreasing the impact on aggregate demand of deficit spending. **This is referred to as the crowding-out effect because government borrowing is taking the place of private sector borrowing.**

Answer 411

Increases in tax rates will increase DTA and DTL

Answer 412

(6,520 / 4,000)^(1/4) - 1 = 12.99% We do not need to care about compounding!

Answer 413

Acquisition goodwill is treated the same way under IFRS and U.S. GAAP: it is not amortized but is tested for impairment at least annually

Answer 414

Since no cash is involved, the transaction will just be described in the notes to the cash flow statement

Answer 415

An external auditor is appointed by the audit committee of the company's board of directors, not by its management

Answer 416

The objective of an audit is to enable the auditor to **provide an opinion on the fairness and reliability** of the financial statements. The auditor generally only provides reasonable assurance that there are no material errors in the financial statements, not an opinion about their numerical accuracy.

Answer 417

Probability distribution functions are defined for the **discrete** random variables Probability density functions are defined for the **continuous** random variables.

Answer 418

The debt ratio is total debt to total assets. total debt / total assets

Answer 419

The HHI is calculated as the sum of the squares of the market shares of the largest firms in the market. E.g. the 4-firm HHI is... HHI is more sensitive to mergers, which is good!

Answer 420

The N-firm concentration ratio is calculated as the sum or the percentage market shares of the largest N firms in a market

Answer 421

**Derivative instruments** are treated the same as trading securities where unrealized gains and losses are recognized on the income statement.

Answer 422

In the IFRS framework, the two assumptions that underlie the preparation of financial statements are accrual accounting and the going concern assumption. Accrual accounting means that financial statements should reflect transactions at the time they actually occur, not necessarily when cash is paid. Going concern assumes the company will continue to exist for the foreseeable future.

Answer 423

**Dilutive securities** are stock options, warrants, convertible debt, or convertible preferred stock that would decrease EPS if exercised or converted to common stock. If a firm has more than one potentially dilutive security outstanding, each potentially dilutive security must be examined separately to determine if it is actually dilutive (i.e., would reduce EPS if converted to common stock).

Answer 424

**Proxy statements** are issued to shareholders when there are matters that require a shareholder vote. These statements are a good source of information about the election of (and qualifications of) board members, compensation, management qualifications, and the issuance of stock options.

Answer 425

Companies' annual financial statemt is called Form 10-K and the quarterly financial statements are called Form 10-Q

Answer 426

Ly = (n+1) * y/100

Answer 427

In some industries, the economics of production lead to a single firm supplying the entire market demand for the product. There are large economies of scale. The average cost of production for a single firm is falling throughout the relevant range of consumer demand, like the electricity grid. Doesn't make sense to have two companioes.

Answer 428

+/- 1 std = 68% +/- 2 std = 95% (1.96 actual) 90% = +/- 1.65 std

Answer 429

Externalities are **the effects the acceptance of a project may have on other firm cash flows**. The primary one is a negative externality called cannibalization, which occurs when a new project takes sales from an existing product. A positive externality exists when doing the project would have a positive effect on sales of a firm's other product lines.

Answer 430

A revolving line of credit is typically for a longer period and involves an agreement to lend funds in the future up to some maximum amount. This is the best. With an uncommitted line of credit, the lender is not committed to make loans in any amount. Factoring does not typically involve an agreement for future receivables purchases.

Answer 431

The five key principles of the capital budgeting process are: 1. Decisions are based on cash flows, not accounting income. 2. Cash flows are based on opportunity costs. 3. The timing of cash flows is important. 4. Cash flows are analyzed on an after-tax basis. 5. Financing costs are reflected in the project's required rate of return.

Answer 432

Shareholder and creditor interests are considered to be better protected in a common-law system under which judges' rulings become law in some instances compared to a civil-law system.

Answer 433

The short-run supply curve for a firm in a perfectly competitive market is equal to the firm's MC curve. A price taker will maximize profits when it produces the output level where P = MC. As price rises, its point of intersection with the MC curve indicates optimal production.

Answer 434

Sources of sustainable long-run economic growth (increases in long-run aggregate supply) include 1. increases in the labor force 2. human capital (the education and skill level of the labor force) 3. the stock of physical capital 4. the supply of natural resources 5. The level of technology.

Answer 435

The money supply schedule is vertical because the money supply is independent of interest rates. Central banks control the money supply.

Answer 436

The buyers of both puts and calls are taking long positions in the options contracts (but the buyer of a put is establishing a short exposure to the underlying)

Answer 437

The matching principle holds that expenses should be accounted for in the same performance measurement period as the revenue they generate.

Answer 438

U.S. GAAP categorizes equity investment without significant control as trading securities, reported at fair value with profit and loss reported on the income statement. Under IFRS, firms can report equity securities in this manner, but may elect at the time of purchase to report an equity security at fair value through other comprehensive income.

Answer 439

An unbiased estimator has an expected value equal to the true value of the population parameter

Answer 440

A consistent estimator is more accurate the greater the sample size

Answer 441

An efficient estimator has the sampling distribution that is less than that of any other unbiased estimator.

Answer 442

1. **Scale and diversification**. Larger companies and those with a wider variety of product lines and greater geographic diversification are better credit risks. 2. **Operational efficiency**. Such items as operating ROA, operating margins, and EBITDA margins fall into this category. Along with greater vertical diversification, high operating efficiency is associated with better debt ratings. 3. **Margin stability**. Stability of the relevant profitability margins indicates a higher probability of repayment (leads to a better debt rating and a lower interest rate). Highly variable operating results make lenders nervous. 4. **Leverage**. Ratios of operating earnings, EBITDA, or some measure of free cash flow to interest expense or total debt make up the most important part of the credit rating formula. Firms with greater earnings in relation to their debt and in relation to their interest expense are better credit risks.

Answer 443

2/20 net 60 means that you get a 2% discount if the invoice is paid within 20 days, the whole amout has to be paid within 60 days.

Answer 444

Regulations often require an audit committee to be appointed

Answer 445

Beta = cov(Ri, Rm) / (std m)^2 So coveriance between asset return and the market divided by the variance of the market

Answer 446

Real Estate Investment Trust indexes track the prices of shares of publicly traded companies that invest in mortgages or real property

Answer 447

F0 = [S0 - PV(benefits) + PV(costs)] x (1+r)^t | Net cost of carry is benefits - costs.

Answer 448

change in full bond price = –annual modified duration x (ΔYTM) + 1/2 x annual convexity x (ΔYTM)^2

Answer 449

Approximate convexity = (V- + V+ - 2V0) / (delta YTM^2 * V0)

Answer 450

Preferred shares typically have no voting rights.

Answer 451

* **Supranational bonds** are issued by multilateral agencies such as the World Bank or International Monetary Fund. * Bonds that trade outside the jurisdiction of any one country are known as **global bonds**. * Bonds that pay coupons in a different currency than their principal are known as **dual-currency bonds**.

Answer 452

The price-to-sales ratio can be used for firms with negative earnings and implicitly recognizes the value of assets not recognized on the balance sheet. The price-to-earnings ratio is the most popular ratio in the investment community; however, it is not a useful ratio for firms with negative earnings. One of the significant disadvantages of the price-to-book value ratio is that it does not recognize the value of nonphysical assets such as human capital or intangible assets generated internally.

Answer 453

If a callable bond has a Z-spread of 180 bp and the OAS is 120 bp, the value of the call option is:180 – 120 = 60 bp. Make sense, the yeild should be higher for callable bonds. So option value is positive for callable bonds, you get higher yield than OAS if it is callable | Z-spread = OAS + option value

Answer 454

Asset-based models are often used to value natural resources companies and companies that are being liquidated.

Answer 455

Prepayment risk is the risk involved with the premature return of principal on a mortgage. A prepayment effectively renders the borrower free of mortgage obligations. Prepayment risk can take one of these two forms: 1. **Contraction risk**: the risk that interest rates decline. Homeowners will then refinance at the available lower interest rates. 2. **Extension risk**: the risk that when interest rates rise, prepayments will be lower than expected.

Answer 456

RMBS not issued by GNMA, Fannie Mae, or Freddie Mac are referred to as nonagency RMBS. They are not guaranteed by the government, so credit risk is an important consideration. The credit quality of a nonagency MBS depends on the credit quality of the borrowers as well as the characteristics of the loans, such as their LTV ratios. To be investment grade, most nonagency RMBS include some sort of credit enhancement.

Answer 457

Commercial mortgage-backed securities (CMBS) are backed by income-producing real estate, typically in the form of: * Apartments (multi family). * Warehouses (industrial use property). * Shopping centers. * Office buildings. * Health care facilities. * Senior housing. * Hotel/resort properties.

Answer 458

Collateralized mortgage obligations (CMO) are securities that are collateralized by RMBS. Each CMO has multiple bond classes (CMO tranches) that have different exposures to prepayment risk. The total prepayment risk of the underlying RMBS is not changed; the prepayment risk is simply reapportioned among the various CMO tranches.

Answer 459

Commodities and real estate investments such as farmland may both provide a hedge against inflation. Investing in farmland may provide income over the life of the investment from crops produced and sold. Investing in commodities typically does not provide income.