CFA WP Flashcards
(362 cards)
1
Q
When a fund manager (charterholder) takes over a portfolio which has cash proceeds ready for reinvestment, prior to talking to the client, what must they do?
A
Invest the funds in a liquid, risk-free security rather than having the money sit idle.
2
Q
How many years does the CFA Institute recommend retaining records for?
A
Seven Years
3
Q
The standard relating to conflicts of interest recommends four procedures all firms should adopt:
A
Limit participation in equity IPOs Restrictions on private placements Establish blackout/restricted periods Reporting requirements
4
Q
The reasons GIPS exists are?
A
Present performance results that are comparable regardless of geographic location. Facilitate dialogue between investment managers and their clients about issues of how the firm achieved their results.
5
Q
To claim GIPS compliance all presentations must be GIPS compliant?
A
True
6
Q
When assigning portfolios to composites for GIPS compliant reporting…
A
All fee paying accounts must be assigned to at least one composite. Assignments must be made prior to calculating portfolio returns. Composite returns must be calculated by asset weighting.
7
Q
In order to claim to be a CFA candidate…
A
Individuals must be registered to take the next exam.
8
Q
GIPS requires in order to claim compliance, firms must present GIPS-compliant performance information for:
A
A minimum of five years or since inception if firm is in existence less than five years.
9
Q
Is speculation by a company’s supplier considered material non-public information?
A
No
10
Q
Under GIPS standard all fee-paying and non-fee-paying accounts must be included in at least one composite.
A
False Only fee-paying accounts must be included, non-fee-paying accounts are optional in GIPS standard
11
Q
In order to accept work outside the firm or additional compensation…
A
A member or candidate must notify their current employer and receive written consent.
12
Q
Free Cash Flow to Firm from Net Income
A
FCFF = Net Income + NCC + (Interest Expense * (1 – tax rate)) – Fixed Capital Expenditures – Working Capital Expenditures NCC = Non-cash Charges such as depreciation and amortization
13
Q
Free Cash Flow to Firm from CFO
A
FCFF = CFO + (Interest Expense * (1 – tax rate)) – Net Capital Expenditures
14
Q
Constant Growth Rate Model
A
Vj = D1 / (k – g) Vj = value of the stock J D1 = Current Dividend times (1 + g) = D0 * (1 + g) k = The required rate of return g = The constant growth rate of dividends g = ROE * (1 – dividend payout ratio)
15
Q
When a dealer strips a Treasury bond and sells the strips in the bond market, what is the coupon on each stripped bond?
A
0% Each Treasury strip is a zero-coupon instrument. Its yield is determined by the market through active trading
16
Q
Do currency swaps have currency risk?
A
NO
17
Q
High return on invested capital and high pricing power are associated with:
A
High industry concentration (ie a small number of firms) High barriers to entry Low industry capacity
18
Q
Yield Curve Risk
A
Bonds with different maturity dates are more or less sensitive to changes in the market interest rate depending on the time until they mature.
19
Q
Moving-Average Line Sell Signal
A
If prices break through the line from above and there is heavy trading volume.
20
Q
Breakdown of ROE
A
ROE = (Net Income / Sales) * (Sales / Total Assets) * (Total Assets / Equity) = Profit Margin * Total Asset Turnover * Financial Leverage = Net Income / Equity
21
Q
The time value of an option is:
A
the amount by which an option’s premium exceeds its intrinsic value. The price of an option is the intrinsic value plus its time value. An out-of-the-money option has no intrinsic value, so its entire price consists of time value.
22
Q
money market yield
A
Money market yield = discount-basis yield × (face value / purchase price) Purchase price = face value – [face value × discount-basis yield × (days to maturity / 360)]
23
Q
Pure Expectations Theory
A
The pure expectations theory explains the term structure in terms of expected future short-term interest rates. According to the pure expectations theory, the market sets the yield on a two-year bond so that the return on the two-year bond is approximately equal to the return on a one-year bond plus the expected return on a one-year bond purchased one year from today.
24
Q
Liquidity Preference Theory
A
According to the liquidity preference theory, the term structure of interest rates is determined by (1) expectations about future interest rates and (2) a yield premium for interest rate risk.
Because interest rate risk increases with maturity, the liquidity preference theory asserts that the yield premium increase with maturity.
25
An American call option must be worth…
At least as much as an otherwise identical European call.
26
The drawbacks of the nominal spread measure are:
1. For both bonds, the yield fails to take into consideration the term structure of spot rates.
2. In the case of callable and/or putable bonds, expected interest rate volatility may alter the cash flow of the non-Treasury bond.
27
Depository Receipts
Are domestically traded securities representing claims of shares of foreign stocks. Those shares are held in deposit in a local bank, which in turn issue depository receipts in the name of the foreign company.
* Unsponsored issued without involvement of the firm
* Sponsored issued with the cooperation of the firm
* Global Depository Receipt, issued outside firm’s home country and outside U.S.
28
Nominal spread, static spread, zero-volatility spread, option-adjusted spread
* Nominal spread = Yield to Maturity of Bond – YTM of similar U.S. Treasury
* Static spread not over treasury’s YTM but over each of the spot rate’s term structure. The same spread is added to all risk-free spot rates.
* Zero-volatility spread is over the entire Treasury spot rate curve.
* Option-adjusted spread also over entire Treasury spot rate curve but accounts for options.
29
Payoff from an interest rate call
(Notational Principal) \* Max[0, (Underlying rate at expiration - Exercise Rate)][Days in underlying rate / 360]
30
Income Approach to valuing Real Estate
* Appraisal Price = NOI / Market Cap Rate
* Market Cap Rate = Bench Mark NOI / Benchmark Transaction Price
* (NOIs on top)
31
Computing the full price of a bond (also dirty price) [w periods]
* w periods = days between settlement date and next coupon date / days in coupon period
* PV = expected cash flow / [1 + i]^(t – 1 + w)
32
In foreign currency swaps both parties exchange:
* Full Interest Payments
* € \* % →
* $ \* % ←
* NOT difference as in interest rate swaps.
33
Discount Yield & Price Formula for T-Bills
* Discount Yield = [(Face Value - Price) / Face Value][360/Days]
* Days to maturity in a 360 day year is convention. BEY is more accurate. Can possibly be simplified further to:
* (1-P)(360/NSM) = Discount Yield
34
Price Value of a basis point
Represents the change in price of a bond when its yield changes by one basis point or 0.01%.
PVBP = duration \* 0.0001 \* bond value
35
Which is the most effective spread measure for valuing an option-free corporate bond?
Zero-volatility spread
36
Payoff of a Call
Max(0, Price of Underlying Asset – Exercise Price)
37
Volatility Risk
The risk that the price of a bond with an embedded option will decline when expected yield volatility changes.
38
Prepayment Risk
The risk a bond will be paid out before scheduled principal payment dates.
39
Taxable-equivalent yeild calculation
taxable-equivalent yield = tax-exempt yield / (1 – marginal tax rate)
40
Yield Ratio
* Yield Ratio = Yield on bond X / Yield on bond Y
* In the U.S. the yield on bond Y is frequently the on-the-run U.S. Treasury Bond.
41
Sustainable Growth Rate formula using ROE
* g = ROE \* (1 – dividend payout ratio)
* (1 – dividend payout ratio) = dividend retention rate
42
Yield to Maturity definition
Is simply the IRR of all future cash flows from the bond.
43
Cost of Equity Capital (Dividend Capitalization Method)
* Re = [(D/P) \* 100] + g
* D = Dividend of firm
* P = Price of firm’s shares
* g = growth rate of dividend
44
Covariance of A & B on BA II Plus
Use DATA then STAT worksheets then multiply:
r \* Sx \* Sy = Cov(A,B)
45
Calculating Beta using investment & market estimate variance
Beta = Cov(Investment, Market) / Variance of Market
Variance of Market = STD^2
46
In bond markets, smaller issue size is associated with:
Less Liquidity
47
P/E Calculation using next periods projected earnings and dividend
P / E1 = (D1/E1) / (k – g)
D1 = Dividend in next period
E1 = Earnings in next period
k = required rate of return
g = dividend growth rate
D1/E1 = Dividend Payout Ratio
48
Yield on Treasury Bills on a discount basis
```
d = (1 – P)(360 / Nsm)
P = settlement price per $1 of maturity value
Nsm = number of days between settlement date and the maturity date
d = yield on a discount basis
```
49
Short Seller loses…
If the stock price increases.
Short seller must post margin and doesn’t short shares he owns directly. Shares are borrowed.
50
Put-Call Parity
Stock + Put = Bond + Call
Negative value for Bond means you’re borrowing money
51
Porter’s Five Forces
Rivalry among Competitors
Bargaining Power of Suppliers
Bargaining Power of Buyers
Threat of Substitutes
Threat of New Entrants
52
Market Segment Theory
The market segmentation theory argues that within the different maturity sectors of the yield curve the supply and demand for the funds determines the interest rate for that sector.
53
Price of a Callable Bond
= Price of option free bond – Cost of the option
54
Default Risk
The risk that the issuer will fail to satisfy the terms of the obligation with respect to the timely payment of interest and principal.
55
Bond Equivalent Yield of an Annual Pay Bond
BEY = 2[(1 + annual pay yield)^.5 - 1]
56
Investing in commodity futures allows an investor to:
Hedge against inflation risk
Earn the return of a commodity without having to store it
Share in the commodity component of the country’s production
57
Covered Call
Long on the underlying plus selling a call on the underlying.
Upside is limited but you always get the income from selling the call. Downside risk is the underlying decreasing in value to zero.
58
Inflation Risk or Purchasing Power Risk
Arises from the decline in the value of a security’s cash flow due to inflation, which is measured in terms of purchasing power.
59
The three major types of stock indices are:
* Price Weighted: arithmetic mean of current prices which means index movements are influenced by the differential prices of the component.
* Value Weighted: Considers both the price and number of shares outstanding.
* Unweighted or Equal Weighted: A set sum is invested in each stock on the index so greater percentage changes in price have the biggest effect.
60
Regulatory Risk
Changes in regulations may require a regulated entity to divest itself from certain types of investments. A flood of the divested securities on the market will adversely impact the price of similar securities.
61
Interest Rate Risk
Since the price of a bond fluctuates with market interest rates, the risk that an investor faces is that the price of a bond held in a portfolio will decline if market interest rates rise.
## Footnote
*Interest Rate Risk is the major risk faced by investors in the bond market.*
62
Exchange Rate Risk or Currency Risk
The risk of receiving less of the domestic currency when investing in a bond issue that makes payments in a currency other than the manager’s domestic currency.
63
After tax yield calculation
after-tax yield = pre-tax yield \* (1 – marginal tax rate)
64
Current Yield of a bond (simplest formula)
* current yield = annual dollar coupon interest / price
* annual dollar coupon interest is the interest times the par value (usually 100)
65
Commodity Futures Contract Margin Call Formula
* IM = Initial Margin Amount
* MM = Maintenance Margin Amount
* F0 = Initial Value
* Ft = Future Value
* X = Units of Commodity
* (Ft – F0)X = IM – MM
* Solve for missing term, usually Ft, aka the margin call price.
66
Prefunded municipal bonds
Are bonds collateralized by an escrow of securities guaranteed by the U.S. government.
67
Swap Spread Formula
Swap spread = LIBOR – Treasury Rate
68
Credit Spread Risk
The risk that an issuer’s debt obligation will decline due to an increase in the credit spread.
69
Close-end funds
Close-end fund shares are fixed in number and trade on exchanges as though they were common stock.
70
Open-end funds
redeem existing shares or issue new shares in accordance with investor demand.
71
50-day MA, 200-day MA sell signal
When the 50-day line crosses the 200-day line from above. And there is heavy trading volume.
72
50-day MA, 200-day MA buy signal
If the 50-day MA line crosses the 200-day MA line from below on good volume.
73
Zero-coupon bonds and reinvestment risk
Zero-coupon bonds have NO reinvestment risk
74
Are depreciation and financing cost a factor when calculating NOI?
NO
75
Computing the Accrued Interest and the Clean Price of a bond
* days in accrued interest period = days in coupon period – days between settlement and next coupon
* days in accrued interest period / days in coupon period = (1 – w)
* Accrued Interest = semi-annual coupon payment \* (1 – w)
* Clean Price = full price – accrued interest
76
Reinvestment Risk
is the risk that the proceeds from the payment of interest and principal (i.e. scheduled payments, called proceeds, and principal payments) that are available for reinvestment must be reinvested at a lower interest rate than the security that generated the proceeds.
77
Using a benchmark to estimate the value of a building is known as:
Sales comparison approach
78
Sustainable growth rate is the same as:
the dividend growth rate.
79
Bond-equivalent Yield convention
Is double the semiannual yield
80
Which bonds are most sensitive to changes in market interest rates?
All other things being equal, low coupon + long maturity equals greatest sensitivity to interest rate changes.
81
The long-run forward P/E of stock is between:
12 & 16
82
Call Risk
The risk associated with a call-able bond being called before maturity.
83
Payoff of a Put
Max(0, Exercise Price – Price of Underlying Asset)
84
Do value-weighted indexes need to be adjusted for stock splits?
NO
85
What do you call it when future price of a commodity exceeds the spot price?
Contango
86
Mortgage Backed Securities
An investment instrument that represents ownership of an undivided interest in a group of mortgages. Principal and interest from the individual mortgages are used to pay investor’s principal and interest on MBS.
## Footnote
**Prepayment Risk always present.**
87
Bond equivalent yield of a US treasury bill uses a 360 day year?
FALSE
88
Earnings Multiplier Model (P/E Calculation via dividend payout ratio)
* P/E = dividend payout ratio / (k-g)
* k = required rate of return
* g = dividend growth rate
* dividend payout ratio = 1 – dividend retention rate
89
Cash Flow Yield from Semi-annual Yield & Monthly Yield
* effective semi-annual yield = (1 + monthly yield)^6 – 1
* cash flow yield = 2 \* effective semi-annual yield
* cash flow yield = 2 \* [(1 + monthly yield)^6 -1]
90
Liquidity Risk
The risk an investor will have to sell a bond below its indicated value where the indication is revealed by a recent transaction.
91
Fiduciary Call
* Consists of an European Call and a risk-free bond
* This gives the same value graph as a protective put and is the basis of put-call parity.
* There is limited downside risk and unlimited profit potential.
92
Limit of covered call profits
…is limited to the premiums collected plus any movement in the stock price up to the strike price.
93
Spot rates are usually given as…
Bond Equivalent Yields
So they need to be halved when discounting back by six month periods.
94
The maximum value of an European put is:
the present value of the exercise price.
95
A bond trading at par and callable at above par, all else being equal, if there is an unexpected decrease in interest rate volatility the value of the bond will most likely:
Increase
96
Bond Duration Definition and Formula
* The estimate of the percentage price change for a 100 basis point change in yield.
* (price if yields decline – price if yield rises) / (2 \* initial price \* change in yield in decimal)
97
Protective Put
Long on the underlying plus buying a put from the market.
This strategy is immediately out of pocket the option premium. But their downside risk is limited to the difference between the strike price and present value of the underlying. Upside potential is unlimited but to profit by this strategy the underlying must increase by more than the option premium.
98
Downgrade Risk
The risk credit agencies will downgrade their rating of the issuing firm therefore increasing the credit spread and causing a decline in the price of the issue.
99
The Dividend Discount Model
* Value of common stock = ∑ Dt / (1 + k)^t
* Dt = dividend during period t
* k = required rate of return of the stock
100
The zero-volatility spread
is the constant spread that is added to each Treasury spot rate to equate the present value of a bond’s cash flows to its actual market value.
101
Absolute Yield Spread Formula
* absolute yield spread = yield on bond x – yield on bond y
* The yield on bond y is frequently the on-the-run treasury bond.
102
The option adjusted spread is a meaure of the yield spread over Treasury spot rates…
Without the option
103
Sovereign Risk
The risk that, as a result of actions of the foreign government, there may be either a default or an adverse price change even in the absence of a default.
104
Why issue Asset Backed Securities?
* The primary motive is to take an asset off the balance sheet.
* It can also help protect assets in case the parent defaults.
105
Moving-Average Line Buy Signal
Approaches the line from below and is accompanied by heavy trading volume.
106
Cumulative Voting
Allows shareholders to vote all their shares for a single board member or group of board members.
Cumulative Voting allows shareholders to vote in a manner that enhances the likelihood that their interests are represented on the board.
107
Steps to calculating borrowing cost of trade discount
1. Determine the difference between the discount and full price
2. Determine the number of days of credit usage
3. Determine simple interest rate = discount / difference
4. One plus simple interest rate raised to 365/days of credit usage
5. Subtract one
108
A firm should continue to invest in new projects along its’ investment opportunity schedule while:
The proposed project’s return is greater than the marginal cost of capital.
109
Diluted EPS formula
Diluted EPS = [Net Income - Preferred Dividends] + [Convertible Preferred Dividends] + [Convertible Debt Interest](1 – t) / [Weighted Average Shares] + [Shares From Conversion of Preferred Shares] + [Shares From Conversion of Debt] + [Shares Issuable from Stock Options]
110
Compared to a firm that primarily capitalizes its leases, a firm that uses primarily operating leases is more likely to have:
A firm that uses primarily operating, instead of capital leases will have lower leverage ratios (due to lower debt and higher equity) and higher return on assets (due to higher net income and lower assets).
111
Always remember in accounting…
A = L + SE
Assets equals liabilities plus shareholders equity
112
Cost of equity using CAPM
k = Rf + Beta(Rm – Rf)
113
Cost of Trade Credit formula
Cost of Trade Credit = (1 + Discount/(1 – Discount))^(365/Number of days beyond discount period) – 1
114
WACC
```
WACC = (We)(Re) + (Wd)(Rd)(1-t) + (Wp)(Rp)
Wp = Weight of preferred stock
Rp = Marginal Cost of preferred stock
```
115
Under IFRS when an asset is permenently impaired…
it must be written down to its recoverable amount (greater of value in use or fair value less selling costs) in the period in which impairment is recognized.
116
Inventoriable costs include…
Freight in but not freight out which is a selling expense.
117
At the end of a depreciable asset’s estimated useful life its remaining book value equals?
Salvage Value
118
Purchase/Sale of trading securities counts as cash flow from?
Operations
119
Average Age of Assets
Average Age = Accumulated Depreciation / Depreciation Expense
120
Extraordinary items are permitted on income statements…
under U.S. GAAP but not under IFRS accounting standards.
121
Capital Component Breakpoint
Capital Component Breakpoint = Value at which components cost of capital changes / Weighting in WACC
122
Quick Ratio
Quick Ratio = (cash + marketable securities + receivables) / current liabilities
123
A plan where the company guarantees a specific benefit amount upon retirement is:
Defined Benefit Plan
124
Business Risk is a combination of:
* Sales Risk
* Operating Risk
125
When calculating Interest Expense and Amortization Expense for a bond…
1. Calculate Cash Payment PMT
2. Calculate Present Value of Bond PV
3. Calculate Interest Expense PV \* YTM
4. Calculate Amortization Expense PMT – Interest Expense
126
Profitability Index
NPV, IRR, and even payback period are more common, but profitability index is calculated:
PV of future cash flows / initial investment
127
Net Income Conversion Formula LIFO to FIFO
Net Income FIFO = Net Income LIFO + ∆LIFO Reserve \* (1 – tax rate)
128
Number of days of receivables
Number of days of receivables = Accounts Receivable / Sales on Credit / 365
129
Average Accounting Return
AAR = average net income / average book value
130
Which combination of inventory methods would provide the most informative measures of ending inventory and COGS respectively?
* Ending Inventory – FIFO
* COGS – LIFO
131
When calculating CFO & CFI back from Net Income, depreciation expense is:
* Added back to Net Income when calculating CFO.
* Depreciation expense is a non-cash operating expense. Property, Plant, & Equipment valuation difference is used for calculating CFI.
132
Free Cash Flow definition
Cash from operations less the amount of capital expenditures required to maintain the firm’s present productive capacity.
133
The installment method should be used when
future cash collection cannot be reasonably estimated.
134
Number of days of payables
Number of days of payables = Accounts Payable / Purchases / 365
135
Assets = Liabilities + Shareholders Equity (Long Form)
Assets = Liabilities + Contributed Capital + Beginning Retained Earnings + Revenue – Expenses – Dividends
136
Retained Earnings LIFO to FIFO formula
Retained Earnings FIFO = Retained Earnings LIFO + Ending LIFO Reserve \* (1 – tax rate)
137
The four principal qualitative characteristics that make financial information useful are: (IFRS)
* Understandability
* Relevance
* Reliability
* Comparability
138
In the IFRS framework the two assumptions that underlie the preparation of financial statements are:
The accrual basis
The going concern assumption
139
Depreciation Expense is: (Net Income & CFO)
subtracted from revenue when calculating taxable income but it is added back when calculating cash flow from operations or net cash flow.
140
Fixed Assets can be revalued upward under:
IFRS
but not under U.S. GAAP
141
The “Fraud Triangle” consists of…
* incentives and pressures (the motive to commit fraud)
* opportunities (the firm has a weak internal control system)
* attitudes and rationalizations (the mindset that fraud is justified)
142
Under U.S. GAAP comprehensive income can be reported…
* On the income statement (below net income)
* In a separate statement of comprehensive income
* In the statement of changes in shareholders’ equity
This may be changing very soon.
143
Ex-Dividend Date
Ex-Dividend Date is two business days before the holder-of-record date.
The ex-dividend date is important, as from this date forward, new stockholders will not receive the next dividend payment.
144
The deferred income tax account is:
where the difference between income tax expense and income tax payable is reconciled.
145
The flow of information in an accounting system:
Prepare journal entries
Post to ledger
Prepare trial balances
Adjust entries
Adjust trial balances and financial statements
146
Basic EPS
Basic EPS = (Net Income – Preferred Stock Dividends) / Weighted Average Shares Outstanding
147
Dividend Retention Rate
retention rate = 1 – dividends declared / operating income after taxes
148
The treatment of income statement items that do not affect cash flows can be summarized as follows: (Indirect Method)
Add to or Deduct from Net Income
Depreciation Expense Add
Amortization Expense Add
Depletion Expense Add
Losses Add
Gains Deduct
149
Degree of Financial Leverage
DFL = [Q(P-V) - F] / [Q(P-V) - F - C]
* Q is the number of units
* P is the price per unit
* V is the variable operating cost per unit
* F is the fixed operating costs
* C is the fixed financial costs
150
A company will favour capital leases over operating leases if it:
has a high marginal tax rate and does not face binding debt covenants
151
Cash flow yield of a firm
Cash Flow Yield = Net Cash Flows from Operating Activities / Net Income
152
Is Goodwill amortized?
No it is considered to have an indefinite life and is therefore not amortized.
153
The following sumarizes the adjustments for increases and decreases in current assets and current liabilities:
154
Pretax Income Formula
Pretax Income = Taxable Income + (increase in differed tax liabilities)/tax rate – (increase in differed tax assets)/tax rate
155
Operating Cycle
Operating Cycle = Number of Days of Inventory + Number of Days of Receivables
156
Under IFRS and U.S. GAAP goodwill should be:
Capitalized and test for impairment annually.
157
Degree of Operating Leverage
DOL = Q(P-V) / Q(P-V) – F
* F is fixed operating cost
* Q is the number of units
* P is the price per unit
* V is the variable operating cost per unit
158
Net Operating Cycle (Cash Conversion Cycle)
Net Operating Cycle = Number of days of inventory + Number of days of receivables – Number of days of payables
159
Options available to an auditor of financial statements:
From best to least:
Unqualified Opinion
Qualified Opinion
Adverse Opinion
Final option is to decline to given an opinion.
160
LIFO vs FIFO in periods of rising prices
161
Impaired Asset
Asset which are carried at more than the sum of their undiscounted expected cash flows.
162
Pure-Play method of determining Beta
* Beta company = Beta unlevered [1 + ((1-t) D/E)]
* t = corporate tax rate
* D/E = debt to equity ratio
163
Under IFRS is LIFO allowed?
No
164
Degree of Total Leverage
```
DTL = DOL \* DFL
DOL = Degree of Operating Leverage
DFL = Degree of Financial Leverage
```
165
How is a lessor to record the sales price of a sales-type lease?
The lessor records the present value of the minimum lease payments discounted at the interest rate implicit in the lease as the sales price.
166
Calculating other comprehensive income
1. Subtract beginning retained earnings from ending retained earnings.
2. Add back Net Income
3. Subtract Dividends Paid
4. Subtract change in retained earnings
= other comprehensive income
167
An optimum dividend policy is one that:
Maximizes shareholder value or share price.
168
Changes to depreciation assumptions can maximize earnings for the year by:
Depreciation expense is minimized and income maximized by using a longer depreciable life and a larger salvage value.
169
Number of days of inventory
Number of days of inventory = Inventory / COGS / 365
170
If ROE is low it must be one of the following is true:
* The company has a poor profit margin.
* The company has poor asset turn over.
* The company is under-leveraged.
171
Information regarding management compensation and qualifications is most likely found in the:
Proxy Statment
172
Under U.S. GAAP are R&D costs capitalized or expensed?
Expensed but some software development costs can be capitalized
173
IFRS requires that expenditures on research be capitalized or expensed?
Expensed
174
What happens to the weighted average cost of capital as the debt-to-equity ratio increases?
WACC Decreases
175
Bank Discount Basis Formula
Rbd = (D/F) \* (360/t)
* Rbd = the annualized yield on a bank discount basis
* D = dollar discount
* F = face value
* t = number of days remaining until maturity
176
Standard error of the sample mean
Population
σx = σ / root n
Sample
sx = s / root n
Equals standard deviation over square root of sample size.
177
The smallest level of significance at which the null hypothesis can be rejected is know as:
P-value
178
An estimator that tends to produce the most accurate estimates of the population parameter as the sample size increase is best characterized as a:
Consistent estimator
179
Combination Formula
nCr = n! / (n-r)!r!
Order does not matter
nCr button on BA II Plus
180
90%, 95%, 99% Confidence Intervals
* 90% Confidence Interval = xbar ± 1.645(s/root n)
* 95% Confidence Interval = xbar ± 1.96(s/root n)
* 99% Confidence Interval = xbar ± 2.58(s/root n)
181
Geometric Mean
G = nth root of (x1x2x3…xn)
Take the product of all observations, all which must be positive numbers. Then use y^x key to find the nth root.
182
Central Limit Theorem
Given a population described by any probability distribution having mean μ and finite variance σ^2, the sampling distribution of the sample mean xbar computed from samples of size n from this population will be approximately normal with mean μ (the population mean) and variance σ^2 / n (the population variance divided by n) when the sample size is n large.
183
Confidence Interval, t-distribution, Population Variance Unknown
mean ± t-value( s / root n)
s = standard deviation of sample
184
The probability of A or B when A and B are mutually exclusive is:
P(A) + P(B) -P(A)P(B)
185
What value does the null hypothesis make a claim about?
Population Parameter
186
Type II Error
When we do not reject a false null hypothesis.
187
The bank discount yield is not a meaningful measure of investors’ return because:
* The bank discount yield is based on a 360-day year.
* The bank discount yield is annualized with simple interest.
* The bank discount yield is based on the face value of the bond.
188
Sample Correlation Coefficient
r = Cov(x,y) / Sx \* Sy
Sx = squared deviations of (xi – xbar)
Sy = squared deviations of (yi-ybar)
r on BA II Plus STAT worksheet
189
platykurtic
a distribution that is less peaked than normal.
190
Nominal Scales
Categorizes data but does not rank it.
Weakest
191
When order matters in selecting and counting use?
Number of Permutations
nPr button on BA II Plus
n! / (n-r)!
192
Sharpe Ratio Formula
Sh = (Expected Return – Risk free Return) / Standard Deviation of Investment
Bigger is better, means less risk for similar returns.
193
a priori probability
based on logical analysis rather than on observation or personal judgement.
194
What is the appropriate statistic to use for a test concerning the difference between the variance of two normally distributed populations?
F-statistic
195
Continuously Compounded Return
The continuously compounded return, Rt,t+1, associated with a holding period is the natural logarithm of 1 plus that holding period return:
Rt,t+1 = ln(1 + r)
196
Negative Skewed Distributions
* Long tail on the left
* Frequent small investment gains and a few extreme losses
*
197
Postive Skewed Distributions
* Long tail on the right
* Frequent smaller investment losses and few extreme gains
198
4 major categories of technical analysis
1. Contrarian
2. Smart money followers
3. Momentum indicators
4. Price-and-volume
199
The most appropriate distribution for modeling asset prices is:
Lognormal distribution
Because the values can be less than zero.
200
% change in price (Price Elasticity of Demand)
% = (P2 – P1) / (P1 + P2) / 2
201
Type I and Type II Errors in Hypothesis Testing
202
Subjective probability
based on personal judgment
203
Leptokurtic
* A distribution that is more peaked than normal.
* Kurtosis \> 3
204
Head and shoulder pattern
* Is a peak followed by a trough, followed by a higher peak, followed by a trough.
* It is a downward trend indicator in technical analysis.
* Inverse head and shoulder pattern is mirrored vertically and indicates an immanent upward trend.
205
Kurtosis
is the statistical measure that tells us when a distribution is more or less peaked than a normal distribution.
206
% change quantity (Price Elasticity of Demand)
% = (Q2 – Q1) / (Q1 + Q2) / 2
207
Present Value of a Perpetutity
PV = payment / interest rate
OR
PV = payment / required rate of return
208
A normal distribution is…
A continuous symmetric probability distribution.
209
The signifigance level of a test is usually equal to:
The probability of a Type I error.
210
Test Statistic Formula
Test statistic = ( Sample Statistic – Value of the population parameter uner Ho) / Standard Error of the Sample Statistic
211
The binomial distribution is an example of a…
discrete distribution
212
Sample Standard Deviation (formula)
Sx on the BA II Plus
213
Coefficient of Variation
CV = standard deviation / arithmetic mean
214
Addition Rule for Probabilities
P(A or B) = P(A) + P(B) – P(AB)
215
Discrete Variable
Random variable where there are a finite and countable number of terms.
E.g. : coin flips, dice rolls
216
Interval Scales
Provides not only ranking but also the assurance that the difference between scale values is equal.
217
Ratio Scales
Has all the characteristics of Interval measurement scale as well as a true zero point as the origin.
Strongest
218
Permutation Formula
nPr = n! / (n-r)!
Order Matters
[nPr button] on BA II Plus
219
Normal Distribution properties
* The mean and the median are equal.
* It is completely described by two parameters – its mean and variance.
* Roughly 68 percent of observations lie between plus and minus one standard deviation from the mean; 95 percent lie between plus and minus two standard deviations; and 99 percent lie between plus and minus three standard deviations.
220
Multiplication Rule for Independent Events
P(AB) = P(A)P(B)
221
Type I error
When we reject a true null hypothesis.
222
Ordinal Scales
Sort data into categories that are ordered with respect to some characteristic.
223
Population Variance formula
224
Empirical Probability
based on observable results such as historical data.
225
Population Standard Deviation (formula)
226
99% Confidence Interval
sample mean ± 2.58s
s = standard deviation / square root of sample size
227
Compute portfolio standard deviation of return (only two assets)
Cov(Ra, Rb) = STDa \* STDb \* Cor(a, b)
ϑ^2(Rp) = (Wa^2)(ϑ^2(Ra)) + (Wb^2)(ϑ^2(Rb)) + (2)(Wa)(Wb)(Cov(Ra, Rb))
STDp = Square Root of ϑ^2(Rp)
228
The cross elasticity of demand of a substitue is:
Positive
As the price increases for a good, demand for its substitute increases.
229
The Monetarist View
A Monetarist is a macro-economist who believes that the economy is self-regulating and that it will normally operate at full employment, provided that monetary policy is not erratic and that the pace of money growth is kept steady.
230
Reasons for the total cost curve to be u-shaped?
1. Spreading total fixed costs over larger output
2. Eventually diminishing returns
3. Economies of scale
231
Under perfect competition marginal revenue equals?
Price
Still produce where MR = MC
232
According to Income Effect an increase in wage rate
will increase the demand for leisure, decreasing the supply of labour.
233
If prices in two countries are rising at the same annual rate, then the prices of imports and exports will:
remain unchanged relative to domestically produced goods.
234
In the short run, the U shape of the average total cost curve arises from the influence of two opposing forces:
1. Spreading total fixed cost over a larger output
2. Eventual diminishing returns
235
A profit-maximizing monopolist produces an output in the:
elastic range of the demand curve where marginal revenue equals marginal cost.
236
Potential Deposit Expansion Multiplier
= 1 / Reserve Ratio
Money supply increased by:
Amount deposited \* (1 / reserve ratio)
237
The Laffer curve
Indicates that tax revenues reach a maximum at some tax rate and decrease if tax rates are increased above that rate.
238
The short-run Phillips curve shows the relationship between inflation and unemployment, holding constant:
The expected inflation rate
The natural unemployment rate
239
The Keynesian View
A Keynesian macro-economist believes that left alone, the economy would rarely operate at full employment and that to achieve and maintain full employment, active help from fiscal policy and monetary policy is required.
240
The quantity of real GDP supplied (Y) depends on:
The quantity of labour (L)
The quantity of capital (K)
The state of technology (T)
241
Monetarist Rule/Equation
MV = PY
```
M = The quantity of money
V = Velocity of circulation
P = Price Level
Y = Real GDP
```
mv=py (price level+real income/expenditure = nominal value of output)
m/p - real money supply
m- nominal money supply
marginal curve PULLS average curve
242
A market structure in which a large number of small firms compete by selling similar products is most likely:
Monopolistic Competition
243
The balance of payment accounts are:
**The Current account**
[CA=(X-M)+NY+NCT]
**The Capital account**
**Official settlements account**
A type of account used in balance of payments accounting to keep track of central banks' reserve asset transactions with each other. The official settlement account keeps track of transactions involving gold, foreign exchange reserves, bank deposits and special drawing rights (SDRs). Essentially, this account keeps track of transactions related to international assets.
244
Contrarian Opinion Rules
* Cash position of mutual funds
* Investor credit balances in brokerage accounts
* Opinions of investment advisory service
* OTC vs NYSE volume
* CBOE put/call ratios
* Stock index futures
Contrarians do the opposite of the heard, ie consensus opinion, so when mutual funds are overweight cash, contrarians believe it is a good time to invest. When investors have lots of unused credit in their brokerage accounts, contrarians are bullish. When all the investment advisory services are recommending selling a stock, contrarians buy. Contrarians analyze volume to determine when retail investors are getting out of the market, they also consider that a buy signal. CBOE is the Chicago Board of Exchange, if puts greatly outnumber calls, consensus is prices are going down, thus the increase in purchasing downside protection, contrarians of course are then bullish. The logic behind the last one is, if stock index futures indicate that market is heading down, contrarians again see this as a buying opportunity.
I’m sure the rules are actually much more complicated and involve trying to time the market not just always buy when others sell, but for CFA Level 1 you only need the gist of contrarian opinion rules.
245
According to the crowding-out effect a govenment budget deficit tends to:
* Raise real interest rate
* Decrease investment
* Increase private savings
246
The Law of Diminishing Returns
States that at some point, as more of a resource is used in a production process, holding other inputs constant, output increases at a decreasing rate.
247
For a particular product produced by a firm, the quantity produced that maximizes total revenue, but not total profit, is the quantity at which demand is most likley:
Unit Elastic
248
The Classical View of the economy
A classical macro-economist believes that the economy is self-regulating and that it is always at full employment. The fluctuations that occur are efficient responses of a well-functioning market economy that is bombarded by shocks, mainly coming from the uneven pace of technological change.
249
The short-run supply curve of the perfectly competitive firm is:
the portion of the firm’s marginal cost curve that lies above its average variable cost curve.
250
Economically efficient
For a process to have the lowest production cost (be economically efficient), it must be technologically efficient.
A process is technologically efficient if there is no other process that can produce the same output with less of at least one input and no more of other inputs.
251
The forward premium (discount)
(Forward Rate – Spot Rate) / Spot Rate = (Rfc – Rdc) / (1 + Rdc)
Rdc is the interest rate of currency DC the domestic currency
Rfc is the interest rate of the currency FC the foreign currency
252
Keynesian economist believe that:
full employment can be achieved only with active (monetary) policy.
253
The quantity of real GDP formula
Y = C + I + G + X – M
```
C = Consumption expenditure
I = Investment
G = Government expenditure
X = Exports
M = Imports
```
254
A quota set below the market equalibrium:
raises prices, lowers the marginal cost of producing the quota, and is inefficient because it results in underproduction.
255
When the expected inflation rate changes, what happens to the short-run Phillips curve and the long-run Phillips curve?
The short-run Phillips curve shifts but the long-run Phillips curve does not shift.
256
What are the U.S. Federal Reserve’s most often used tools for changing money supply?
Open market operations
257
In perfect price discrimination the marginal revenue curve is:
the market demand curve.
258
In a Monopoly, demand is always elastic?
True
259
In long run equilibrium, firms in a monopolistically competitive market:
Charge a price above marginal cost and earn zero economic profits.
260
Herfindahl – Hirschman Index
The HHI is the square of the percentage market share of each firm summed over the largest 50 firms (all firms if less than 50).
C1^2 + C2^2 + C3^2 + C4^2 + … + C50^2
261
The new Keynesian feedback rule persues the basic goal of price stability, but also pays attention to:
the current state of the business cycle.
262
Inflation can result from either:
An increase in aggregate demand : demand-pull
OR
A decrease in aggregate supply : cost-push
263
Monetary Base
The sum of all Federal Reserve Notes, coins, and banks’ deposits held at the Fed.
264
Elasticity of Supply
Elasticity of Supply = % change in Quantity supplied / % change in Price
265
Price Elasticity of demand
Price Elasticity of demand = % change in Quantity demanded / % change in Price
266
Can CFA be used as a noun?
NO
267
When a fund manager (charterholder) takes over a portfolio which has cash proceeds ready for reinvestment, prior to talking to the client, what must they do?
Invest the funds in a liquid, risk-free security rather than having the money sit idle.
268
How many years does the CFA Institute recommend retaining records for?
Seven Years
269
The standard relating to conflicts of interest recommends four procedures all firms should adopt:
1. Limit participation in equity IPOs
2. Restrictions on private placements
3. Establish blackout/restricted periods
4. Reporting requirements
270
The reasons GIPS exists are?
Present performance results that are comparable regardless of geographic location.
Facilitate dialogue between investment managers and their clients about issues of how the firm achieved their results.
271
To claim GIPS compliance all presentations must be GIPS compliant?
True
272
When assigning portfolios to composites for GIPS compliant reporting…
* All fee paying accounts must be assigned to at least one composite.
* Assignments must be made prior to calculating portfolio returns.
* Composite returns must be calculated by asset weighting.
273
In order to claim to be a CFA candidate…
Individuals must be registered to take the next exam.
274
GIPS requires in order to claim compliance, firms must present GIPS-compliant performance information for:
A minimum of five years or since inception if firm is in existence less than five years.
275
Is speculation by a company’s supplier considered material non-public information?
No
276
Under GIPS standard all fee-paying and non-fee-paying accounts must be included in at least one composite.
False
Only fee-paying accounts must be included, non-fee-paying accounts are optional in GIPS standard.
277
In order to accept work outside the firm or additional compensation…
A member or candidate must notify their current employer and receive **written consent.**
278
Historic riskiness of U.S. security types from riskiest to least risky is:
As measured by standard deviation:
* small-cap stocks
* large-cap stocks
* Treasury bonds
* long-term corporate bonds
* T-bills
279
The efficient frontier plots…
expected return against the standard deviation of return, a measure of total risk.
Does not consider a risk-free asset specifically in portfolio construction.
280
CAPM \< Expected return of discounted future cash flows
* Stock is undervalued
* Investor should buy
* CAPM considers risk of individual stocks relative to all other alternatives in the market
281
The capital market line plots…
expected returns against standard deviation of returns for efficient portfolios.
Capital Market Line allows for risk-free assets in portfolios.
282
CAPM \> Expected return on discounted future cash flows
* Stock is overvalued
* Security should be sold
* CAPM considers risk of individual stock relative to all other alternatives in the market
283
Total Risk
Total Risk = Systematic Risk + Unsystematic Risk
Systematic risk is associated with the market and cannot be diversified away.
Unsystematic risk is the risk inherent to a stock. Can be diversified away by building a portfolio.
284
Global macro funds invest based on:
Expected shifts in global economies
Primarily in currencies and interest rate derivatives
285
Pastor-Stambaugh Model
Adds a proxy for liquidity factor to Fama & French 3-Factor model which added two factors to CAPM to account for:
* Excess return of small caps
* Excess return of high book value stocks
286
The Fama French or 3-factor model
Fama and French noticed that two classes of stocks regularly outperformed the market, small caps and “value” stocks, ie high book value. So they added two additional factors to CAPM.
r = Rf + ℬmkt(Rm – Rf) + ℬs(Rs – Rb) + ℬv(Rh – Rl)
287
Event-driven funds…
seek to profit from investment strategies based on specific corporate events and one-time transactions.
288
Long/short funds take…
long and short positions in equities.
long - hold
short - write
289
mm
(equity + p - stockprice )/ p= mm
when = validity
fundamental - value tilt
290
marginal curve __________ average curve
PULLS
291
z-spread and spot rate curve
z-spread exaggerates the spot rate curve. If spot curves upward, z-spread is higher. If spot curves downwards, z-spread is lower.
292
If your wealth is divided between the market portfolio and the risk free asset, the portfolio beta equals:
the fraction invested in the market portfolio.
293
In Markowitz portfolio theory the market portfolio has how much unsystematic risk?
Zero
294
Security Market Line Axis
Expected Return
Risk – Beta
295
Capital Market Line Axis
Expected Return
Risk – Standard Deviation
296
Capital Market Line adds…
Option of a risk-free investment to the efficient frontier
297
Criteria for selecting the appropriate test statistic
298
What does it mean if p = -1.00? (correlation coefficient of population)
* Coefficient of determination equals 1.
* High values of one variable are associated with low values of the other variable.
* Dependent variable can be perfectly predicted by the independent variable.
* All of the variation in the dependent variables can be accounted for by the independent variable.
299
Definition of Conditional Probability
P(A|B) = P(AB) / P(B)
P(B) ≠ 0
300
What are the four major scales in order from weakest to strongest:
W) nominal
2) ordinal
3) interval
S) ratio
301
Homoskedastic
The variance of the error term is the same for all observations.
302
Effective Annual Yield
* EAY = (1 + HPY)^(365/t) -1
* HPY = Holding Period Yield
* HPY = (P1 – P0 + D1) / P0
303
Chebyshev’s Inequality
The proportion of observations within K standard deviations of the arithmetic mean is at least 1 – 1/K^2 for all K \> 1
304
Bayes’ Formula
P(Event|Information) =
[P(Information|Event) / P(Information)] \* P(Event)
305
7 Steps to Hypothesis Testing
* What are the null hypothesis and the alternative hypothesis?
* Which test statistic is appropriate and what is the probability distribution?
* What is the required level of significance?
* What is the decision rule?
* Based on the sample data, what is the value of the test statistic?
* Do we reject or fail to reject the null hypothesis?
* Based on previous decision, what is our investment or economic decision?
306
Multiplication Rule for Probability (Non-Independent Events)
P(AB) = P(A|B)P(B)
307
Everything else being equal, suppose a country decides to shift to a more expansionary monetary policy, a shift that was not anticipated, what happens in the short run?
This monetary shock has the following two effects on the domestic economy:
the real interest rate will temporarily drop
there is upward pressure on the domestic price level and inflation will accelerate
Both factors will lead to depreciation of domestic currencies relative to other currencies.
308
Aggregate Demand Decreases if:
Expected future income, inflation, or profits decrease
Fiscal policy decreases government purchases, increases taxes, or decreases transfer payments
Monetary policy decreases the quantity of money and increases interest rates
The exchange rate increases or foreign income decreases
309
Instrument Rule
An instrument rule is a decision rule for monetary policy that sets a policy instrument at a level that is based on the current state of the economy.
310
Aggregate Demand Increases if:
* Expected future income, inflation, or profits increase
* Fiscal policy increases government purchases, decreases taxes, or increases transfer payments
* Monetary policy increases the quantity of money and decreases interest rates
* Exchange rates decrease or foreign income increases
311
M1
* Currency held outside banks and traveler’s checks
* Checking deposits at commercial banks, savings and loan associations, savings banks, and credit unions.
312
M2
* M1
* Time deposits
* Savings deposits
* Money market mutual funds and other deposits
313
Deadweight Loss Diagram
314
Automatic stablaizers are:
built-in features that tend to automatically promote a budget deficit during a recession and a budget surplus during an inflationary boom, without change in policy.
315
Annualized Forward Premium formula
= [(forward rate - spot rate) / spot rate] \* [12 / number of months forward] \* 100%
316
In the long run the change/growth in velocity of money is:
Assumed to be ZERO
Therefore:
Inflation = Money Growth Rate – Real GDP Growth Rate
317
According to substitution effect an increase in wage rate…
will increase the opportunity cost of leisure, increasing the supply of labour.
318
The Kinked demand curve theory of oligopoly predicts that:
if there are large changes in a firm’s marginal costs, the price the firm sets does change.
319
Stock price at which margin call will occur:
Original Price \* [(1 - initial margin %) / (1 - maintenance margin %)]
320
Yields on TIPS are…
* Effectively real rates of interest
* Inflation protection is built in
321
The two most common types of stock exchanges are:
* Call Market : the intent is to gather all the bids and asks for the stock at a point in time and attempt to arrive at a single price where the quantity demanded is close to the quantity supplied.
* Continuous Market : trades occur at any time the market is open. Stock prices are determined by auctions or dealers.
322
The nominal yield (current yield) is less than or greater than the yield to maturity for a discount bond?
Less Than
323
Collateralized Mortgage Obligation
A derivative of a passthrough security with a payment structure that redistributes risk among various classes or tranches of bonds.
Investors choose in which tranche they invest.
Tranche A would be repaid first followed by B etc.
324
Relative Yield Spread formula
Relative Yield Spread = (yield on bond X – yield on bond Y) / yield on bond Y
Frequently in the US the yield on bond Y is the on-the-run Treasury Bond.
325
Venture Capital Stages
Seed : Finances early development, smallest round
Early Stage: Able to begin operations but not yet manufacturing & selling
Start-up: Product Development & Marketing
First Stage : Manufacturing & Sales
Formative Stage : Includes Seed & Early Stage
Later Stage : Capital provided after manufacturing and sales but before IPO
326
Contango VS Normal Backwardation
Contango is when the future price is above the expected future spot price, contango implies that future prices are falling over time as new information brings them into line with expected future spot price.
Normal backwardation is when the futures price is below expected future spot price. This is desirable for speculators who are “net long” in their positions: they want futures prices to increase. Futures Prices Are Increasing
327
Maintenance Margin Formula for Stocks
P = Price of stock
[(Shares Held \* P) - Money Borrowed] / (Shares Held \* P) = Maintenance Margin %
Solve for P.
328
Market Value of Real Estate using NOI
NOI = Net Operating Income
NOI is before financing and personal taxes
Market Value = Annual NOI / Market Capitalization Rate
329
FRA Payoff formula
If rate increase long party/end user receives payment:
1. Underlying Rate at Expiration – Forward Contract Rate
2. Notational Principal \* Rate Difference \* Days in Underlying Rate / 360
3. Discount payment back using Underlying Rate at Expiration raised to (Days in Underlying Rate / 360)
This is one of the biggest, nastiest formula in CFA Level 1, so it helps to break it down.
* FRA Payoff Numerator = NP \* (Underlying Rate at Expiration – Forward Contract Rate) \* (Days in Rate / 360)
* FRA Payoff Denominator = (1 + Underlying Rate at Expiration)^(Days in Underlying Rate / 360)
Maintaining at least four decimal points of accuracy is important if you have to calculate forward rate agreement payoff in an exam.
330
Payoff from an interest rate put
(Notational Principal) \* Max(0, Exercise Rate – Underlying Rate at Expiration) \* (Days in Underlying Rate / 360)
331
Five Stages of the Business Cycle + Attractive Investments
Recovery : cyclicals and commodities
Early Expansion : stocks and real estate
Late Expansion : bonds and interest rate sensitive stocks
Slowing, entering recession : bonds and interest rate sensitive stocks
Recession : commodities and stocks
332
Minimum Value of European Call Option
Max[0, Stock Price - (Strike Price / (1 + risk free rate)^T)]
T = time until the option expires
333
Convexity Adjustment to the precentage price change
Convexity Adjustment = C \* (∆y)^2 \* 100
∆y = the change in yield for which the percentage price change is sought
C = Vincrease + Vdecrease – 2Vcurrent / (2 \* Vcurrent \* (∆y)^2)
The ∆y in the second formula is slightly different strictly speaking. Convexity is a popular question topic, duration even more so, understand it don’t just try to memorize the above formulas.
334
Convexity
Convexity is a measure of the degree of curvature of the price/yieldrelationship, to indicate the error in the estimated change in bond's price based on duration.
Effective convexity = (V\_ + V+ - 2 x Vo) / (2 x Vo x dy2).
It is the 2nd derivative of price function wrt yield. For callable bond, V is capped at call price.
Contribution of convexity = Convexity x dy2.
For noncallable bond, convexity effect is always +ve no matter which direction interest rate move but it can be –ve if the bond has embedded options.
Thus, approximate bond price change (using duration and convexity), i.e.
Approx. price change = -1 x Duration x dy + Convexity x dy2
Modified Convexity vs. Effective Convexity
With modified convexity the cash flows do not change due to a change in interest rates.
Effective Convexity, on the other hand, assumes that cash flow does change due to a change in interest rates.
When bonds have options, it is best to use effective convexity just like you should use effective duration. For option-free bonds, either convexity measure will be a positive value, whereas when it comes to bonds with options, the effective convexity could be negative even if the modified convexity is positive.
335
5 Assumptions of the Markowitz Portfolio Theory
* Investors consider each investment alternative as being represented by a probability distribution of expected returns over some holding period.
* Investors maximize one-period expected utility and their utility curves demonstrate diminishing marginal utility of wealth.
* Investors estimate risk on basis of variability of expected returns.
* Investors base decisions solely on expected return and risk.
* Investors prefer higher returns to lower risk and lower risk for the same level of return.
336
Real Risk free Rate
Real Risk free Rate = (1 + nominal risk free rate) / (1 + inflation rate) – 1
337
In Markowitz Portfolio theory, in equalibrium all assets and all portfolios should be:
On the security market line
338
The CAPM concludes that expected returns are:
a positive (linear) function of systematic risk
339
Sections of the GIPS Standard
* Fundamentals of Compliance
* Input Data
* Calculation Methodology
* Composite Construction
* Disclosures
* Presentation & Reporting
* Real Estate
* Private Equity
* Wrap Free / Specialty Managed Account (SMA) Portfolios
340
The seven sections of the CFA Code of Ethics
1. Professionalism
2. Integrity of Capital Markets
3. Duties to Clients
4. Duties to Employers
5. Investment Analysis, Recommendations, and Actions
6. Conflicts of Interest
7. Responsibilities as a CFA Institute Member or CFA Candidate
341
In general, as compared to companies with capital leases, companies with operating leases report:
Higher working capital and higher asset turnover.
342
Comprehensive Income
Comprehensive Income = Net Income + Other Comprehensive Income
Other Comprehensive Income = Foreign currency translation adjustments + Unrealized holding gains/losses on available-for-sale securities + Unrealized gains/losses on derivative contracts + Minimum pension liabilities
343
What factors would change the cash consequences of deferred tax debits and credits?
* The firm’s growth rate
* Changes in accounting methods
* Non-recurring items
* Future tax rates and tax laws
* Price level changes
344
Compared to issuing conventional bonds, a firm that issues debt with equity features is more likely to have:
lower interest expenses
higher debt-to-equity ratio
higher operating cash flow
345
Effects of Lease Classification
346
Average Investment in Receivables
Average Investment in Receivables = Sales / (365 / Collection Period)
Collection Period is measured in days.
Collection Period = 365 \* Average Accounts Receivables / Sales
347
Free Cash Flow from Net CFO
Free Cash Flow = Net Cash Flows from Operating Activities – Dividends – (Purchase of Plant Assets – Sales of Plant Assets)
348
Converting from COGS LIFO to COGS under FIFO
COGS FIFO = COGS LIFO – (Ending LIFO Reserve – Beginning LIFO Reserve)
349
Capitalizing costs tends to…
* Smooth earnings and reduces investment cash flows.
* It will also increase cash flows from operations and increase profitability in the early years.
350
Net work-in-progress balance using percentage of completion accounting method
Expensed Dollars \* Percentage of expenses completed \* Expenses Remaining
Compare the first figure with the amount of money invoiced for the project to get net work-in-progress balance.
351
Required disclosures for long-lived assets are more extensive under IFRS or U.S. GAAP?
IFRS
IFRS requires a reconciliation of beginning and ending carrying values for classes of long-lived assets while U.S. GAAP does not.
352
Permanently impaired assets must be…
Written down immediately and a loss reported “above line” as an operating loss.
353
Degree of Operating Leverage
DOL = % change in operating cashflow / % change in sales
354
Whether a lease is an operating or finance (capital) lease both U.S. GAAP and IFRS require disclosure of:
The minimum lease payments for each of the next five years and the sum of the minimum lease payments more than five years in to the future.
355
A lease is a capital lease if:
* The title is transfered to the lessee at the end of the lease period.
* A bargain purchase option exists.
* The lease period is at least 75% of the asset’s life.
* The present value of the lease payments is at least 90% of the fair value of the asset.
Otherwise it is an operating lease not a capital lease.
356
Average Depreciable Life of Assets
Average Depreciable Life = Ending Gross Investment / Depreciation Expense
357
Relative Age of Assets Formula
Relative Age (%) = Accumulated Depreciation / Ending Gross Investment
Can only be used with straight line depreciation.
358
The four general categories that determine a companies’ capacity to repay debt according to credit rating agencies:
* Scale and Diversification
* Operation efficiency
* Margin stability
* Leverage
Bonus tip: The final three correspond to the three components of ROE according to the DuPont Method.
359
An EPS amount is always shown for:
1. Cumulative effect of accounting changes
2. Income from continuing operations
3. Income before extraordinary items and the cumulative effect of accounting changes
360
Breakdown of ROE
* ROE = (Net Income / Sales) \* (Sales / Total Assets) \* (Total Assets / Equity)
* = Profit Margin \* Total Asset Turnover \* Financial Leverage
* = Net Income / Equity
361
Chance in EBIT for EPS
EBIT/(EBIT-I)=(%change in EPS)/(%change in EBIT)
So, 20/(20-8)=X/10%
Hence, X=%change in EPS=0.166x=17% increase
362
