CFA Level 2

Correcting multicollinearity?

omit one or more of the Xs. It may be difficult to determine which X is the problem. Use stepwise regression (reading does not tell us how to do stepwise regression)

2 major contributors to earnings manipulation?

revenue recognition issues and expense recognition issues (capitalization)

Value of noncallable non putable conv bond? Value of callable conv. bond?

straight value + value of call option on stock straight value + value of call option on stock - value of issuer's call option on bond

3 Duties to Clients (a) Loyalty prudence and care Rule? Guidance? (5)

-duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. and place their clients' interests before their employer's or their own interests. (1) Make investment decisions in the context of the total portfolio. (2) Inform clients of any limitations in an advisory relationship (e.g., an advisor who may only recommend her own firm's products). (3) Vote proxies in an informed and responsible manner. Due to cost benefit considerations, it may not be necessary to vote all proxies. (4) Client brokerage, or "soft dollars" or "soft commissions" must be used to benefit the client. (5)The "client" may be the investing public as a whole rather than a specific entity or person.

Effect of model misspecification?

Biased and inconsistent coefficients, unreliable hypothesis tests, inaccurate predictions

III - Duties to Clients -(C) Suitability Rule? Guidance? (3)

Make reasonable inquiry into clients or prospective clients risk/return/experience prior to any investment recommendation or taking any inv. action. --information has to be updated with some regularity. Look at suitability in the "portfolio context" when managing port. w/ specific mandate you can only make investment recommendations or take only investment actions that are consistent with the stated objectives and constraints of the portfolio (1) have to prepare IPS - updated at least annually --must be an effective update (2) consider whether or not leverage is suitable for client (3) if client requests an unsuitable trade - you must discuss that the trade is not suitable based on the client's IPS - if not material to portfolio (6,000 in stock of family's start up out of a $100mm portfolio) - if it is material than you need to discuss updating the IPS based on this trade - and finally if the client refuses to not make the trade or update the IPS, than you may have to tell client that they will have to find another portfolio mnr.

What is serial correlation?

Refers to when the residual terms are correlated with one another. AKA Autocorrelation

What is the regression line?

Regression line of b0 and b1 such that the sum of squared errors is minimized. (the squared differences between the actual y values and predicted y values)

What is the RMSE? How do we use RMSE? Higher or lower better?

Root Mean Squared Error (RMSE) is the square root of the average of the squared errors for the out of sample data. we use it to determine which model more accurately forecasts future values. the model with the lower RMSE is more accurate in predicting

Confidence interval for regression coefficient in multiple regression?

Same as linear regression ^b +/- (tc*Sb) ^b is the estimated value of coefficient, tc is critical value with n-k-1 df, and Sb is the standard error of the coefficient And the test is whether or not 0 is in the confidence interval, if 0 is not within the CI, we can reject H0 that the coefficient is = 0 and conclude that b is statistically sign.

Degrees of freedom for t-test? which row do you use Degrees of freedom for f-test? which table to use? Breusch-Pagen Chi square test df?

T-test: df = n-k-1 with n being obs. and k is number of independent variables so for simple linear regression df = n-2 t-test is two tailed so use the row of half of the level of sign. F-test: df = numerator = k, denominator = n - k - 1 F-test is one-tailed so use the table for the level of sign. = k

TPPC formula?

TPPC = ending PBO − beginning PBO + benefits paid − actual return on plan assets Alternatively, TPPC is equal to the contributions minus the change in funded status during the year. TPPC = contributions − (ending funded status − beginning funded status)

Correcting serial correlation?

Use the Hansen method to adjust the standard errors. these are called the Hansen-white standard errors. only use the Hansen method if serial correlation is the problem, if heteroskedasticity is the problem use the white corrected se. if both conditions are present use the Hansen method. The other alternative is to improve the specification of the model

Code and Standards question: if question says that quant. analyst developed their own complex model at Firm A and is moving on firm B, is analyst allowed to recreate model at new firm from memory?

Yes. As long as he doesn't take any docs from the old firm (which would violate 4a) and as long as he recreates all supporting docs (as to not violate 5c record ret.)

Test statistic formula? Hypothesis test on regression coefficient?

^b1 - b1 / Sb1 = estimated b1/standard error of b1 H0: b1 = 0 use 0 as b1, and compare test statistic to critical values from n-2 degrees of freedom, 2 tailed test **if the calculated tstat falls outside the critical values then you can reject H0 that the regression coefficient is 0 **reject is good for model There are 2 ways to test the regression coefficient. With this formula or with the test on the previous card

Describe limitations of Regression Analysis? (3)

1. parameter instability - linear relationships can change over time, may not be relevant in a different time period 2. if the model is accurate, it may not be useful for investment if other participants are also aware of the relationship 3. assumptions in regression analysis may not hold

4 ETHICS: TRADE ALLOCATION: Explain the compensation arrangement piece regarding allocating client trades on an Ad Hoc Basis? The other issue regarding using ad hoc procedures for trade allocation is client relatinoships. explain?

by allocating client trades on an ad hoc basis gives rise to allocate more profitable trades to client accounts that have a performance-fee-based structure at the expense of client's with an asset-based-fee structure. The investment manger may allocate trades to these clients over the others to increase overall fees paid to himself the investment advisor similar idea as above, ad hoc procedures tempt firm or advisor to distribute more shares of profitable trade to favored clients, clients should not recieve better access to trades or hot IPOs just so that the firm can try to get more business from them in the future.

4 - Duties to Employers-(C) Responsibilities of Supervisors Rule? Guidance? (3)

make VERY STRONG efforts to ensure that employee's you supervise comply with laws, regs, and code and standards (if you haven't lived up to this high standard you are violating this whether there is or isn't a violation committed by supervisee's) (1) make STRONG efforts to PREVENT employees from violating laws, regs, code AND make STRONG effort to DETECT violations (2) must bring inadequate compliance systems to mngt w/ corrective action - when investigating limit the suspected employee's activities. (3) A member or candidate faced with no compliance procedures or with procedures he believes are inadequate must decline supervisory responsibility in writing until adequate procedures are adopted by the firm.

What are the three broad categories of misspecification? What are the subcategories?

Functional Form can be misspecified, explanatory variables are correlated with the error term in time series models, other time series misspecifications Functional Form 1. important variables are omitted 2. variables should be transformed 3. data is improperly pooled Explanatory variables are correlated with the error term 1. a lagged dependent variable is used as an X 2. a function of the dependent variable is used as an independent variable (forecasting the past) 3. independent variables are measured with error Other time Series - more details later

Will the Sharpe ratio or information ratio be affected by addition of more cash or more leverage?

Sharpe ratio will not change. IR will change

Compare arbitrage free binomial tree with zero coupon yield curve approach?

Should produce the same value.

Number of call options to delta hedge

= # shares hedged/delta of call option

BR if bets are correlated?

BR = N/[1+ ((N-1)*r))]

Dividend yield?

D1/P0

Justified P/CF ratio

FCFE(0) x (1+g) /r-g

Residual Income formula?

NI - (cost of equity x beg. value of equity)

Backward induction?

process of valuing a bond using a binomial interest rate tree.

Reclassification under IFRS 9?

reclassification of equity securities is not permitted since FVPL and FVOCI are irrevocable. (before FVOCI which was AFS could be reclassified to HTM) Reclassification of debt is only allowed if there was a change in business model. Reclassifying from Amortized Cost to FVPL is allowed. Transferring debt securities FVPL to amortized cost is allowed. So only two things allowed and only for debt (AC to FVPL, and FVPL to AC)

when to apply control discount in private company valuation? How to get discount for lack of control? and formula?

when comparable firm's value is based on controlling interest and subject is non-controlling interest usually backed out of control premium DLOC = 1 - (1/1+control premium)

Which method is least affected by international differences in comparisons?

when comparing firms of different countries, P/FCFE is least affected by country differences

combined active risk for 2 sectors? annualized active risk as function of bets per year? annualized active return?

σ= σx^2 - 2*σx*σy*rXY + σY^2)^(1/2) σactive= σcombined x √BR E(RA) = IC x √BR x σactive

Effective duration?

—Measures the sensitivity of a bond's price to parallel shifts in the benchmark yield curve. (-)not accurate for non parallet shift (+) parallel shifts explain most variation in bond portfolio returns.

Financial Assets prior to IFRS 9? (definition, BS accounting, IS accounting)

"passive investment is less than 20% interest". Recorded at cost, which is presumably the fair value at acquisition Dividend or Interest Income is recognized on the investors income statement Recognizing changes in fair value depends on if HTM, FVPL (HFT and designated at FV), or AFS Next question, asks about the different accounting requirements for HTM, HFT, or AFS for Financial Assets

Fixed income exposure using duration? Using duration and convexity? Options risk measured by three factors?

%∆P=-Dx(∆Y) %∆P=-D(∆Y) + 1/2*convexity*(∆Y^2) delta (sensitivity to asset price changes) = change in option value/change in value of underlying gamma (sens. to change in delta) = ∆ in delta/∆ in value of underlying Vega (sens. to vol.) = ∆ in option value/∆ in volatility of underlying

Forward looking estimate of equity risk premium (aka ex ante) strength and weakness? example?

(+) does not assume stationary (-) need to be updated over time - div yield is low low and growth exp are high during boom (-) assumption of stable growth rate Gordon growth model

Strengths and weaknesses of histrocial estimate of equity risk premium? (1 and 1)

(+) easy to compute (-) assumes mean and variance of returns are constant over time (stationary) but they are not, premium is countercyclical it is low in good times and high in bad times

Survey estimates ERP estimate s and w?

(+) easy to obtain (-) wide disparity between opinions

Supply side estaimtes of ERP strengths and weaknesses? (aka macroeconomic model)

(+) use current information (-) only appropriate for developed economies where public equities represent a relatively large share of the economy

There are four important effects on certain balance sheet and income statement items that result from the choice of accounting method (in most situations): And one more general point?

(1) Both (equity and acquisition) methods report the same net income. (2) Compared to the equity method, acquisition method equity will be higher by the amount of minority interest. (3) Assets and liabilities are higher under the acquisition method compared to the equity method. (4) Sales and expenses are higher under the acquisition method compared to the equity method. Assuming net income is positive, these effects generally result in the equity method reporting more favorable results compared to the acquisition method

PV of RI (4 scenarios) 1. RI persists at current level forever? 2. RI drops immediately to zero? 3. RI declines over time to zero? 4. RI declines to LR level in mature industry?

(1) PV of RI in T-1 = RI(T)/r (2) PV of RI in T-1 = RI(T)/(1+r) (3) PV of RI in T-1 = RI(T)(1+r-w) (4) PV of RI in T-1 = P(T) - B(T) + RI(T)/(1+r)

Strategic Asset Allocation definition? Where is it within the planning step? what should it consider? what 2 things does SAA reflect?

(1) The set of exposures to IPS-permissible asset classes that is expected to achieve the client's long-term objectives given the client's investment constraints. final step in planning tactical asset allocations which are the temporary shifts in asset allocation due to shifts in cap mkts exp. the IPS and cap. mkts expectations

2 types of arbitrage opportunities?

(1) Value additivity (when the value of whole differs from the sum of the values of parts) and (2) dominance (when one asset trades at a lower price than another asset with identical characteristics)

✔ 16. MULTINATIONAL OPERATIONS: 2 ways foreign currency can affect a firm with multinational operations? Distinguish between the 3 currency's?

(1) firm may engage in business transactions denominated in foreign currency (2) firm may invest in subsidiaries that maintain books in a foreign currency 1. Local Currency - currency of the country being referred to. so if referring to subsidiary in a different country, it is that country's national currency 2. Functional Currency - it is the currency of the primary economic env. that the firm operates in, it is generally the currency that the firm generates and expands cash in, and it can be the same or different than the local currency 3. Presentation currency - aka reporting currency, it is the currency that the parent company reports FS in

How to estimate beta for a thinly traded and non-public company? (3 steps)

(1) identify publicly traded benchmark company; and estimate the beta of the benchmark company; (3) unlever the benchmark company's beta; and (4) relever the beta using the capital structure of the thinly-traded/non-public company.

SG&A forecasting?

(1) less sensitive to changes in revenue. (2) R&D and OH components stable and selling and distribution costs likely to be linked with revenue

What are the key changes to ratios under current method from before to after translation? (2)

(1) pure BS and IS ratios are likely to remain unchanged after remeasurement (2) Mixed ratios will increase if foreign currency is depreciating (ratios with IS in numerator and BS in denominator like ROA), and will decrease if foreign currency is appreciating

VII Responsibilities as a CFA Institute Member or CFA Candidate 7(A) Conduct as participants in CFA Institute programs (3)

(1) revealing anything about either broad or specific topics tested, or formulas required or not required on the exam -(2) Members and candidates are not precluded from expressing their opinions regarding the exam program or CFA Institute but must not reveal confidential information about the CFA program. (3) Members who volunteer in the CFA program may not solicit or reveal information about questions considered for or included on a CFA exam, about the grading process, or about scoring of questions.

Explain mean reversion in earnings in evaluating earnings performance?

(1) tendency of earnings at extreme (high or low) levels to revert back to normal levels over time (2) analysts should not expect extreme high levels over time (3) mean reversion is quicker for accrual-based earnings, and even faster if accruals are discretionary

Reduced form models of corporate credit risk? And 1 +

(1) unlike structural model, it does not explain WHY default occurs instead WHEN default occurs (2) default is randomly occurring EXOGENOUS variable *meaning uses regression model* which is Default Intensity (3) key advantage is that it allows DI is allowed to change over time, however the negative is that default is treated as a random event

What is the Equity Risk Premium? Basic formula? RR for individual stocks using equity risk premium? (public and private)

(called the market risk premium in the CAPM context) is the return over the risk-free rate that investors require for holding equity securities. equity risk premium = required return on equity index − risk-free rate RR for stock j = RFR + BetaJ*(ERP) For a private stock RR = RFR + ERP + other risk premium or discounts for company

variance of a portfolio? obtaining 5% value at risk? annual expected return if given daily value? annual SD if given daily values?

(expected return of portfolio - 1.65*σ of portfolio) x (value of portfolio) =daily exp. return x 250 =daily sd x √250

Roll Return? Roll return in market in backwardation?

(price expiring - price new futures contract)/price expiring futures contract positive

What is market fragmentation? (high frequency trading) Liquidity aggregators and smart order routing?

**related concepts same security trading on different markets with price and liquidity differences among mkts add up the liquidity available across multiple markets, then executes trades to markets with best liquidity and price. a human may have a lag in ability that is many many times slower than a computer

Strengths and weaknesses of RI model? (5 +'s, 3 -'s) what is clean surplus?

+ TV does not dominate estimate + easy to access data + can be used on firms that dont pay div. or dont have positive cash flows + applicable even when cfs are volatile + focuses on econ. profits rather than accounting - relys on accounting data that can be manipulated therefore requires lots of adjustments - assumes clean surplus relation holds (not appropriate if clean surplus doesn't hold) assumes that ending BV = beg BV + (NI - div) *does not hold if there are accounting charges directly to equity

Put option delta bw?

-1 and 0 deep in the money = -1 deep out of the money = 0

Pastor Stambaugh Model

-Adds a liquidity factor to the Fama-French model -Less liquid assets should have a positive beta and more liquid assets have a negative beta = Fama French Model + Beta x MRP ( liquidity)

market-based approaches to private company valuation: Guideline transactions method? 4 issues to consider?

-Prior acquisition values for entire companies that already reflect any control premiums are used so no adjustment needed 1. strategic or financial trans. 2. contingent considerations of transaction like specific performance targets included in the price 3. stock or cash transaction in data 4. date - economic changes may have occurred

RI Valuation and Justified P/B Relationship? (what is Tobin's Q ratio)

-RIMS (Residual Income Method) can be used to establish market multiples like P/B based on RoE and EPS -RIMS are closely related to Justified P/B and Tobin's q Ratio : (MV Debt + MV Equity)/Replacement cost or total assets -When the PV of expected future RI is positive, the justified P/B based on fundamentals is greater than 1.0

What is an absolute valuation model? What are the types? (4) What is a relative valuation model?

-estimates assets intrinsic value based on investment characteristics (earnings, cfs, and risk) w/o regard to value of other firms -1.Dividend Discount model. 2. Free cash flow approach and 3. residual income approach (expand DDM to include expected cash flows that are not payable to senior claims like bondholders senior stock holders and taxing auth. 4. asset based model (commonly used for oil coal and mineral companies) -estimates the value of a security relative to market prices of other similar securities. Valuation based on price-to-earnings, price-to-cash flow, and price-to sales ratios of other securities or securities indexes are examples of relative valuation models.

Sum of parts valuation, when is it useful? conglomerate discount? why does it exist?

-add up ind parts of company to determine value as a whole - useful for companies that that operate in mult. unrelated industries based on idea that mkt discounts conglomerates compared to other firms, the conglomerate discount is the amount that mkt value is less than sum of parts value conglomerate discount is due to 1. internal capital inefficienceis 2. endogenous factors (internal) is that may be hiding poor operating perf. 3. some hypothesize that the cong. discount does not exist and rather it is Research Measurement Errors

What is the purpose of porters 5 "elements of industry structure? What are the 5 forces? What are the 3 general strategies companies use to compete and generate profits?

-attractiveness and lt profitabiliity of industry is determined by these forces 1. threat of new entrants in industry 2. threat of substitues 3. bargaining power of buyers 4. bargaining power of suppliers 5. rivalry among existing competitors 1. cost leadershiop (lowest cost) 2. product differentiation (this allows premium on price) 3. focus (using one of the first 2 in a particular segment in order to gain adv)

What is an operating lease? (how does it appear on BS and IS) What is a finance lease? how does it appear on BS and IS How do you treat operating lease for analytical purposes?

-operating lease is simply treated as rental agreement, the lessee does not report asset or liab. on BS. The lessee reports rental expense on the IS which is the periodic lease pmt finance lease (aka capital lease) is treated as the purchase of an asset with debt so the lessee reports an asset and a liability on the BS and the lessee reports depreciation exp and int. exp. instead of rental expense capitalize the operating lease to treat it like a finance lease

Effect of changes in assumptions on PBO, TPPC, and PPC? increase discount rate? decrease rate of compensation growth? Increase expected rate of return?

1 = PBO 2 = TPPC 3 = Periodic Pension Cost Increase DR 1. decrease 2. decrease* 3. decrease* *for mature plan TPPC and PPC could increase for mature plans, but rarely Decrease in compensation growth 1. decrease 2. decrease 3. decrease Increase Exp ROR 1. no effect 2. no effect 3. Decrease (if GAAP) No effect (not applicable IFRS)

Some things regulators use technology to monitor for these abusive activities: Front running? "Painting the tape"? Fictitious orders? Wash trading? Trader collusion?

1 Somewhat similar to insider trading, front running is when a trader has advance knowledge of a large buy order and trades slightly earlier than that large order to profit from the price movement that the large transaction will cause. Algorithms can be used to detect such a situation where a trader has made a transaction just before another market participant's large trade. 2 In this scenario, a trader who wishes to sell a large quantity of a security first buys small quantities of the same security in order to drive up the market price. A trader often needs to purchase only a small strategic quantity of shares in order to move the market price significantly. 3 Traders submit fictitious orders to move the market price or to induce other algorithms to make unwise trades. (ie quote stuffing, layering, and spoofing) 4 The algorithm buys and sells the same securities repeatedly, in order to create false trading volume and increase buyer interest in a security that the trader wishes to sell. 5 In this category of manipulation, multiple traders conspire to sway markets in a direction that is favorable to them. One relatively recent example of collusion was the Libor scandal of 2012, where it was alleged that traders manipulated interest rates in order to turn their derivatives trades profitable. In response to such scandals, communications between traders have received greater scrutiny.

GGM ERP? and GGM intrinsic value?

1 yr div yield forecast on mkt index + LT earnings growth rate - LT govt bond yield =(D1/P) + g - r **r for LT govt bond yield

How to detect seasonality in an AR model? (for example with quarterly data)

1) look at the autocorrelations of the residuals for lag 1, 2, 3 and 4. 2) Test each of the autocorrelations for statistical significance. 3) perform test using the t-test. degrees of freedom of n-2 and a 2 tailed test with appropriate level of significance 4) for each lag if the t-stat is inside the critical values you do not reject the null that the autocorrelations are 0, and if they are outside the critical values than you reject the null of the autocorrelation being 0 **so smaller t-stats on the autocorrelations is good, in the case of seasonablity means that lag is not indication of seasonality 5) when you conclude that the 4th lag is different from 0 than you know that the 4th lag is related to xt, and therefore seasonality is present

✔ 19. FINANCIAL REPORTING: INTEGRATION OF FINANCIAL STATEMENT TECHNIQUES basic financial analysis framework involves? (6)

1. Establishing objectives 2. Collect data 3. Process data 4. analyze data 5. develop and communicate conclusions 6. follow up

✔ 20 - 25 CORPORATE FINANCE **likely to be exam questions Best Practices for Board: 1. best practice for board composition independence? 2. best practice CEO and chairman? 3. best practice for board members regarding other boards? 4. best practice for compensation committee? (regarding members) 5. separate session for ind. directors? (frequency) 6. audit comm? 7. nominating comm? (referring to independence) 8. salary? 9. legal counsel? 10. insider related party trans? 11. board member election?

1. 75% of board independent 2. CEO and chairman should be seperate individuals 3. board members should not serve on more than 2-3 boards total 4. committee is only independent directors 5. preferably quarterly, at least annually 6. all independent directors, meets with auditors at least annually 7. all ind. directors 8. most of management salary is performance based rather than base and perquisites 9. consult legal counsel when needed 10. board reviews approves all of these 11. annual election of all board member

Quality of earnings issues can be broken down into several categories (what are the 5)? and may be addressed only ___________?

1. Accelerating or premature recognition of income.2. Reclassifying gains and non-operating income. 3. Expense recognition and losses. (delaying recognition of expenses, or classifying op. exp. as non-operating) 4. Amortization, depreciation, and discount rates. (discretion in choosing methods) 5. Off-balance-sheet issues. (especially with SPEs and use of operating leases) in the footnotes and disclosures to the financial statements.

explain the spectrum of quality of financial reports? (4 and 2)

1. GAAP compliant, decision useful, sustainable and adequate returns 2. same as 1 ut low quality earnings bc unsustainable or do not provide adequate return 3. GAAP compliant but less useful due to biased choices 4. still compliant but "earnings mngt" ------- 5. non compliant accounting 6. fraudulent

What are the 4 versions of multiperiod DDM?

1. GGM 2. 2 stage growth model 3. 3 stage 4. H model

Residual income is most appropriate for valuation when?(*hint not talking about control or no control) which discount rate is used?

1. Do not have dividend payment histories. 2. Have negative free cash flow for the foreseeable future. 3. Have transparent financial reporting and high-quality earnings. cost of equity

What are the limitations to correlation analysis? explain.

1. Impact of outliers (can show a relationship/or no relationship when there is or isn't one) 2. spurious correlation (correlation exists by chance, no actual casual relationship) 3. nonlinear relationships (correlation could be 0 when there is in fact a strong non-linear relationship)

2 options when there is strong correlation bw variables used in a simulation?

1. allow only one variable to vary and algorithmically compute the other variable, 2. build the correlation behavior into the simulation.

Gross debt? Net debt? and Net interest expense?

1. LT financial debt + ST financial debt + accrued interest 2. gross debt - cash eq and st securities 3. net interest expense = interest expense - interest income on cash and st securitys

2 questions for assessing Financial Report quality?

1. are the underlying financial reports GAAP/IFRS compliant and decision useful? 2. are the quality of earnings high?

Accounting for non-pension post retirement benefits is very similar to pensions with 2 differences?

1. The accumulated postretirement benefit obligation (APBO) is the actuarial present value of the expected postretirement benefits. It is estimated using a discount rate applied specifically to those benefits. 2. Many postretirement benefit plans are unfunded, which means there are no plan assets, employer contributions equal benefits paid, and the funded status (liability) equals the APBO.

Free cash flow is appropriate for valuation when? (3) 2 types of free cf? which discount rate to use for each?

1. The company does not have a dividend payment history or has a dividend payment history that is not related to earnings. 2. The free cash flow corresponds with the firm's profitability. 3. The asset is being valued from the position of a controlling shareholder. FCFE and FCFF FCFE use cost of equity, and FCFF use WACC

Dividends are appropriate cf to use for valuation when? (3) which dis rate is appropriate?

1. The company has a history of dividend payments. 2. The dividend policy is clear and related to the earnings of the firm. 3. The asset is being valued from the position of a minority shareholder. cost of equity

✔ 30 EQUITY: FREE CASH FLOW VALUATION Firm value? Equity Value?

Firm value = PV of FCFF = sum of FCFF discounted at WACC Equity value = PV of FCFE = sum of FCFE discounted at RR on equity

Two potential problem affecting financial report quality. 1. measurement and timing and 2. classification issues *additionally biased acconting choices. Explain measurement and timing? (2) GAAP compliance is _____ but not _____ for high quality financial reporting.

1. effects multipole financial statement elements, 2. example is aggressive revenue recognition necessary but not sufficient for high quality financial reports

When examining capital structure, these 2 items are likely more burdensome then these 3 items?

1. financial and bond liabilities 2. employee benefit obligations, deferred taxes, restructuring provisions

1. Interest rates decline, value of callable bond ___. 2. As rates decline value of embedded call option ___. 3. when yield curve is upward sloping, the value of call option is ___. 4. Interest rate increase, value of putable bond ____. 5. put option value ___ as yield curve flattens.

1. Value of bond increases but less because limited upside potential 2. increases 3. upward sloping 4. Value of bond decreases but less 5. declines

3 types of trading algorithms?

1. Volume-weighted average price algorithms (VWAP) - split order based on historical daily trading patterns so that pieces get executed during times of day when market depth is greater - so when can order be executed the fastest 2. Implementation Shortfall Algorithms - evolution from #1. balances potential for taking too long to execute and negative price impact from executing too quickly, so same idea as 1 but more advanced 3. market participation algorithms - chop an order into slices sized proportionally to volume at that time *all three are trying to do the same thing = fit the order in when you can buy or sell at the price you want

1.) From HTM to AFS? 2.) From HTM to FVPL? 3.) From AFS to HTM? 4.) From AFS to FVPL? 5.) From FVPL to HTM? 6.) From FVPL to AFS?

1. Yes 2. GAAP YES 3. Yes 4. GAAP Yes 5. GAAP Yes 6. GAAP Yes So GAAP allows all movements. IFRS only allows AFS to HTM and HTM to AFS

Adjusting operating lease: what are the changes? (5, 2 are ratios) adj. financial leverage? adj. debt to equity? adj. interest coverage ratio? If analyst decides to split into current and non-current how does he do this? and result?

1. assets increase by PV of lease pmts 2. liabilities increase by PV of lease pmts equity is unchanged 3. financial leverage increases 4. NI is lower in early years 5. interest coverage will decline = TA + PV of lease pmts/equity =TD + PV of lease pmts/equity =EBIT-dep exp. + rent exp./int exp + assumed int. exp. ---- where dep exp is PV of lease pmts depreciated over term of lease and assumed int. exp. is PV of lease pmts x an interest rate adjust current liab by adding the current portion of assumed debt, which is annual lease pmt - assumed interest expense, this results in lower current ratio

What do we know about F test in simple linear regression?

1. bc there is only one independent variable, it does the same thing as t test 2. tests hypothysis that b1 = 0 3. F stat = MSR/MSE with 1 and n-2 degrees of freedom 4. If Fstat > Fc reject H0 5. Always a one tailed test

How do each of the 5 forces affect financial results in the future? 1. threat of new entrants in industry 2. threat of substitutes 3. bargaining power of buyers 4. bargaining power of suppliers 5. rivalry among existing competitors

1. better prospects for earnings growth = threat of new entrants is low. And Significant barriers to entry into an industry = existing companies to maintain high returns on invested capital. 2. more pricing power when low 3. less pricing power when high, especially in a circumstance where a small number of customers are responsible for a large proportion of a firm's sales and when switching costs are low. 4. higher = lower earnings growth, especially when there are few suppliers 5. more rivalry = less pricing power

3 conditions for a timeseries that is convariance stationary?

1. constant and finite expected value, the expected value of the time series is constant over time 2. constant and finite variance. The time series volatility around its mean does not change overtime 3. constant and finite covariance between variables at any given lag

Under the equity method, the investment is listed at ___ on the BS. Dividends that are paid by the investee ______ the investment account on the asset side of the BS. Also, the investor's pro rate sahre of the investee's NI increases the ____ and ____ on the investor's income statement. Two adjustments that need special attention with the equity method?

1. cost 2. increase cash and decrease the investment account 3. the asset account 4. listed as income 1. Adjustment for additional depreciation due to the difference between the fair value and book value of the investee's fixed assets. This difference is measured initially when the investment is made, and then the investor's pro rata share is depreciated using the same method as the investee uses. 2. Removal of a pro rata share of unconfirmed profits (upstream or downstream).

QM: steps in running a simulation? (4)

1. determine prob. variables 2. define prob. distributions for these variables 3. check for correlations amongst variables 4. run the simulation

What are the 3 assumptions that firms must disclose regarding pension calculations? Explain the effects of these assumptions?

1. discount rate 2. rate of compensation growth 3. expected return on plan assets Increasing the discount rate will reduce the PV of PBO so it will decrease the liability on BS, and decrease TPPC and periodic pension cost on IS Decreasing the compensation growth rate will decrease future BO and therefore PBO, so it will decrease the BS liability, and decrease TPPC and periodic pension expense on IS Increasing expected return on plan assets (only applies to GAAP), it will reduce pension expense on IS, but leave the BS and TPPC unchanged.

What are the types of equity risk premium estimates? (broad types, not specific models)

1. historical estimate, 2. forward looking estimates 3. supply side estimates (aka macroeconomic model estimate) 4. survey estimates

describe procedures to determine which method to use for currency translation? (4 scenarios)

1. if the subsidiary's functional currency is the same as the local currency (remember CLEF = use Current if Local Equals Functional), the current rate method is used to translate. "Translation Method" - Current Rate Method is used when sub's operating, financing and investing are decentralized from parent (ex US firm has sub in japan with functional currency being yen) 2. If the subsidiary's functional currency is the same as the parents, the temporal method is used/ "remeasurement" = temporal is used when subs activities are well integrated with parent (parent makes the decisions) (US firm with sub in japan that has functional currency US dollars) 3. if local, functional, and reporting are different, both methods are used. The temporal method is used to convert local to functional, and current is used to convert functional to reporting 4. if subsidiary is operating in a hyper-inflationary environment, GAAP=the functional currency is designated as the presentation currency and the temporal method is used. IFRS=the sub's FS are reinstated for inflation, and then the current rate method is used

For the 4 definitions of CF for using P/CF what are the nuances and limitations of each? 1. Earnings + NCC 2. CFO 3. FCFE 4. EBITDA

1. ignores items that affect cf like noncash revenue and net WC changes 2. CFO: often is adjusted for non-recurring items. Also if comparing GAAP to IFRS, remember that interest paid is op cash flow under GAAP but may be Op or Fin under IFRS. Int Rec is Op under GAAP but may Op or Inv under IFRS. And Div. Rec. are Op CF under GAAP but may be op or inv. under IFRS. 3. preferred method, but may be more volatile than others 4. pretax and interest so it better represents whole company value

✔ 33 EQUITY: PRIVATE COMPANY VALUATION Characteristics of private firms vs public firms for these 7 company specific factors: 1. stage of lifecycle 2. size 3. Quality of mngt 4. mngt/SH overlap 5. ST investors 6. quality of information 7. taxes and for these 3 stock specific factors 1. liquidity 2. restrictions on mktability 3. concentration of control

1. less mature 2. smaller - less capital and higher risk 3. more diff. to find qualified mngt 4. substantial overlap 5. less ST investors so they can focus on LT profits 6. more uncertainty 7. more concerned about taxes b/c mngt are owners 1. less liquid = liquidity discount on stock 2. often have agreements with SH's restricting selling stock 3. few SH's

6 assumptions of linear regression?

1. linear relationship exists bw dependent and independent 2. independent variable is uncorrelated with the residuals (it is not random) 3. expected value of residual term is 0 4. variance of the residual term is equal for all observations 5. (independently distributed error term) error term from one obs is not correlated with error from another obs 6. the residual term is normally distributed

✔ 17. FINANCIAL REPORTING: ANALYSIS OF FINANCIAL INSTITUTIONS 3 pillars of Basel III?

1. minimum levels of capital 2. liquidity minimums 3. stable funding

✔ 42 ALTERNATIVE INVESTMENTS: PRIVATE REAL ESTATE INVESTMENTS investment in private debt? investment in private equity? investment in publically traded debt? investment in publically traded equity?

1. mortgages 2. direct investment in property through sole prop., part., commingled RE fund (CREF) 3. MBSs 4. REITs or REOCs

V Investment Analysis, Recommendations, and Actions V(B) Communication with Clients and Prospective Clients Rule? (5) Guidance? (2)

1. must disclose to clients and prospective clients the basic format and general principles of process used to analyze, select, and construct. (don't have to give away all proprietary information but enough for client to make decision. 2. and material changes to inv. process (like going from fund. to quant.) 3. Disclose to clients and prospective clients significant limitations and risks associated with the investment process. 4. Use reasonable judgment in identifying which factors are important to their investment analyses, recommendations, or actions and include those factors in communications with clients and prospective clients. 5. distinguish bw fact and opinion (you can state opinions but that must be clear and it still has to have a basis for making statement) (1) suitability in portfolio context (2) all communication applies, any phone calls, emails, anything

3 methods to obtain VAR? adv. of VAR? (4) disadv. of VAR? (4)

1. parametric method 2. historical simulation 3. Monte Carlo + accepted by regulators + simple to understand + expresses risk as single number + useful for comparisons - subjective choice with time period and probability - very sensitive to assumptions - focuses only on left tail outcomes - vulnerable to misspecification by user

How to adjust FCFF and FCFE if firm has pref dividends? (3)

1. pref dividends are added to FCFF 2. WACC must be adjusted for pref. div. 3. FCFE you treat pref. div. like debt so add pref. stock issuance and subtract pref stock repay.

3 factors that affect CDS pricing (cds spread)? conditional prob of default? survival rate in given year? loss given default? upfront payment by protection buyer? Upfront premium? % Quote CDS price using Upfront Premium%?

1. prob of default 2. loss given default 3. coupon rate on swap (1) Prob. of Default: -prob. of default given that it has not already occurred, which is implied in CDS since otherwise the CDS would no longer exist. Prob of default = the hazard rate -survival rate in 3 years given hazard rate of 2% that goes up 1% each year is (1 - 2%)x(1-3%)x(1-4%) (2) Loss given default = expected loss in event of default. And expected loss for given period = hazard rate(t) x LGD (t) (3) Upfront payment by buyer = PV of Protection leg - PV of premium leg Upfront premium% = (CDS Spread - CDS coupon) x duration of the CDS **you can rearrange to solve for CDS Spread **duration of CDS not of reference obligation CDS price per $100 notional = 100 - upfront premium **so if CDS coupon is greater than spread than upfront premium% will be negative and CDS price will be greater than 100 so seller will pay buyer a upfront payment

when is cost approach best for RE valuation? (3)

1. property is new 2. property is unusual 3. comparable trans. are limited

3 keys to profitability for P&C? Explain the 3 types of P&C insurance? Explain the Cycle of P&C market? Soft mkt is when ____ ratio is ____?

1. prudent underwriting 2. pricing the risk of policys 3. diversification of risk Property - obviously covers property Casualty (aka liability) - protects against legal liability to 3rd party Multiple Peril - covers both P&C market is cyclical in that the market moves bw a soft mkt and a hard mkt - soft mkt is when P&C companies are generating low earnings or loss. the cycle is driven by the combined ratio soft mkt is when COMBINED RATIO is HIGH

Effect of serial correlation?

1. results in coefficient standard errors that are too small 2. results in greater t stat and an over rejecting of the null 3. results in type 1 error

Performing analysis of company with investments in financial assets?

1. separate operating results from investment performance by removing the dividends interest and gains and losses from NI that are from financial assets 2. for comparison you should adjust the asset value to market value 3. and when calculating return on operating assets, you must remove the financial assets from the value of operating assets

4 Effects of Heteroskedasticity

1. standard errors are unreliable estimates. 2. coefficient estimates aren't affected 3. t-test results will result in errors since the t-stat is affected by the standard errors which are unreliable 4. the f-test is also unreliable

advantages of swap rate curve? (3)

1. swap rates reflect the credit risk of commercial banks rather than govts. 2. swap rates among countries are more comparable since the swap mkt is not regulated by any govt. 3. swap curve has yield quates at many matuirtyes compared to govt bond yc

How to forecast revenue with a growth relative to GDP growth approach? and how to use market growth and market share approach?

1. the relationship between GDP and company sales is estimated, and then company sales growth is forecast based on an estimate for future GDP growth. 2. begins with an estimate of industry sales (market growth), and then company sales are estimated as a percentage (market share) of industry sales. Forecast revenue then equals the forecasted market size multiplied by the forecasted market share.

Under the acquisition method, the balance sheets of the two entities are consolidated as follows: add _______; do not adjust ________; and list the minority interest ____. Minority interest is equal to ______. On the consolidated income statement, ____. Subtract _____. The minority interest amount on the income statement equals ____

1. together all asset and liability accounts net of intercorporate transfers 2. the equity accounts of the parent 3.as a separate component of stockholders' equity 4. the proportion of the subsidiary that the parent does not own times the net equity of the subsidiary. 1. add the revenues and expenses of the parent and the subsidiary together as of the consolidation date 2. the minority shareholders' share of the subsidiary's net income from this amount 3. the proportion of the subsidiary the parent does not own multiplied by the net income of the subsidiary.

Presentation of Pension Expense under GAAP and IFRS? (3 things)

1. under GAAP all components of periodic pension expense are aggregated into one line item on IS 2. under IFRS the components may be presented separately 3. under both GAAP and IFRS, TPPC is required to be disclosed in the notes to the financial statements

Explain each of the traditional theories of the term structure of interest rates? 1. unbiased expectations theory 2. Local Exp. Theory 3. Liquidity preference theory 4. segmented mkts theory 5. local exp. theory

1.**underlying principal is risk neutrality, investors don't demand premium for inv. that differs from their invest. horizon. it is investors expectations that shape the interest rate curve. every maturity strategy has the same expected return over given investment horizon. (5 yr bond vs 3 year then 2 year) 2. similar to ^. one major diff. is that it assumes risk neutrality for short holding periods only. and for longer periods premiums should exist. *****This implies that every bond should earn RFR for short holding period. doesn't hold bc of liquidity premiums.****** 3. Liquidity preference theory - Investors demand a liquidity premium that is positively related to a bond's maturity. 4. Segmented markets theory—The shape of the yield curve is the result of the interactions of supply and demand for funds in different market (i.e., maturity) segments. various mkt participants only deal in securirties of a particular maturity, and yields at different maturities are independent of each other 5. similar to segmented mkts, supports that there is a premium but not due to maturity, so 25 year might have greater premium than 10 year. diff than segmented mkts because it recognizes that mkt partipants will deviate from their preferred maturity habitat if compensated

1Conversion Ratio Formula 2Conversion Price Formula? 3Conversion Value? 4Minimum Value of Convertible Bond? 5Mkt Conversion Price? 6Mkt Conversino Premium per share? 7Mkt conversion premium ratio? 8Premium over straight value? What does this mean?

1=number of shares of common stock from exercising call option = Par Value / Conversion Price 2=par/CR or (if not issued at par) = issue price/CR 3=mkt price of stock x CR 4=max(conversion value, straight value) 5=mkt price of conv. bond/CR 6=mkt conversion price - current stock price 7=mkt conversion premium per share/current stock price 8= mkt price of conv. bond/straight value - 1 **the greater this number, the less attractive the conv. bond

Describe how to perform unit root test for covariance nonstationarity? what do you do if the time series has unit root/random walk?

2 methods 1. run an AR model and examine the autocorrelations, if stationary residual autocorrelations are insignificantly different from 0 at all lags, or the residual autocorrelations decay to 0 as the number of lags increases 2. unit root test using Dickey Fuller Test > transforms the AR1 model into simple linear regression. starting with the AR1 and then subtracting xt-1 from both sides. then you perform a hypothesis test with H0: g = 0 H1: g ≠ 0 (no unit root) you are testing whether b1-1 is different than 0, "g" represents b1-1, and the test is performed using modified t-test, the important thing here is that if you reject the null there is no unit root and if you do not reject the null then the time series has unit root transform the time series using First Differencing

what is multicollinearity?

2 or more of the independent varialbes are highly correlated.

Calculating WCinv?

= change in current assets excl. cash and cash eq. - change in current liab. excl. ST debt *so increases in current assets will reduce FCFF and increases in current liab. will increase FCFF

2 stage DDM formula? 3 stage DDM?

3 stage use financial calculator solving for cash flow, remember you don't need to discount the cash flows as calculator does this. Except for the TV which needs to be discounted to year n

Correlation Formula?

= Covariance/(std x * std y)

Carhart four-factor model

= FF model + (Beta of momentum x winners minus losers)

DC Plan - Pension Expense?

= company annual contribution to plans adjusted for change in year end accruals

Liquidity Coverage Ratio? (define the components) Basel III recommended minimum? What does it measure? Net stable funding ratio? Basel III recommended minimum?

= highly liquid assets/expected cash flows *expected cash outflows are those estimated one month liquidity needs 100% *liquidity in stress scenario =available stable funding/required stable funding *available stable funding is from maturity dist. of bank's capital and liabilities, required stable funding is function of maturity distribution of assets *100% *funding stability

LIBOR-OIS spread? What to do with it?

= libor rate - "overnight indexed swap rate" -roughly reflects the fed funds rate -useful indicator of well being of banking system and credit risk, low LIBOR-OIS means high liquidty and no concerns about credit bw banks.

expected active return? (when in multiple asset classes, equities, bonds, etc.)

= ∑[(weight in Active P of asset class - weight of asset class in BM)*benchmark return for asset class)] + ∑[(return in portfolio for each asset class - return on bm for each asset class)*(weight of asset class in active portfolio)] first part is the return from asset class selection second part is return from security selection when given information about different asset class weights and returns to benchmark and portfolio, we know that asset class weights were different as given, and the return differences are due to differences in weights of particular securities in the asset class

effective duration and convexity formula? What are these good for?

=(V-) - (V+)/(2 x V0 x change in Y) =(V-) + (V+) - (2xV0)/(2 x V0x change in Y^2) effective duration and conv. takes into account how changes in interest rates may alter cash flows. standard or modified duration measure bonds price sens. to changes in interest rates assuming cfs don't change. convexity approves upon this estimate. Neither are good for bonds with options as the cash flows would change.

WACC? Why does this make sense? What value to use for debt and equity? When to use WACC as discount rate on cfs?

=(mkt value of debt/mkt value of debt and equity)x(rate on debt)x(1 - tax rate) + (mkt value of eq/mkt value of d and eq)x(rr equity) firms can deduction for int. exp. so debt is x (1-t) use the mkt value of debt if thare their target rates, if mkt value of debt and equity are not target weights then use target weights. **cash flows to entire firm should be discounted at WACC. Cash flows in excess of debt requirements uses rr equity

Calculating FCFF from CFO? FCFF from EBIT? FCFF from EBITDA?

=CFO + int(1-t) - FCinv =EBIT(1-t) + dep - FCinv - WCinv =EBITDAx(1-t) + dep*t - FCinv - WCinv

Cash return on total assets? Cash flow to reinvestment? Cash flow to total debt? Cash flow interest coverage?

=CGO/average assets =CGO/Cap. Ex =CGO/total debt =CGO/cash interest

single stage valuation with FCFF and FCFE? calculating TV with P/E (2)

=FCFF(1)/WACC - g =FCFE(1)/r-g TV in year n = trailing P/E x earnings year n TV in year n = leading P/E x earnings in year n+1

forecasting FCFE formula?

=NI - (1-DR)x(FCinv - dep) - (1-DRx(WCinv)

Cash Flow statement approach: aggregate accruals? CF statement approach accruals ratio?

=NI - CFO - CFI Accruals ratio = NI - CFO - CFI/average net operating assets *lower the better indication of earnings quality

Active risk decomposition: active risk squared?

=active factor risk + active specific risk where active specific risk = ∑[(Wpi-Wbi)^2 x asset i residual risk] **active risk squared is the variance of active returns **active factor risks are like grocery store or any particular industry in active portfolio that are more sensitive than bm. **active specific risk is is more or less weight in one stock than bm

book value per share? common adj's to book value? (3) justified P/B?

=assets - equity - preferred stock / os shares *1. use tangible BV by subtracting intangible assets (2) adjust for off BS items and adj. recorded costs to fair value (3) adjust BV's if companys use different inventory accounting methods =ROE-g/r-g

Unlevered Beta? estimate of beta for the thinly traded stock?

=beta of XYZ x 1/(1+ debt of XYZ/eq of XYZ) =unlevered beta of XYZ x (1 + (debt of ABC/eq of ABC) difference bw first and second is to unlever you take 1/(1+d/e) to relever you dont put 1 in numerator so just 1+(d/e)

Forecasting inventory on BS? Forecasting A/R on BS?

=estimated COGS/inventory turnover =estimated annual sales x (DSO/365)

How do you forecast income tax expense? 3 types of tax rates?

=expected effective tax rate x forecasted pretax income 1. statutory - % tax charged by country 2. effective -income tax expense as % of pretax income 3. cash tax cash taxes paid as % of pretax income

More P&C insurance company ratios. 4. Loss and loss adjustment reserve ratio? 5. Dividends to policy holders ratio? 6. combined ratio after dividends? 7. total investment return ratio?

=loss expense + loss adj. exp./(net premiums EARNED) =dividends to policy holders /(net premiums EARNED) =combined ratio - dividends to policyholders =total investment income/invested assets

Calculate a confidence interval for the predicted value of the dependent variable? Interpret?

=predicted y value +/- (critical t value)*(standard error of forecast) tc from the table with n-2 degrees of freedom *this formula is used with a predicted value of y given the forecasted X, and with this estimated y you can say that you are 95% confident that given X is 10% that y will fall between the two values given by above formula *Sf is Standard Error of Forecast, usually provided on the exam. If you had to calculate it

active risk (AKA tracking risk) formula?

=sd of active return = sd of (Rp - Rb)

✔ 45 ALTERNATIVE INVESTMENTS: COMMODITIES Basis? basis and calendar spreads are __ in contango

=spot price - futures price negative

Parent Co. Pro-Rata share of subsidiary? (in dollars or currency units) Parent co. stand alone value? Parent co. stand alone P/E? P/E discount to mkt?

=sub's share price in FCxshares held by parent co. x Exchange rate = sub's mkt cap in FC x parent co. equity share *in % pro-rata share/parent co. mkt cap =parent mkt cap - pro-rata share in sub. =stand alone mkt cap of parent/(parent NI - equity income from sub) =benchmark's P/E - parent co PE / benchmark's P/E

breakeven inflation rate

=yield on non-inflation indexed bond - yield on inflation indexed bond or = π + θ

HHI formula? rules for when it will be challenged?

=∑ (market share% x 100)^2 post merger less than 1000 - unlikely challenge 1000-1800: moderate likelihood of being challenged AND if change bw pre and post HHI is greater than 100 than it is likley to be challenged post HHI greater than 1800, very likely, if change is greater than 50 certain to be challenged

expected return on active return? (for all within same asset class since the returns have to be the same for each one only the weights can differ)

=∑∆w(i)*(expected return of security i) where ∆w(i) = weight portfolio - weight in benchmark

What is a collar? max profit, loss, and BE? What is a straddle? max profit, loss, BE?

A combination of a covered call and a protective put is a collar. (so a long stock, long put, and short call) Similar to spreads, collars limit downside risk but at a cost of limited upside. Puts a band or collar around returns from long position in stock. maximum profit = XH − S0 − (P0 − C0) maximum loss = S0 − XL + (P0 − C0) breakeven price = S0 + (P0 − C0) A long straddle is constructed in expectation of higher future volatility of the stock price, but unsure of which direction. It is constructed with a long call and a long put on the same stock with the same X. Investor only loses if the stock price remains stable. maximum profit = ST − X − (C0 + P0) (unlimited upside as STincreases) maximum loss = C0 + P0 breakeven price = X − (C0 + P0) and X + (C0 + P0)

Key rate duration definition in words and in math? And 2 (+'s)

A method of measuring the interest rate sensitivities of a fixed-income instrument or portfolio to shifts in key points along the yield curve. (+)more precise (+)superior for non parallel shifts The approximate % change in value of portfolio given a 100 bp change in corresponding key rate

z spread?

A spread that when added to each spot rate on the default-free spot curve, makes the present value of a bond's cash flows equal to the bond's market price. Z refres to zero volotility this refers to assumption of zero interest rate volotility. Z spread is not approprite for bonds with options

Under Old IFRS, which classification is different bw GAAP and IFRS? IFRS change for AC? Under IFRS 9 - reclassification is not allowed for? and is allowed for?

AFS - similar but under GAAP, unrealized foreign g/l on debt sec. are rec. in IS under IFRS **HTM and HFT are same standards bw GAAP and old IFRS definition changed now you can use AC if meets both of these criteria 1. business model test - held to collect contractual cash flows 2. cash flow characteristic test - cf must be principal or interest on principal not allowed for equity securities (which can only be FVPL or FVOCI) and is allowed for debt securities only if business model has changed

Active return decomposition?

Active return = factor return + sec. sel. return ∑(porfolio sen. - bm sensitivity)x(factor return) security selection return = active return - factor return

Advantages of Using Simulations in Decision Making? (2) Issues in Using Simulations in Risk Assessment? (4)

Advantages of Using Simulations in Decision Making: (1)The analyst is encouraged to more carefully estimate the inputs. (2) The forecast output takes the form of a distribution and thus is more informative than a point estimate. Issues in Using Simulations in Risk Assessment: (1)Input data quality. (2)Inappropriate specification of statistical distributions. (3)Non-stationary distributions. (4)Non-stationary (dynamic) correlations.

CF: After tax operating cfs?

After-tax operating cash flow (CF). Calculated using either of the following: CF = (S − C − D)(1 − T) + D = (S − C)(1 − T) + (TD) where: S = sales C = cash operating costs D = depreciation expense T = marginal tax rate

Balance sheet approach to accruals ratio: aggregate accruals? Accruals Ratio?

Aggregate accruals=NOA(end) - NOA(beg) --where NOA = Operating assets - Operating liab. --and Op Assets = total assets - cash - mkt securities, and Op Liab = Total Liab - Total debt (LT and Current debt) BS Accruals ratio = NOA(end) - NOA(beg)/[NOA(beg) + NOA(end)/2] ---or NOA(end) - NOA(beg)/average NOA lower ratio = less earnings from accruals = better earnings quality

What is ARCH? What is the impact of ARCH? Testing for ARCH? Correcting for ARCH?

Autoregressive conditional heteroskedasticity exists if the variance of the residuals in one period is dependent on the variance of the residuals in the prievious period whe nthe condition exists, the standard errors of the regression coefficients in an AR model are INVALID and the hypothesis tests of the coefficeints are INVALID An ARCH model is used to test for autoregressive conditional hetero.. the squared residuals from an estimated time series are regressed on the first lag of the squared residuals the model looks like this ε̂ = a0 + a1(ε̂2 t-1) + u if a1 is stat dif than 0 the timeseries is ARCH1 generalized least squares must be used to correct for heteroskedasticity

✔ 28 EQUITY: INDUSTRY AND COMPANY ANALYSIS Bottom up analysis? Top Down analysis? Hybrid analysis?

Bottom-up analysis starts with analysis of an individual company or reportable segments of a company. (revenue forecasts, new products) Top-down analysis begins with expectations about a macroeconomic variable, often the expected growth rate of nominal GDP. (forecast revenue based on GDP growth forecasts) A hybrid analysis incorporates elements of both top-down and bottom-up analysis.

how to apply the temporal method? Also inventory and COGS impacts from temporal method?

BALANCE SHEET - monetary assets and liabilities are remeasured using Current Ex Rate Non-monetary ass and liab are remeas. using Historical Rate. Non-monetary liab are less common, one example is deferred revenue Common stock uses historical rate Dividends use historical rate Expenses related to non-monetary BS items, are remeasured using the historical rate (COGS, depreciation) Other expenses are remeasured using average rate, and revenues are remeasured using average rate Remeasurement Gain or Loss is recognized on Income Statement! more volatile net income Finally NI overall is calculated from a mix of rates due to different rates for different items on BS The ending inventory on the BS will be using historical exchange rates so if FIFO, then the ending inventory will be using more recent exchange rates, and the COGS will be using older exchange rates, and if LIFO the ending inventory will be based on older exchange rates, and COGS will be more recent exchange rates. Both inventory and COGS are using historical ex rates

Breush pagen test formula? (also tricky thing to remember?) and df?

BP = n x R2 *R2 is from a second regression on the residuals - not the R2 from the initial regression Chi squared test with k degrees of freedom

Keys to acquisition method? (3)

Balance Sheet adjusted as follows (1) acquiring company's total assets increase by Company A assets and company B assets - cash to acquire company. (2) Do not adjust equity accounts of parent. And list minority interest as separate component of equity. Minority interest on BS beginning value is the % not purchased x acquired company's equity. Minority interest increases from this % x the acquired company's reported NI and is decreased by dividends paid x minority interest. (3) Consolidated NI for acquiring company is Com A net income + Co B Ni - minority interest in CO B share of NI (% parent does not own * NI of subsidiary)

the ______ is a regression model that estiamtes the probability of earnings manipulation using 8 dependent varianbles, and generates a _____. Limitations of the model include (2) maximum acceptable M-score?

Beneish. M-score relies on accounting data which may not relect economic reality. mngt may game the tool as they become more aware of it which is indicated by less predictive power over time -1.78, so greater than -1.78 (for example -1.5 is higher than acceptable prob. of earnings manipulation) equivelabnt to 3.8% being max prob. of earnings man.

Business Combinations accounting method?

Business Combinations - 50% or more controlling interest. acquisition method of accounting is required under GAAP and IFRS. Business Combination is still the designation if there is less than 50% interest but there is control.

3 ways to estimate the rr on an equity investment (7 models)?

CAPM 1. CAPM Multifactor models 2. Multifactor model 3. Fama French 4. Pastor Stambaugh 5. Macroeconomic multifacotr model Buildup Models 6. buildup models (which includes Bond Yield Plus Risk Premium Approach)

Strengths and weaknesses of the 3 types of models? (CAPM, MFM, BU)

CAPM - simple but may have low explanatory power Multifactor models have more explanatory power but are more complex and costly. Build-up models are simple and can apply to closely held companies, but they typically use historical values as estimates that may or may not be relevant to the current situation.

single name CDS: reference obligation and reference entity? When does it payoff? How much? index CDS: total notional? credit protection for each entity? pricing of index CDS?

CDS pays off when reference entity defaults on reference obligation. Or when they default on obligation that is ranked Pari Passu (same rank or higher) The payoff is the notional principal amount less the mkt value of the "cheapest to deliver" bond of the same seniority Total notional principal is the sum of the protection for each issuer. therefore, the credit protection for each issuer is the total notional principal divided by number of entities in index. The higher the correlation of default among the entities in the index, the higher the index CDS spread, because higher loss potential means more risk for seller of CDS

Cash generated from operations? (CGO) (2 ways to calculate) **nuance for IFRS? What do we do with CGO?

CGO = EBIT + Non-cash charges - increase in working capital or CGO = OCF + cash interest paid + cash taxes paid if IFRS AND they decide to report interest paid as financing cash flow than do not add back the cash interest paid Compare CGO to operating income, if CGO is greater than operating income than we have no concerns

Considerations for forecasting COGS?

COGS is closely related to revenue so it is usually estimated as a percentage of future revenue forecast COGS = (historical COGS / revenue) × (estimate of future revenue) forecast COGS = (1 − gross margin)(estimate of future revenue)

How to perform Durbin Watson Test? (calculation and Degrees of freedom?)

Calculate DW Stat = Σ(ε - εt-1)/Σ(ε^2) OR DW = 2(1-r) for large sample size. r is the correlation of the residuals. You will compare the calculated DW Stat to the DW Critical Values. The DW Table gives you the upper and lower DW found using K=number of independent variables and N for the number of observations DW above 2 indicates negative serial correlation, DW below 2 indicates positive serial correlation, but you must use the test below to determine whether it is stat. sig. The test for positive serial correlation: H0: no positive serial correlation. If the DW is less than the D lower critical value than we reject H0 and conclude positive serial correlation, if it is inbetween the critical values then the test results are inconclusive, if it is greater than the upper critical value then we do not reject the null that there is no positive serial correlation. *However if it is close to 4, then we can reject H0 but conclude that there is negative serial correlation

Common equity tier 1 capital? Tier 1 capital? Tier 2 capital? Total capital? Basel III capital requirements?

Common equity tier 1 = common equity (including additional paid-in capital + retained earnings + OCI) less intangibles and deferred tax assets Tier 1 capital = Common Equity Tier 1 + subordinated instruments with no specified maturity and no contractual interest/dividend (which is preferred stock with discretionary dividends) Tier 2 = subordinated instruments with original maturity of more than 5 years Total = Tier 1 + Tier 2 minimum common equity tier 1 to RWA of 4.5% minimum tier 1 to RWA of 6% Total capital of 8% of RWA

How to adjust a firm's cash flows for differences bw pension cash flow and total periodic pension costs?

Compare amount of contributions to total periodic pension cost. If difference is significant analyst may want to make adjustments. If contributions exceed TPPC, it is like a principal reduction, you increase operating cf and decrease financing cf. If TPPC exceeds contributions, you decrease operating cf and increase financing cf. However, some of these adjustments need to include the tax rate

Extensions of VaR: is the expected loss given that the loss exceeds the VaR is the estimated change in VaR from a specific change in the size of a portfolio position is the estimate of the change in VaR for a small change in a portfolio position and is used as an estimate of the position's contribution to overall VaR. also referred to as relative VaR, measures the VaR of the difference between the return on a portfolio and the return on the manager's benchmark portfolio.

Conditional VAR Incremental VaR Marginal VaR Ex ante tracking error

✔ PORTFOLIO MANAGEMENT 47: MULTI FACTOR MODELS How is arbitrage pricing model different than CAPM? 3 assumptions in APT Model? Expected Return formula? (same formula as APT model except APT is generalized with unlimited number of factor sensitivities and factor risk premiums) Advantage of APT model over CAPM?

Created as alternative to CAPM, unlike CAPM it does not identify specific risk factors to use (1) unsystematic risk can be diversified away in a portfolio, (2) returns are generated using a factor model, and (3) there are not opportunities to earn risk-free returns Expected return = risk-free rate + ∑(factor sensitivity) × (factor risk premium) *does not require that mkt portfolio be one of the risk factors

Periodic Pension Expense to P&L under IFRS?

Current Service Cost +/- net interest cost + past service cost *net interest cost is either positive or negative, it is beginning funded status x discount rate, so it is added to cost if plan was underfunded and subtracted from cost if plan was overfunded, in IFRS net interest cost is used rather than under GAAP where you have +interest cost and -expected return past service costs are immediately added to pension cost under IFRS as shown in formula, compared to GAAP where they go to OCI and then are amortized And actuarial gains/losses are not included in pension expense since these always go to OCI and are not amortized under IFRS So you never have to worry about adding in amortizations under IFRS periodic pension cost

Compare RI model to valuing company to DDM and FCF models? (2)

DDM and FCFE value a stream of exp. cash flows, while RI starts with Book value and adds present value of expected RI's Models theoretically should arrive at same value

✔ 15.FINANCIAL REPORTING: EMPLOYEE COMPENSATION: Definition and Accounting for Defined Contribution Plan? (Income Statement and BS)

Defined Contribution Plan is where employer contributes certain sum to employee's retirement account each period. The amount is based on years of service, age, % of employee's contribution, etc. Accounting for DCP is straightforward. Employer contribution equals pension expense recorded there is no future obligation to report on the BS

what are the 2 income approach methods to valuing RE? NOI calculation?

Direct Capitalization and Discount CF Method - both use NOI Rental income if fully occupied + Other income = Potential gross income - Vacancy and collection loss = Effective gross income - Operating expense (which includes insurance, property taxes, utilities, repairs, and maintenance) = Net operating income

Dummy variable trap? Value of the dependent variable with dummy variables?

Dummy variable trap means that you must always use n-1 dummy variables to avoid multicollinearity. Given EPS = 1.25 + .75Q1 + .20Q2 + .10Q3. The predicted first quarter EPS is found by turning on Q1 by adding in a 1 and turning the rest off with a 0. The omitted coefficient is Q4 so we know that the mean EPS in the 4th quarter is simply 1.25

Ibbotsen Chen equity risk premium

ERP = (1+i)x((1+rEg)x(1+pEg) - 1 + Y - RF where i is expected inf. rEg is exp. real growht in EPS, PEg is exp. change in PE ratio, Y is exp. yhield on index rEg should be approximately = real GDP growth = labor prod. growht rate + labor supply growth rate

Country Spread Model: ERP Estimate? What is the other method to estimate ERP for country risk?

ERP for a developed market + Country Premium where, country premium = yield on emerging mkt bonds (den in curr of developed mkt) - yield on developed mkt govt. bonds Country risk rating model - estimates a regreession equation using ERP for developed mkts as Y and risk ratings of em mkt as X, regression estimates ERP for emerging mkt

EV/EBITDA Multiple Total invested capital?

Enterprise Value / EBITDA where EV = MV of common stock + MV of preferred stock + MV of debt + minority interest - cash - ST investments TIC = MV of common equity +MV of pref. stock + MV of debt

Under GAAP and IFRS, if there is sign. influence what accounting method is used? if there is shared control/joint venture which accounting method under both standards? if there is control under both standards which accounting method?

Equity Equity **rare cases GAAP allows proportionate consolidation acquisition method

✔ 36: FIXED INCOME: VALUATION AND ANALYSIS OF BONDS WITH EMBEDDED OPTIONS Describe the 3 types of call options? Investor is __ the call option. For a putable bond, investor is __ the put option. What type of bond allows investor to extend maturity of the bond? how is it valued? What is Estate Put? The value of the bond is related to what? Sinking fund bond?

Euro - single day window to call 2. American - anytime after lockout period 3. Bermudan - fixed dates that bond can be called short long extendable bond. valued the same way as putable bond allows heirs of an investor to put the bond back to the issuer upon investors death. The value of the bond is inversely related to investor's life expectancy. require the issuer to set aside funds periodically to retire the bond. (reduces credit risk of the bond)

✔ PORTFOLIO MANAGEMENT 50: ANALYSIS OF ACTIVE PORTFOLIO MANAGEMENT Ex-Ante Ex-Post

Ex Ante means "based on expectations" - so expected value Ex Post means "after the fact" so already happened

Forward exchange rate formula? (currency forward price) Value of currency forward after initiation? (formula is for value to who)

F = S0 x [(1+R price curr)^T/(1+R base curr)^T] **F and S are quoted in price currency per unit of base currency Vt = [FPt - FP] x (contract size) / (1+R price)^(T-t) *where Vt is value in price currency units to party long the base currency

What is the F-stat? How do you calculate it? How do you perform test?

F stat is used to determine whether the independent variables as a group explain the dependent variable. H0 is all b's = 0, H1 is that at least one of the b's is not 0 (at least one of the b's explains the y) F=MSR/MSE=(RSS/k)/(SSE/n-k-1) calculate the F stat. Compare it with the Fc. FC is always one tailed test. The Fc is found with k for df in numerator and n-k-1 for df denominator Ho is that coefficients = 0, reject H0 if the F-stat exceeds Fcv so if calculated F-stat exceeds the F CV than good for model

_____ cointed the name VIE, to identify an SPE that meets certain conditions. If an inetity is considered a VIE, it must ______. 6 common examples of common variable interests?

FASB be consolidated by the primary beneficiary 1. At-risk equity investment. The investor receives the residual benefits but also absorbs the potential losses. 2. Debt guarantee. In the event of default, the guarantor will experience a loss. 3. Subordinated debt. Since senior debt is repaid before subordinated debt, the subordinated debtholders absorb the loss in the event the senior debtholders cannot be repaid. 4. Lease residual guarantee. The lessee guarantees the fair value of the asset at the end of the lease. If the fair value is less than the guaranteed amount, the lessee experiences a loss. 5. Participation rights. The holder receives a predetermined share of the profit. 6. Asset purchase option. The holder benefits from an increase in the fair value of the asset.

what is one major change in accounting standards that you must be aware of? (hint relating to lease)

FASB has generally eliminated the operating lease, requiring the finance lease treatment which may sign. increase leverage of affected firm

FCFE from FCFF? FCFE from NI? FCFE from CFO? net borrowings?

FCFE = FCFF - int(1-t) + net borrowings FCFE = NI + NCC - WCinv - FCinv + Net borrowings FCFE = CFO - FCinv + net borrowings net borrowings = new debt issuance - debt repayments

explain how changes in the components of sales for companys with multinational ops affect the sustainability of sales growth?

FS are reported in reporting currency even though sales occurred in various currencies, sales growth due to volume or price is more sustainable than sales growth due to appreciation of foreign currency organic growth in sales = sales growth excluding effects of acquisitions/divestitures AND currency effects

A _______ is a portfolio with a factor sensitivity of 1 to a particular factor and zero to all other factors. It represents a pure bet on a single factor and can be used for speculation or hedging purposes. A ________ is a portfolio with a specific set of factor sensitivities. Often designed to replicate the factor exposures of a benchmark index like the S&P 500.

Factor portfolio Tracking portfolio

Bear Put Spread: formula for max profit, max loss, BE? characteristics?

For a bear put spread: maximum profit = XH − XL − PH0 + PL0 maximum loss = PH0 − PL0 breakeven price = XH + PL0 − PH0 buy a put with X > X of put you sell premium you pay on put is higher than premium you receive on put *limited up or down side, and provides a gain if underlying falls

bull call spread max profit, max loss, BE? characteristics?

For a bull call spread: maximum profit = XH − XL − CL0 + CH0 maximum loss = CL0 − CH0 breakeven price = XL + CL0 − CH0 *buy call with XL < XH of call you sell *premium on call you buy will be > premium on call you sell *provides gain if underlying increases with limited upside and limited downside

✔ 35. FIXED INCOME: ARBITRAGE-FREE VALUATION FRAMEWORK When to use binomial interest rate tree framework?

For bonds with embedded options - Valuation of bonds using a zero-coupon yield curve (also known as the spot rate curve) is suitable for option-free bonds. However, for bonds with embedded options where the value of the option varies with outcome of unknown forward rates, a model that allows for variability of forward rates is necessary. One such model is the binomial interest rate tree framework.

REIT valuation: Funds from operations: Price-to-FFO approach: Adjusted funds from operations:

Funds from operations: FFO adjusts reported earnings and is a popular measure of the continuing operating income of a REIT or REOC. FFO is calculated as follows: accounting net earnings + depreciation charges (expenses) + deferred tax charges (i.e., deferred tax expenses) - gains (losses) from sales of property and debt restructuring = funds from operations (FFO) Price-to-FFO approach: funds from operations (FFO) ÷ shares outstanding = FFO / share × sector average P/FFO multiple = Value per share Adjusted funds from operations: AFFO is an extension of FFO that is intended to be a more useful representation of current economic income. FFO (funds from operations) - non-cash (straight-line) rent adjustment - recurring maintenance-type capital expenditures and leasing commissions = AFFO (adjusted funds from operations) AFFO/ s/o = AFFO per share x industry mult. = value per share

Financial Asset impairment under GAAP? IFRS? Explain IFRS loss events? (for both debt and equity)

GAAP - asset is impaired if decline in value is determined to be other than temporary. for both HTM and AFS, the write-down to FV is treated as realized loss on IS. reversal of an impairment loss is not allowed under GAAP. IFRS - just like GAAP, losses are recognized through IS. Impairment under IFRS is when at least one loss event has occurred and the effect on the securities future cash can be estimated reliably. Losses due to occurrences of future events, regardless of probability of event, are not recognized. IFRS Loss events for debt securities - include 1. default 2. likely that borrower will enter bankruptcy or reorganization 3. concessions from bondholders 4. other financial difficulty **absent another event, a credit rating downgrade or lack of liquid mkt for security, are not considered loss events. For equity, loss event has occurred if the FV of the security has experienced a substantial or extended decline below its cv OR if the business environment of equity issuer make it unlikely that the equity security will recover to initial cost of security

Fair value option with investment in associates?

GAAP allows for using equity method, but instead of recorded at cost, recording at fair value, under IFRS, the fair value option is only allowed for Venture Capital firms, mutual funds, and similar entities. the decision to use the fair value option is irrevocable and any changes in value are recorded in IS along with dividends

Periodic Pension Expense Reported on P&L? (GAAP)

GAAP: current service cost + interest cost - expected return on plan assets Expanded for amortizations = current service cost + amortization of past service cost + interest cost - expected return on plan assets +/- amortization of actuarial gains and losses where expected return on PA = expected rate of return on PA x beg plan assets If there are amortizations of either actuarial gains/losses and/or past service cost, you must also add those into pension expense (add actuarial losses and subtract actuarial gains) To determine whether the balance of Actuarial Gains/Losses in OCI needs to be amortized use the Corridor Method. First, determine whether beginning PBO or Plan Assets is greater. Take the greater amount and multiply by 10%. Compare the unamortized actuarial gains and losses to this value, if it is greater than this 10% number than you must amortize it

If subsidiary is in hyperinflationary environment, what method under GAAP and IFRS?

GAAP=the functional currency is designated as the presentation currency and the temporal method is used.IFRS=the sub's FS are reinstated for inflation, and then the current rate method is used

Going concern assumption and liquidation value?

GC is what all valuation models are based on. Liquidation value is an alternative to GC, when GC cannot be assumed. LV is estimate of selling price of all assets net of company liabiliiteis.

Estimating value using gross income multiplier? (2 formulas)

Gross Income Multiplier = comparable sale price/gross income Value = gross income x gross income multiplier

Formulate hypothesis that population correlation coefficient equals zero?

H0: p=0 Ha: p doesn't = 0 test statistic in picture critical values with n-2 degrees of freedom 2 tailed test **if the calculated t-stat falls outside of the CVs than reject H0 that p=0

✔ 27 EQUITY: RETURN CONCEPTS Holding Period Return? and HPR for a common share of stock (and decomposition)? HPR if CF is received prior to end of period?

HPR = P1 - P0 + CF1 / P0 for common share of stock = CF1/P0 + P1 - P0/P0 *first part is cash flow yield, second is price appreciation CF equals the CF + interest received from reinvesting CF until end of the period

Treatment of financial assets prior to IFRS 9? Treatment of HTM, FV through Profit or loss, and AFS? Also IFRS and GAAP difference with AFS?

HTM - debt securities w/ intent and ability to be HTM. Cannot be sold prior to maturity. Reported on BS at amortized cost (original cost plus disoucnt or minus premium amortized to date). Amortized cost is simply the present value of remaining cash flows discounted at the mkt rate at the time of issuance, interest income is recognized on IS and changes in FV are ignored. ONLY DEBT SECURITIES CAN BE HTM!! FV through Profit or loss (HFT and designated at FV) - HFT acquired for purpose of profiting in near term usually less than 3 months. reported on BS at FV, realized and unrealized changes in FV are recognized on IS along with any interest or dividend Designated at FV - securities that would otherwise be treated as HTM or AFS can be designated as Designated at FV and treated like a HFT security. this reduces volatility and inconsistincies. AFS - like HFT they are reported on BS at fair value. however, only realizedgains/losses are reported on IS and dividend and interest income are recorded on IS. unrealized gains/losses are reported as separate component of BS "OCI" unrealized gains or losses are removed from OCI when securities are sold and recognized on IS. With AFS, IFRS and GAAP are similar except for treatment of foreign exchange movements. Under GAAP, foreign exchange g/l are recorded in equity, under IFRS they are recorded in IS. For equity AFS securities, they both record these g/l in OCI.

IFRS reversal of impairment? (new and old)

HTM security's value recovers, the impairment loss can be reversed. AFS security is treated the same. For equity securities, reversals are not permitted. New and old are the same as far reversal of impairment, except terminology changed for when to impair asset, new standard has Expected Credit Loss Model

What are the factors in determining the functional currency? (5)

IASB says the functional currency should be determined by: 1. the currency that influences sales prices for goods and services 2. currency of country whose competitive and regulatory forces determine sales prices 3. the currency that influences labor and material costs 4. the currency from which funds are generated 5. the currency in which receipts from op activities are usually retained FASB has similar but not identical factors

Information coefficient of a market timer?

IC = 2x(% correct) - 1 higher the IC, the better skill of the manager in timing the market

Financial asset classification under IFRS 9?

IFRS 9 replaces HFT with FV through P or L, replaces HTM with Amortized Cost, and replaces AFS with FV through OCI FVPL=for debt and equity, debt may be classified as FVPL if held for trading or if accounting for at amortized cost would result in accounting mismatch. For equity securities, if the purpose is for trading it must be FVPL. Other equity securities can be FVPL or FVOCI. Once classified as FVPL the decision is irrevocable. FVOCI=exact same as rules for AFS.

Information ratio formula with it's 3 parts? active return with 3 parts?

IR = TC*IC*√BR E(R active) = TC*IC*√BR*σA For an unconstrained portfolio TC = 1

What are the 3 definitions of value, and which definition is most relevant to public company valuation?

IV, fair mkt value, and investment value IV - most relevant in valuing public equities, except for acquisitions, then investment value is best.

Gross lease? Net Lease? Percentage Lease?

In a gross lease, the owner is responsible for the operating expenses, and in a net lease, the tenant is responsible for all expenses minimum rent + % of sales revenue above a certain level. so if level is 400 and sales are 500 you take 500-400)x% **remember grOss, expenses paid by Owner, neT, expenses are paid by Tenants

Pathwise valuation? How many paths in 3 year bond?

In the pathwise valuation approach, the value of the bond is simply the average of the values of the bond at each path. For an n-period binomial tree, there are 2^(n-1) possible paths. 3 year bond there will be 2^2 = 4 unique paths. ***To find value of path one: coupon payment year 1 divided by (1 + 1 year forward rate) + coupon payment year 2 divided by (1 +year 1 forward rate)x(1 + year 2 forward rate) + cash flow year 3 divided by (1 + year 1 rate)*(1 + year 2 rate)*(1 + year 3 rate)

Information ratio's 3 components? (explain each)

Information Coefficient - measure of manager's skill, and is the correlation bw forecasted active returns and actual active returns Transfer Coefficient - correlation bw actual active weights and optimal active weights Breadth is the number of independent active bets taken per year

Total Periodic Pension Cost?

It is the employer's contributions adjusted for changes in funded status. In other words, the expense to the company is either paid via contributions or deferred via a worsening of the plan's funded status TPPC = employer contributions - (ended funded status - beg. funded status) OR TPPC= current service cost+interest cost+prior service cost-actual return on plan assets +/- actuarial losses/gains due to changes in assumptions affecting PBO **Add each of the items with the term "cost" or "loss" subtract each item with "gain" or "return"

Estimate value of property using cost approach? (3 steps)

LESS DETAIL =replacement cost + builders profit) - adjustments for deterioration in depreciation + mkt value of land IN DETAIL =Replacement cost (cost to rebuild using modern building materials + developer profit) -curable physical deterioration (the cost of any thing that needs to be repaired that is worth repairing, so it is curable if the benefit to fix exceeds the cost to fix) = Replacement cost - curable physical deterioration -incurable physical deterioration (( this is = (effective age/total economic life)x(replacement cost - curable physical deterioration) - functional obsolensence (loss in NOI per year/cap rate) **example bad design creates loss in value like bedrooms too small -locational obsolescence (loss in NOI per year/cap rate) ) **prison built next door **subtract loss in the land value from this same factor so it is not double dinging -economic obsolescence **new construction not feasible under the current economic conditions + mkt value of land

Both GAAP and IFRS use the Fair Value Hierarchy in estimating value of investment securities? What are level 1, 2, and 3 inputs?

Level 1 inputs are quoted market prices of identical assets; Level 2 inputs are observable but not quoted prices of identical assets; and Level 3 inputs are non-observable.

Balance Sheet accounting for loans? Accounting for investments under IFRS 9? Under GAAP? Accounting differs b/w GAAP and IFRS for bank assets for which?

Loans are generally carried at Amortized cost IFRS 9:investment in securities under IFRS 9-debt securities carried at AC, FVOCI, or FVPL. Equity securities can only be carried as FVOCI or FVPL. GAAP: investment in equity securities are FVPL, debt securities are AC, FVOCI, or FVPL investment securities*main difference is IFRS 9 equity securities can be carried at FVOCI or FVPL, GAAP only FVPL

Describe hyperinflationary environment? Accounting standards definitions?

Local currency will rapidly depreciate due to deterioration of purchasing power. Using the current rate method, the assets and liabilities of subsidiary assets and liab of sub are disappearing in parent's BS. In reality, the values of non-monetary assets are held, such as real estate, the market value increases with the rapid inflation. Under IFRS, FS are adjusted for inflation, which corrects for the issue above, but this is not allowed under GAAP FASB definition is where cumulative inflation exceeds 100% over a 3 year period, annual inflation rate of 26% IASB definition - does not have a specific definition, however, at a minimum, the 100% would be hyper inf. Under GAAP, the functional currency is considered to be he parents currency and remeasurement is done using temporal. under IFRS, you restate the foreign currency financial statements and then use the current rate method.

MM (with no taxes) MM (with taxes) Pecking order theory? Static trade off theory?

MM1 with no taxes concludes capital structure is irrelavent since everyone is splitting the same pie MM2 with no taxes makes same conclusion that CS is irrelevant bc cost of debt goes down with more debt and cost of equity goes up and WACC stays the same including taxes into MM says that the tax shield provided by debt makes debt more valuable than equity and that the optimal level of debt in CS is 100% says that mngrs prefer financing choice that sends least visible signal to investors with internally generated capital most pref., then debt, last external equity seeks to balance the costs of financial distress with the tax shield benefits from using debt. Under the static trade-off theory, there is an optimal capital structure that has an optimal proportion of debt

3 factor model/Sensitivity to parallel, steepness, and curvature movements?

Measures sensitivity to three distinct categories of changes in the shape of the benchmark yield curve. level (L) parallel up or down in rates steepness - LT rates increase, ST rates decrease curvature - LT and ST rates increase and intermediate rates doe not change. change in P/P = -DL*change in L - DS*cahnge in S - DC*change in C

1. Professionalism (d) Misconduct Rule? violation for civil disobedience relating to personal belief such as political activism?

Members and Candidates must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their professional reputation, integrity, or competence. usually not a violation

How to calculate ROIC? Things to remember about ROIC? How to calculate ROCE?

NOPLAT/Invested Capital = EBI/(op assets - op liab) *EBI is operating profitx(1-t) 1. is a return to both equity and debt. 2. Firms with ROIC consistently higher than those of peer companies are likely exploiting some competitive advantage in the production and sale of their products. 3 preferable to ROE as it allows comp. of firms with diff cap structures *similar to ROIC but allows for comparison of firms with different tax rates =EBIT/Capital employed = EBIT/(total assets - current liab)

2. Integrity of capital mkts (a) Material Non-Public Information Guidance? violation for failing to prevent transfer of material nonpublic information to others at firm - such as others overhearing conference call?

Members and Candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information. (1) Guidance—Mosaic Theory - There is no violation when a perceptive analyst reaches an investment conclusion about a corporate action or event through an analysis of public information together with items of nonmaterial nonpublic information. (2) Guidance—Social Media- When gathering information from internet or social media sources, members and candidates need to be aware that not all of it is considered public information. Members and candidates should confirm that any material information they receive from these sources is also available from public sources, such as company press releases or regulatory filings. Yes - violation for failing to prevent others from hearing the information

Adjusting NI to arrive at FCFF? Components of NCC?

NI + NCC + int(1-t) - FCinv - WCinv NCC = expenses that reduce NI that weren't actual cash flows (1) dep (2) amort of intangibles (3) proisions ofr restructuring (4) other non cash losses (5) gains or losses from sale of LT assets *these are accounted for in FCinv (6) income from reversal of restructuring charges and other non-cash gains are subtracted (7) for bond issuer, amortization of discountet added to NCC (8) deferred tax liab not expected to reverse over time should be added to NCC, and def. tax. ass. not expected to reverse should be sub. from NCC

Net Interest Exp and Net Interest Inc. for pension?

NIE = Dis rate x net pension liab NII = dis rate x net pension asset

Economic value added? (2) difference bw RI and EVA?

NOPAT - (WACC*Total capital at beg of year) where total capital = net WC + net fixed assets = bv of LT debt + bv of equity or EBIT*(1-t) - $WACC RI uses NI after interest, EVA uses NOPAT before interest. RI subtracts charge for equity capital based on cost of equity. EVA subtracts charge for D and E based on WACC

Cannibalization factor? Formula for revenue loss due to cannibalization

One way for an analyst to model the introduction of new substitutes for a company's products is to estimate a cannibalization factor, the percentage of a new product's sales that are stolen from an existing product's sales. Revenue loss = (new product sales in units x cannibalization rate)x(average price of existing company product)

✔ PORTFOLIO MANAGEMENT 46: THE PORTFOLIO MNGT PROCESS ***Key to Curriculum*** In equity pricing which risk is priced? Which risk can be diversified away?

Only systematic risk is priced Unsystematic risk is diversified away

Keys to avoid confusion when comes to periodic pension cost and TPPC? (3)

Pension Expense 1. what is reported on IS 2.uses expected return rather than actual return 3. is computed differently under GAAP and IFRS TPPC 1.true economic reality of costs, includes what goes to OCI and what goes to IS 2. same for IFRS and GAAP 3. uses actual return on plan assets

(+) and (-) of P/E,P/B, P/S, and P/CF

P/E (+)earnings are primary determinant of inv. value - earnings have mngt discretion - volatile portion of earnings difficult to forecast P/B + BV usually positive + more stable than earnings so better when earnings are very high low or volatile + useful in company's that are expect. to go out of business - can be misleading comparing firms of very different sizes P/S (+)can be used for distressed firms since always positive unlike E and BV (+) sales are more difficult to distort than BV and E (+) used for mature companys, start up companys, cyclical companys, and investment mngt companies (-) sales do not indicate earnings or cash flow abilities (-) does not capture differences in cost structures (-) revenue recognition practices can distort sales (+) cf is harder to manipulate (+) more stable ratio than P/E (+) does not rely on quality of reported earnings (-) determining true cash flow can be difficult as EPS + NCC ignores non-cash revenue (-) FCFE may be better than CF to entire firm but FCFE is more volatile +++All three are proven by empirical evidence

Justified leading P/E? Justified trailing P/E?

P0/E1 = D1/E1/(r-g) = 1-b/r-g P0/E0 = D1/E0/r-g = (1-b)(1+g)/r-g **P0 is also V0

economics: Pure monetary model: ___ holds at any point in time, therefore an expansionary monetary policy results in what? (2) Dornbusch overshooting model: restrictive monetary policy leads to dep/app in short term and dep/app in the long term? portfolio balance model focuses on the longterm implications of what? and when govt. reuns a fiscal deficit what happenes?

PPP, increase in inflation, and a depreciation in home currency restrictive monetary policy leads to excessive appreciation of local currency in short term and then a slow depreciation of local currency in the long term sustained fiscal policy (deficit or surplus) on currency values. it borrowers money from investors and will lead to eventual depreciation of home currency

CDS: Cash settlement: payout amount?

Payout amount = payout ratio x notional principal payout ratio = 1 - recovery rate % RR % = mkt value of bond after default/par of bond

Calculating changes in Plan Assets and Projected Benefit Obligation? Describe the components of PBO? 1. current service cost 2. interest cost 3. past service cost 4. changes in actuarial assumptions 5. benefits paid

Plan assets: Beg Year Plan Assets + Contributions + Actual Return on Plan Assets - Benefits Paid = Fair Value of Plan Assets at Year End PBO: Beg PBO + service cost + interest cost + Past service cost (+losses/-gains) actuarial gains/losses during year - benefits paid = End of Year PBO Current Service cost - present value of benefits earned by employees during current period interest cost - increase in the obligation due to passage of time, it is the discount rate x obligation at the beginning of the period past service cost - retroactive benefits to employees when plan is initiated or amended, under IFRS these are expensed immediately and under GAAP they are amortized over average service life of employees Changes in Actuarial Assumptions - changes in assumptions that result in gains or losses, gain will decrease PBO, and loss will increase PBO Benefits paid - are the benefits paid to employees during period

The 3 steps of the portfolio management process: steps in the 1st step? (4)

Planning, Execution, Feedback 1. analyzing objectives and constraints 2. developing an IPS 3. determining the appropriate investment strategy 4. selecting an appropriate asset allocation.

Positive serial correlation vs negative serial correlation?

Positive regression error in one time period increases probability of a positive error in the next period Positive regression error in one period increases the probability of a negative regression error in the next period

✔ 44 ALTERNATIVE INVESTMENTS: Post money value? Pre-money value? Shares issued to VC firm? price per share?

Post money value = PV of exit value Pre-money value = Post-money value - investment (1) fraction of company value that inv. represents f = Investment/Post-Money Value (2) SHARESvc = founder's shares x (f/1-f) price per share = investment/SHARESvc

R2 in simple linear regression?

R2 in simple linear regression is simply the squared correlation coefficient, R^2 = r^2

Formula to forecast RI?

RI = EPS(t) - (r*B(t-1) = (ROE - r) x B(t-1) B is bv per share

Characteristics of both P&C, and Life insurance companies? What are the two source of earnings for insurance companies? 2 key differences bw P&C and Life insurance companies?

Premium income is 1st key source of investment income and investment returns is second. Premium income and Income on Float (investment income) P&C have shorter contract periods (policy periods), lumpier claims (less predictable/less stable claims)

✔ 34. FIXED INCOME - TERM STRUCTURE AND INTEREST RATE DYNAMICS Discount Factor? Formula? Term structure of spot rates?

Price today of $1 par zero coupon bond is known as discount factor = PT P(T) = 1/(1+spot)^T spot rate ST vs maturity T is the "spot curve"

PEG ratio interpretation?

Price-Earnings Ratio/Earnings Growth Rate (%) stocks with lower PEG are more attractive

Quoted futures price?

QFP = FP/CF = [(full price)x(1+Rf)^T) - AI - FVC]x(1/CF) FP = futures price full price = clean price + accrued interest at t = 0 AIT = accrued interest at future contract maturity

✔ 32 EQUITY: RESIDUAL INCOME VALUATION Residual income? (economic profit) Rationale?

RI = NI - equity charge. where eq charge = cost of equity x equity capital (+) recognizes that NI may be enough to cover cost of debt which is included in NI but not enough for cost of equity which is not included in NI calculation

Extended DuPont Equation? Adjust the ratios for investment in associate? (assuming use of the equity method) (2 changes to make)

ROE = (NI/EBT)x(EBT/EBIT)x(EBIT/Sales)x(Sales/Asset)x(Asset/Eqty) or (tax burden)x(int. burden)x(EBITmargin)x(Aset TO)x(Fin Lvg) 1. adjust asset base = total assets - investments in associates on BS 2. adjusted NI = NI - NI from associates 2 ratios are impacted in Extended DuPont - 1. Adjusted Tax Burden = adjusted NI/EBT 2. Adjusted Asset TO = Sales/[beg adjusted asset base+ending adjusted asset base/(2)] **Do not adjust financial leverage ratio

CAPM formula? Multifactor model formula?

RR = RFR + (ERPxBeta) where ERP is expected return - risk free rate required return = RFR + (risk premium)1 + ... + (risk premium)n where risk premium = factor risk premiumxfactor sensitivity(which is equivelant to a beta)

IPS investment obj and constraints? (7) what is considered long time horizon? which two investor types are tax exempt? who is and isn't usually affected by legal constraints? what is institutional investor?

RRTTLLU -- Risk Return Tax Time Liquidity Legal/Regulatory, and Unique over 10 years pension funds (DBP or DCP) and endowment funds Trust/institutional have significant legal constraints especially with New Prudent Investor Rule. Individual investors do not large enough quantities of trades that they receive lower commissions (endowment funds, mutual funds, hedge funds, pension funds)

COGS formula?

Raw materials + Direct labor + overhead in producing goods

✔ 39-41 DERIVATIVES Put Call Parity

S0 + PO = CO + PV(X) P + Se^-yT = C0 + e^-rTX

swap fixed rate? (formula) swap fixed rate payments? Value of swap after initiation?

SFR periodic = 1 - final discount factor / sum of discount factors SFR annual = SFR periodic x number of settlement periods per year where discount factors Z, Z = 1 / (1+(LIBORxdays/360) *the LIBOR used in the discount factors is the LIBOR for that maturity are the annualized LIBOR rates, which is why you must multiply by days/360 SFR periodic x notional principal Value to payer = ∑Z's x (SFRold - SFRnew)*(days bw payments per year/360)*notional principal **Z's remaining so if 3 semiannual pmts remain than the Z's for 180 days, 360 days, and 540 days

Estimate Sustainable growth rate? (2 ways)

SGR = b*ROE or SGR = NI-dividends/NI x NI/sales x sales/assets x financial leverage or PRAT where retention ratio is R, profit margin P, asset turnover is A, and financial leverage is T This is the same as the first formula except this is the decomposition of ROE, multiplied by b

A/R Turnover? Days Sales Outstanding? Inv TO? Inventory days?

Sales/Average A/R =365/ AR TO =COGS/Av inventory =365/Inv TO

issuer rating on company is based on which type of bond?

Senior unsecured debt

How to calculate the predicted value with a linear trend model? How to calculate predicted value for log-linear model?

Simply replace t with the time period. So for y=1.7 + 3t, if t=1, y1=4.7 and y2=7.7 replace t with the number of the period. Then for ln(yt) = bo +b1t, convert the natural log of the forecast into the actual value. So take the number and then "2nd" "ex" on calculator

How are straight, call, and putable bonds related to interest rate volatility?

Straight bonds are unaffected by changes in volatility of interest rates Call options are positively related to interest rate volatility, so volatility increases, the call option increases, and the value of the callable bond decreases Put options are also positively related to interest rate volatility, so vol. increases, put option increases in value, and the putable bond increases in value

8.MULTIPLE REGRESSION: How do you perform test about regression coefficient in multiple regression? How do you do this using p-value?

T-test, using ^b - bi / Sd = estimated regression coefficient/standard error of regression coeff CV from degrees of freedom of n - k - 1 if the t-stat is outside the CVs than we can reject null H0 that b1 = 0 and conclude that coefficient is significant *good if the p-value for the coefficient is less than level of sign. that reject null that b1=0 **small p-value is good

TED Spread? How to use TED Spread?

TED spread = (3-month LIBOR rate) - (3-month T-bill rate) combines the T-bill with "ED" (the ticker symbol for Eurodollar futures contract) Is is seen as an indication of the risk of interbank loans because t-bills are risk-free while LIBOR reflects the risk of lending to commercial banks. -It is an indicator of perceived credit risk in the general economy -It reflects more accurately the risk in the banking system compared to the swap spread **remember formula is backwards from the acronym T-ED spread = ED - T

when lease rate differs from market use: term and reversion approach? layer method?

TERM AND REVERSION APPROACH when the contract (term) rent is different than mkt rent, you must adjust for this as the current rent will likely adjust to the mkt rent when the leases are up for renewal. *we are usually talking about a contract rent that is below market rent and in this case the discount rate used to find PV of term rent payments is lower as we discount future contract rent payments less since they are less likely default since they are below market rent *Estimated Rental Value (AKA ERV) is the market rent Total value = PV of term rent + PV of reversion to ERV where PV of term rent = PV of lease payments til end of contract discounted at a lower discount rate where PV of reversion to ERV = (1) TV at end of contract = market rent/ERV cap rate (2) discount the TV to present based on ERV cap rate LAYER METHOD value = PV of term rent + PV of incremental rent where PV of term rent = term rent/term cap rate where PV of incremental rent (1) TV of incremental rent= (ERV rent - term rent)/ERV cap rate (2) PV of incremental rent discounted to present using ERV cap rate

CF: Terminal year after-tax non-operating cash flow (TNOCF)?

TNOCF = SalT + NWCInv − T (SalT − BT) where: SalT = cash proceeds from sale of fixed capital BT = book value of fixed capital

TV based on fundamentals? TV based on comparables?

TV = justified leading P/Ex(forecasted earnings in year n+1) *or substitute trailing for leading and use earnings in year n. same applies below. TV = benchmark leading P/E x (forecasted earnings n+1)

What are the two methods used for remeasuring/translating the foreign sub's FS to the parents?

Temporal method or Remeasurement-converting the local currency into the functional currency under the temporal method Current Rate Method or Translation-converting the functional currency into the presentation currency using the current rate method

draw the current rate method versus temporal rate method table for what rates to use for BS and IS accounts? Also what are the exposures to sub's currency? and where does exchange rate gain or loss go?

Temporal: Exposure-net monetary assets(if sub has net mon assets=parent has loss if local (foreign) currency depreciates gains and losses go to IS Current Rate Method: Exposure-net assets(if sub has net assets=parent has loss if local(foreign) currency depreciates

Who determines if a credit event has occurred? 2 ways for settlement in the event of credit event? which is more common?

The Determinations Committee is a 15 member committee of the ISDA (international swaps and derivatives), requires a supermajority vote of 12 to declare a credit event Cash and physical, cash settlement is more common

1. narrowly addresses the social responsibility of business and concludes that the only social responsibility is to increase profits "within the rules of the game," meaning through "open and fair competition without deception or fraud." 2. argues that business must weigh the consequences of each of their actions to society and seek to produce the highest good for the largest number of people. 3. argues that people are different from other factors of production; they are more than just an economic input and deserve dignity and respect. 4. argues that all individuals have fundamental rights and privileges. The greatest good of utilitarianism cannot come in violation of these fundamental rights of others. 5. focus on a just distribution of economic output. John Rawls argued that justice is met if all participants would agree the rules are fair if the results would be acceptable when decided under a "veil of ignorance."

The Friedman Doctrine Utilitarianism Kantian ethics Rights theory Justice theories

Main Difference between GAAP and IFRS with total periodic pension cost?

The TPPC calculation is the same either way. Main difference is how TPPC is allocated to the income statement (periodic pension cost) and to OCI. Hence, total periodic pension cost = periodic pension cost in P&L + periodic pension cost in OCI

Build-Up Method

Usually applied to closely held companies (private companies) where betas are not obtainable. Required return = risk free rate + factor premiums. (no beta!) Uses historical data. specifically RR = RFR + ERP + size premium + specific company premium

Define the binomial interest rate tree framework? (what type of model?) 3 assumptions in model? 2 desirable traits?

The binomial interest rate tree framework is a lognormal random walk model with two equally likely outcomes for one-period forward rates at each node. A volatility assumption drives the spread of the nodes in the tree. The tree is calibrated such that (1) the values of benchmark bonds using the tree are equal to the bonds' market prices, (2) adjacent forward rates at any nodal period are two standard deviations apart, and (3) the midpoint for each nodal period is approximately equal to the implied one-period forward rate for that period. 1. higher volatility at higher rates 2. non-negative interest rates

Equity: Macroeconomic multifactor models? (specifically the Burmeister Roll and ROss model) what are the 5 factors with this model.

Utilizes factors associated with economic variables such as: Confidence risk, time horizon risk, inflation risk, business cycle risk, mkt timing risk =t-bill rate + (conf risk x confidence risk premium) + do this for the other 4

What are the key differences in financial ratios depending on use of temporal or current rate method?

The impact exchange rates have on the parent's financial ratios is only clear for current rate method, for temporal rate method it depends.

Multistage RI formula? PV of continuing RI in yr T-1?

V0 = B0 + PV of high growth RI + PV of continuing RI = RI(t)/(1+r-w)

✔ PORTFOLIO MANAGEMENT 48: MEASURING AND MANAGING MARKET RISK monthly 5% VAR of 25,000 means? (2) or as a CI?

There is a 5% prob. that company experiences $25,000 loss or more in any given month OR 5% of the time the minimum monthly loss is $25,000 **can also be stated as a percentage of the portfolio 5% prob. company experiences 3% loss in any given month 95% of the time the portfolio loss will be no more than $25,000

Bond yield plus risk premium approach

This is a build up method for a company with publically traded debt. logic here is that the companys debt already factors in risks relating to inflation leverage and senstivity to business cycle cost of equity = Bond yield + Risk Premium

Trailing Dividend Yield? Leading Dividend Yield? Justified Dividend Yield?

Trailing D/P = (4 x recent quarterly div)/market price per share Leading D/P = forecasted div per share next year/ current price D0/P0 = r-g/1+g

RI valuation model? single stage RI valuation model? implied growth rate in RI model? contrast to DDM?

V0 = B0 + RI(1)/1+r ...... ***current book value of equity + PV of expected future RIs V0 = B0 + [(ROE-r)*(B0)/(r-g)] g = r - B0x(ROE-r)/V0-B0 value is rec. earlier in RI approach b/c RI model includes current BCV which represents a large amount of estimated value with less forecast error than TV

P&C Company Ratios 1. UW loss ratio? 2. Expense Ratio? 3. Combined Ratio?

UW Loss Ratio = claims paid + change in loss reserves/(net premium EARNED) expense ratio = uw expenses including commissions/(net premium WRITTEN) Sum of these two ratios

Neoclassical Growth Theory

also G* is also = G* + ∆L

What do you record on Balance Sheet for DBP?

Under both GAAP and IFRS you record the funded status of the plan. Funded Status of Plan = fair value of Plan Assets - the Projected Benefit Obligation. If funded status is negative you report a liability, if positive you report an asset

How do you calculate the CTA?

Under the current rate method, the CTA is a plug value in the account equation to balance it. first calculate the ending balance of retained earnings using beg balance of RE, net income for the period and dividends paid, then balance the equation and solve for CTA <-this is calculating the cumulative amount of translation gains and losses, to calculate the amount of CTA for the period, we would need to know the beg balance of CTA =Assets - Liabilities - Common Stock - Retained Earnings

Gordon Growth Model formula? Assumptions in GGM model? (2) limitations of GGM (3)

V0 = D0(1+g)/r-g = D1/r-g dividends grow indef. at constant rate And g is less than r 1 Valuations are very sensitive to estimates of r and g. 2 The model assumes that the firm is paying dividends now, or will be during the foreseeable future. 3 Unpredictable growth patterns from some firms make using the model difficult.

PVGO formula? How/why use formula? Use PVGO to determine amount of leading P/E attributable to growth opportunies?

V0 = E1/r +PVGO plug in the current mkt price as V0 and calculate the PVGO implied by price, a large PVGO implies a high expected growth P/E implied by PVGO divided by leading P/E is the % of leading P/E attributable to growth opportunities

advantages and limitations of VAR, sensitivity, and scenario analysis

VaR provides a prob. of loss. sensitivity provides exposure to risk factors but not probabilities. scenario provides information about simultanious changes to risk factors but also does not provide prob. of scenario

Value of embedded call option? (to issuer) Value of embedded put option?

Value of call option = value of straight bond - value of callable bond Value of put option = value putable bond - value of straight bond

Private Company Valuation: Formula for Capitalized CF to the firm? and to equity? Excess earnings method?

Value to firm = FCFF(1)/(WACC-g) Value of equity = V - MV of debt or FCFE/(r-g) RI = Normalized earnings - (RR on WC x value of WC) + (RR on fixed assets x value of fixed assets)

What is best measure of portfolio or index P/E (and other price multiples)? How is it calculated for a portfolio? What if there are extreme high or low values?

Weighted harmonic mean where weight is price(i) divided by sum of prices which is numerator, and denominator is P/E the arithmetic mean will be most impacted by outliers. In this case, best calculation is weighted harmonic mean with outliers removed.

justified P/S?

[Net profit margin x payout ratio x (1+g)]/ r-g = (E0/S0) x (1-b) x (1+g)/(r-g) = net profit margin x justified trailing P/E # like trailing P/E except net profit margin is included here

Accounting for share based compensation IFRS vs GAAP? Specifically, how do you do accounting for stock options? What is the result? How to determine value? Next, what are the 6 inputs used for options pricing models? and how do the assumptions affect value?

accounting for share based compensation is similar under GAAP and IFRS compensation expense related to stock option plans on the IS based on the options value at issuance. This can sig. decrease reported earnings. (compensation expense is based on the fair value of the options on the grant date based on the # of options expected to vest. The vesting date is the first day the employee can exercise the options. (comp exp. will decrease NI, decrease RE, but leave equity unchanged as paid-in capital increases by amount of compensation expense. fair value of an option is based on similar options at market price, however these are rarely available since these are customized options, use opotions valuation model, either Black Scholes or Binomial Model, there is no preference under GAAP or IFRS The 6 inputs are exercise price, stock price at grant date, expected term, expected volatility, expected dividends, and risk-free rate... Lower volatility, shorter-term, lower riskfree rate, or higher expected dividend yield will decrease fair value and therefore comp. expense

4 - Duties to Employers-(A) Loyalty Rule? Guidance? (3) Guidance - independent practice (2) Guidance - Leaving employer? (5) Guidance - whistleblowing? (2)

act on benefit of employer over your self, do not deprive employer of your skills and abilities, divulge confidential information, or otherwise harm employer (1) place client interest first but consider effects on firm integrity and sustainability (2) no requirement to put employer interests ahead of family and other personal obligations (3) if you do have influence on compensation make sure you are not encouraging unethical behavior Independent practice (1) plan to have ind. practice on your own time, you must notify employer of services, compensation, and duration (2) must be sure employer is fully informed prior to independent practice Leaving employer (1) act in best interest of employer until resign. is effective (2) employer records on any medium are property of the firm (3) Once an employee has left a firm, simple knowledge of names and existence of former clients is generally not confidential - but you can't solicit prior to leaving (4) once you separate from service, you can contact former clients based on knowing their names or numbers (5) you get to keep skills developed from employer like if employer paid for your CFA (1) only permitted if it protects clients or capital markets in general (2) CANNOT be done for personal gain like interviews on Today Show

adjacent and non-adjacent forward rates in binomial tree framework? if one year forward rate up is 5.7883% and down is unknown, how do you find the 1 year forward rate down scenario? assuming volatility of 20%?

adjacent forwares are 2 sd apart (i1L and i1U) and non-adjacent forward rates are a multiple of 2 sd apart (i2LL and i2UU) 5.7883 x e^(-2)(.20) **These are adjacent forward rates so 2 standard deviation is where you get the 2 and .20 is for 20% volatility. Solve by (-.4) -> 2nd LN -> times 5.7883 = 3.88% is the 1 year forward rate in year 1 with rates down scenario.

Adjusting real estate for private company?

adjust company owned real estate by removing expenses and revenue from real estate from income statement, and replacing it with a rental cost for the real estate, and then the market based value of real estate is added to the value

applying the current rate method?

all income statement accounts are translated using average exchange rates, all BS are translated using the current exchange rates except common stock which uses the historical rate Dividends are translated at the historical rate when they were issued. Translation gains and losses are reported in SE as part of Cumulative Translation Adjustment (CTA) not in the INCOME STATEMENT!

Forward rate? explain f(j,k)

annualized interest rate on a loan to be initiated at a future period is the forward rate for that period. k-year loan, starting in j years (years out, term of loan) and matures in j+k years

PM - 3 types of multifactor models 1. macroeconomic factor models? (explain what this model generally does)

assumes asset returns are explained by surprises in macro. econ risk factors, the return is explained by the unexpected part of the economic variable (realized value of factor - expected consensus value of factor) (ie retail stores are more sens. to GDP than a grocery store)

Modern term structure models? what are the two main types? and what are the specific models under these types/

atempt to capture statistical prop of ir movemnets and precidt how rates will change. equilbrium models 1. cox ingersoll ross (CIR) - based on idea that rate movements are driven by individuals choosing bw consumptoin today vs investing and saving. model says volotility is higher at higher interest rates 2. vasicek model - similar but voltility does not increase with rates. Arbitrage free models - Ho Lee Momdel - assumes that changes in yc are consistent with no arbirateg condition, model produces a normal dist. of future rates and generates the curetn term structure.

Regression Coefficient Confidence Interval?

b1 +/- (tc x Sb1) degrees of freedom is (n-2) Used to test H0: b1 = 0 if 0 is not within CI, reject the null *as Sb1 increases ,the CI increases, and it is more likely that the null cannot be rejected

Basis trade? synthetic CDO? Formula?

basis trade takes advantage of mispricing bw bond and CDS mkt. If bond yield is higher than CDS yield over the benchmark, buy bond and buy CDS, expecting the spread to converge uses CDS's to create a similar risk as buying CDO. if synthetic CDO can be created at lower cost than buying CDO, a profitable arb. opportunity exists. Do this by buying/creating synthetic CDO and selling cash CDO. =portfolio of default-free securities + CDS

what is beta? How to get beta for publically traded company? How to adjust beta for publically traded company? Why?

beta is measure of Systematic risk from holding the security A regression of the returns of a publicly-traded company's stock returns on the returns of an index provides an estimate of beta. For forecasting required returns using the CAPM, an analyst may wish to adjust for beta drift using the Blume method: adjusted beta = (2/3)×(regression beta) + (1/3)×(1.0) adjust beta for "beta drift" beta tends to revert closer to 1, adj beta calculates a value that is closer to 1 than unadjusted beta

fundamental law of active portfolio management limitations?

bias in measurement of ex-ante information coefficient and lack of true independence while measuring the breadth of an active strategy

Examples of revenue recognition issue? red flags? example of expense recognition issue? red flags?

bill and hold sales. Channel stuffing. red flags 1. growth rate of rec > growth rate of revenue. 2. increasing DSO over time under report an operating expense by capitalizing it. Red flags 1. proportion of PP&E increases over time 2. revenue is increasing and asset turnover is decreasing

CRE has bondlike and equity like characteristics. Why?

bond like bc they have stable income stream, quality of tenants is credit risk, and terminal value at the end of the lease term and equity like bc future value is unknown and value is cyclical like equity

4 - Duties to Employers-(B) Additional Compensation Rule?

cannot accept compensation including gifts benefits compensation or consideration that may create a conflict of interest bw you and your employer - unless you provide written consent by all parties *email counts as written (like serving on board with annual retreat in Bahamas or quarterly stipend) --you can accept work even if it competes with your employer if they consent to it

1. Quick ratio? 2. Cash Ratio? 3. Defensive interval ratio? 4. Cash Generated From Operations? (CGO)

cash + ST mark. sec + A/R / curr. liab. cash + ST mark sec / curr. liab cash + st mark sec + A/R / daily cash expenditures = operating cf + cash interest + cash taxes = EBIT + noncash charges - increase in working capital

Change in price from change in spread on bond from change in the credit rating?

change in price % = -(mod dur) x (change in spread)

Classification issues vs measurement and timing issues?

classification issues usually affect one element of financial statement vs multiple

3 components of analysis of securitized debt? Collateral pool - how to analyze short-term granular and homogenous? Medium-term granular and homogenous? Non-granular and heterogeneous? Examples of internal enhancements? external enhancements? covered bond?

collateral pool, servicer quality, and structure Statistical approach on book of loans, portfolio based approach as characteristics change over time, loan by loan internal: 1. tranching of credit risk with diff. seniority (waterfall) 2. overcollaterization 3. excess servicing spread - additional return built in that is greater than exp. losses external - third party guarantee by a bank or insurance company covered bond - special structure of security that would be issued by a bank, they are senior secured bonds backed by collateral pool and by the issuer (investors have recourse) common forms are residential mortgages and public sector.

Accounting for stock grants? 3 potential types of stock grants? Other share based compensation-what is stock appreciation rights(2 advantages and 1 disadvantage) and what is phantom stock?

compensation expense for a stock grant is the fair value of the stock on the grant date, which is generally the market price of the stock on the grant date. The expense is spread over the service period. a stock grant can involve a 1. outright transfer of stock without conditions 2. restricted stock grant which cannot be sold by employee until vesting date 3. performance stock contingent on performance metrics such as earnings, ROA, or ROE (however, this one can have unintended consequence of incentizing mngt to manipulate accounting) stock appreciation rights- the diff bw stock appreciation rights and stock option is the form of pmt. stock appreciation gives employee right to compensation based on the increase in the firm's stock over a predetermined amount. And the employee does not actually hold the shares. Advantages are that the risk aversion problem is less existent than options and stock grants since employee has limited downside risk. Also advantage is that it does not dilute shares of existing shareholders. Disadvantage is that it requires current period cash outlays. Phantom stock is similar to stock appreciation rights except it is based on hypothetical stock price instead of actual shares. It is used by private companys with illiquid shares of stock

3 qualities of high quality BS reporting? Completeness of BS may be comprised by existence of ___. Biased measurement may be present in the measurement of ___, ___, ____, ___, and ___. (5)

completeness, unbiased measurement, clarity Off BS liabilities Pension obligations, goodwill, investments, inventory, and other assets

The Fed Model? (*hint not a formula) The Yardeni Model? Yardeni model formula?

considers the overall market to be overvalued (undervalued) when the earnings yield (i.e the e/p ratio) on the S&P 500 index is lower (higher) than the yield on 10 year US treasury bonds. Yardeni model expands analysis to include expect. earnings growth rate P/E = 1/(CBY - K*LTEG) where CBY is current A rated corp bond yield, LTEG is 5 year consensus earnings growth rate, and K is constant assigned by market to earnings growth which is around 0.20

Joint Ventures?

control is shared by 2 or more investors. IFRS and GAAP require equity method. in rare cases, IFRS and GAAP allow proportionate consolidation instead of equity method

covered call and protective put delta

covered call delta = delta of stock − delta of call option = 1 − ∆c protective put delta = delta of stock + delta of put option = 1 + ∆p

✔ FIXED INCOME 38: CREDIT DEFAULT SWAPS: Explain a CDS? What are the common coupon rates? payments?

credit protection buyers pays the seller to obtain the coverage, the credit protection buyer pays the seller a premium called the CDS spread. For investment grade 1%, for high-yield securities 5% Since coupon rates (premiums) usually differ from the credit spread, one party pays the other the difference bw the credit spread and the coupon on the CDS upfront at origination. So if investment grade and credit spread is 0.75%, than buyer pays 1%, and seller pays buyer the present value of 0.25% of the notional principal upfront.

explain value of CDS to buyer and seller after inception? profit for protection buyer?

credit spread widens than buyer profits. credit spread declines than profit to seller as they locked into higher spread payments from buyer = change in spread x duration x notional principal or %=change in spread % x duration

credit spreads relation to business cycle? and compare this to higher vs lower rated bonds? spreads increase significantly for cyclical or non-cyclical company's? consumption hedging property and equities?

credit spreads narrow in good times and widen in bad times higher rated bonds yields increase less in downturn than lower rated bonds, therefore price decreases less and they outperform lower rated when economy downturns cyclical spreads increase sign. in downturns (durable goods manufacturers, and consumer discretionary) compared to non-cyclical (consumer non-discretionary) consumption hedging property is assets that perform well in economic downturns, equities are usually very cyclical so they do not have consumption hedging property

Define the three exchange rates used in translation/remeasurements?

current rate = exchange rate on the BS date average rate= average exchange rate over the reporting period historical rate=actual rate that was in effect when the transaction occurred

✔ 18. FINANCIAL REPORTING: EVALUATING QUALITY OF FINANCIAL REPORTS High quality reporting provides ___, which is_____. High Quality Earnings refers to ____ and _____, low quality earnings are from ____ A company cannot have ____ and ____. But they can have ___ and _____.

decision useful information, which is accurate and relevant sustainable earnings and good return on investment. genuine bad performance or low quality of reporting (does not represent economic performance) poor quality reporting and high quality earnings, however they can have high quality reporting and low quality earnings

VI Conflicts of Interest VI(A) Disclosure of Conflicts Rule? Guidance? (5)

disclose to clients, prospects , and employers all matters that could reasonably impair indep. and objectivity **focus is clients** such disclosures must be PROMINENT (not tiny font or buried in the report), are delivered in PLAIN LANGUAGE (not legal jargon), and communicate the relevant information. --although this does not mean your free from standards like duties to clients TO CLIENTS: (1) all matters that could impair objectivity and allow clients to decide if they are ok with using you (2) this could be bw you and the firm, or you and the stock issuer, or others TO EMPLOYERS: (1) own stock in a company you analyze or sit on board a company you analyze (2) or any other pressures, such as family has stake in a firm that you analyze (3) or a position or situation that could damage your firm's reputation if made public

Disclosure requirements for foreign currency measurement?

disclosure requirements are limited. if there is information on specific exposures and translation method used, it is found in the footnotes and the MD&A.

effects of multicollinearity?

distors the SEE. and the standard errors of the coefficients. the result is 1. the coefficients are unreliable 2. the SE of the coefficients are too high 3. the likelihood of a type 2 error is greater.

✔ 29 EQUITY: DISCOUNTED DIVIDEND VALUATION What are the 3 definitions of future cash flows in stock valuation?

dividends, free cash flow, and residual income

✔ 26 EQUITY: EQUITY VALUATION - Intrinsic value mispricing framework and formula?

divides mispricing perceived by analyst into two sources 1. difference b/w mkt price and IV (actual mispricing) and 2. analyst estimate of IV versus actual IV (valuation error) IV(analyst) - price = [IV(actual) - price] + [IV(analyst) - IV(actual)]

5 common accounting issues when using RI include: 1. clean surplus - explain? 2. variations from fair value - explain adjustments? 3. intangible asset effects - explain? 4. Non-recurring items and aggressive accounting practices 5. international accounting differences

doesn't hold when there are items that go straight to equity and not NI, like OCI gains and losses on AFS's. We must adjust NI unless these items are expected to reverse and net to zero bv's may be different than mkt value - common adj include 1. operating leases 2. SPE's 3. Allowances 4. inventory under LIFO should be changed to current value of inventory 5. pension asset or liability should be adjusted to funded status of plan 6. deferred tax liab. should be added to equity 1. amort. of goodwill reduces ROE 2. long term productivity of R&D expenses should be reflected in ROE

Cox-Ingersoll-Ross (CIR) model? Vasicek Model? Ho-Lee model?

dr = a(b - r) dt + σ √𝑟*𝑑𝑧 where dr = change in short-term rate, a = speed of mean reversion parameter, b = longrun value of the shortterm interest rate, dt = small increase in time, and dz a small random walk movement **assumes the economy has natural long run rate b that it converges to dr=a(b-r)*dt + σ*dz **no r in the second term so volatility does not increase with the level of interest rates **volatility is independent of the level of short term interest rates dr = θt*dt + σ*dz **arbitrage free model

Analytical issues for investments in associates?

due to the use of the equity method, investor has higher earnings than the if it was accounted for as a passive investment *as long as dividend is less than 100%. Analyst should determine whether they actually have influence or if they just want to report the higher earnings. Investors leverage is lower using equity method due to investor only reported one line item in equity rather than assets and liabilities of investee. Margin ratios are higher since investor shows the income but not the revenue from investee

Earnings yield?

earnings per share / market price per share inverse of P/E ratio

CF: economic income?

economic income = after-tax cash flow − economic depreciation where: economic depreciation = (beginning market value − ending market value)

What is effective tax rate. What is statutory tax rate? Accounting standards requirements? Describe how multinational operations affect a companys effective tax rate?

eff tax rate is the tax expenses on the IS divided by pretax profit statutory tax rate is provided by tax code of the home country Require a reconciliation b/w statutory tax rate and effective tax rate effective tax rate can change due to changes in the mix of profits from various countries or a change in the actual tax rates

effective duration of callable, putable, zero-coupon, fixed coupon, and floater? Change in rates effect on duration of straight, putable, and callable?

eff. duration (callable/putable) ≤ effective duration straight eff. duration zero coupon ≈ maturity eff. duration (fixed rate coupon) < maturity eff duration floater ≈ time to next reset change in rates (straight) = duration unaffected. increase in rates (putable) = duration decreases decrease in rates (callable) = duration decreases

What is benefit of one sided durations? When at or near the money: Callable bonds are more sensitive to rates up or down?Putable bonds are more sensitive to rates up or down?

effective duration relies on equal parallel shifts in yc so good for small changes in yield curve (or of course for option free bonds) but better than modified duration --for bonds with options one sided durations are better than effective duration when at or near money: callable bonds are more sensitive to rates up (price goes down more for increase in rates than the price goes up for decrease in rates) putable bonds are more sensitive to rates down (price goes up more for rates down than price goes down for up rates)

Investors with above average risk tolerance? (1) Investors with below average risk tol? (2) Investors that risk tolerance depends on specific factors? (3)

endowment life insurance, non-life insurance individual, Pensions (DCP or DBP), bank

Impairment test for equity method investments (GAAP and IFRS)

equity method investments must be tested for impairment. GAAP: if FV < CV and is considered Other Than Temporary the inv. is written down to fv and loss is recognized on IS. IFRS: recognized if one or more loss events occurred. ****Under GAAP and IFRS, the asset cannot be written up if value is recovered.

✔ PORTFOLIO MANAGEMENT 51: ALGORITHMIC TRADING AND HIGH-FREQUENCY TRADING describe the two types of trading algorithms?

execution algorithms - execute large orders with minimal price impact (primarily used for large buy orders executed into smaller pieces High-Frequency Trading - analyze real time market data for patterns and hold securities for a short time such as less than a day and sometimes less than a second

Formula for stable dividend policy moving towards target dividend payout?

expected increase in dividends = [(expected earnings × target payout ratio) - previous dividend] × adjustment factor where: adjustment factor = 1 / number of years over which the adjustment in dividends will take place **so you add this to the previous year dividend for next years dividend. The dividend p/o ratio may actually decrease, which seems counter intuitive but should work over long-run

Asset based approach to private company valuation: what is it? 2 facts? when to use it? (5)

fair value of assets - liabilities 1. used when company is not a going concern, income and mkt approaches are preferred if company is going concern 2. usually results in the lowest value of the 3 approaches 1. firm has minimal profits 2. for a bank or financial firm 3. REITs 4. comanys with few intangilbe asssets 5. nautial resource firms

Definition of Defined Benefit Plan?

firm promises to make periodic pmts to employee after retirement. The benefit is usually based on employee's compensation at retirement and years of service

How does first differencing work?

first differencing is the process of subtracting the value of the timeseries (THE DEPENDENT VARIABLE) in the prior period from the current value to create a new dependent variable, y. The process is modeling the change in the dependent variable the result is that b0 is now 0 and b1 is now 0, and the result is that the mean reverting level is 0 rather than undefined and the series is covariance stationary

currency swap fixed rate for $ receiver? (periodic) and annual? payments received for $ receiver? value after initiation to dollar receiver?

fixed rate periodic (% received in $)= 1 - final discount factor / sum of discount factors fixed rate annual (received in $)= SFR periodic x number of settlement periods per year where discount factors Z, Z = 1 / (1+(LIBORxdays/360) *using $ interest rates *the LIBOR used in the discount factors is the LIBOR for that maturity are the annualized LIBOR rates, which is why you must multiply by days/360 notional principal on the swap is just the amount that makes the two currencies equal based on current exchange rate so if euro .5 per $1 than exchange $5mm and 2.5 euro payments received in dollars = fixed rate periodic x notional $ value after initiation (1) par + remaining fixed payment in $ x discount factor for remaining days to maturity -- if 60 days remain, 1/(1 +(rate x 60/360) (2) calculate the present value of the euro side using same steps in 1 (3) convert the euro value into dollars, and receive dollar PV - receive euro PV (in $) = value of receive dollar side

I Spread?

for a credit risky bond is the amount by twhich the yield on the bond exceeds the swap rate for the same matuirty. if the swap rate for a specific maturity is unavailable the missing swap rate can be detemined using linear interpolation hence the I in I spread

Explain issues associated with accounting for share based compensation?

for share grants, if the stock is not publically traded, you must estimate a value. And for stock options, if they are not market available you must estimate value using options pricing model If shares are granted with contingencies such as employee cannot sell them for a period of time, then the expense must be spread across the time from the grant date to the available sell date, AKA the service period

Definitions of value: Fair mkt value? Fair value for financial reporting? Fair value for litigation? mkt value? investment value? intrinsic value?

for tax purposes - cash price char. by hypothetical willing and able buyer/seller or arms length trans. or well informed buyer and seller current price paid to transfer liability or purchase asset (also arms length and well informed B and S) depends on state and legal precedent for RE and real assets - arms length well informed B and S, asset has been marketed value to particular buyer (cf estimates, risk, financing costs, synergies) mkt value once others arrive at "true value"

Information Ratio? what does the number mean? sharpe ratio?

higher IR means higher return per unit of risk Rp-Rf/sd of portfolio -- similar to IR but uses rfr instead of benchmark and uses asset sd instead of active return sd

describe foreign currency transaction exposure? for example, us firm sells goods to com in Italy for 10,000 euro when spot is $1.60. pmt due in 30 days, euro depreciated to 1.50 on pmt date? What if the BS date is before the payment date? Reporting requirements of transaction gains and losses?

foreign currency transactions including sales are measured in the reporting currency at the spot rate on the transaction date. foreign currency risk arises when transaction date and the pmt date differ US firm recognizes the sale on the transaction date by recording revenue of $16,000 and A/R of $16,000. On the payment date, the firm actually converts to $15,000 and records a loss of $1,000 on income statement. If instead euro had appreciated, they would have recognized a gain. the exchange rate is based on the BS date and an unrealized gain or loss is recognized on the IS. IFRS and GAAP require them to be reported on income statement, however, they do not specify whether to be in operating or non-operating. Both require disclosures of amounts of transaction gains and losses that are on income statement

forward price formula?

forward price is big F

REIT Valuation: Price to AFFO approach

funds from operations (FFO) − non-cash rents − recurring maintenance-type capital expenditures = AFFO ÷ shares outstanding = AFFO / share × property subsector average P/AFFO multiple = NAV / share

Economics: solving triangular arbitrage?

given three currencies simply use the rule "up-the-bid-and-multiply" and "down-the-ask-and-divide" Solve by starting with currency given and go around the triangle to see if you have more than what you started with. Do this for both possible triangle paths, if either is more than you started with than you have arbitrage profit

Investment in Associate: goodwill recorded for investee? investors income from investment in investee? and carrying value of investment?

goodwill=purchase price - pro rata share of bv of net assets + excess fv of equipment or land. where pro rata share of bv of net assets is what the net assets are worth in book value (so if buying 30% of company, 30% of bv of net assets) and the plant and equipment reduction is % ownership x diff. bw bv and fv of equipment or land Investors share of income for the year = share of net income less depreciation from share of equipment Balance sheet value = purchase price + share of income (calculated above) - Div. received Alternatively, beg net assets +net income - dividends paid =ending net assets Then find proportionate share of recorded net assets (ending net assets x ownership) + unamortized excess PP (excess PP - amount attributable to PP&E) =investment in investee

Investor will always choose manager with what?

highest information ratio regardless of risk aversion

How to determine if Economies of scale are present?

if average cost goes down as industry sales go up = EOS exists if COGS% to sales are lower for larger company = EOS present in COGS if SG&A are lower as % sales for larger company = EOS exist

General treatment and accounting of impairments of financial assets?

if carrying value is greater than the fv of the financial asset, it is impaired. IFRS and GAAP require that HTM and AFS securities be tested for impairment annually. HFT are not tested for impairment because changes in value are recognized on IS immediately

factors that determine whether linear or log linear should be used? what does it mean when trying to fit a linear model with non-linear data?

if data creates a non linear shape, the residuals using a linear model will be persistently negative or positive for a period of time which is serial correlation. A log linear model should be used, a natural log of y corrects this so that the regression line better fits the data. log linear reduces potential negative impact of serial correlation.

calculating FCinv? (if LT assets weren't sold in year, and if LT were sold during year)

if no LT assets are sold in year = end gross PPE - beg. gross PPE = end net PPE - beg net PPE + dep. FCInv = cap ex - proceeds from sales of LT assets = end net PPE - beg net PPE + dep. - gain on sale

explain price convergence? and expected return from price convergence?

if rr does not equal expected return, there will be a return from convergence of price to IV Return from convergence of price to IV = V0-P0/P0 Expected return = Req. Ret. + V0-P0/P0

Explain option-adjusted spread?

if you discount a credit risky bond using RF rate, the value would be too high. The OAS is a spread added to all one period rates to result in the mkt price of the bond. The OAS is added to the bond after the adj. for embedded option. OAS is used in relative valuation, if two bonds have same risk but one has higher OAS, than it is undervalued as it is giving higher yield for same level of risk.

Correcting for an AR model with seasonality? formula for t-stat of autocorrelations?

if you find that there is seasonality in quarterly data in an AR model, this means that the current x is related to not only the previous quarter but the quarter 4 quarters previous to it. To model for this we add a lagged value of the dependent variable 4 quarters previous to it. the equation would now look like this: xt = b0 + b1(xt-1) + b2(xt-4) + ε the resulting model should have a t-stat on the autocorrelation of the 4th lag that is no longer stat. sig. different from 0 t-stat = (autocorrelation)/(1/T) where 1/T is the standard error

Forward rate model?

illustrates how spot and foward rates are related. model suggests that the forward rate f(2,3) should make investors indiffernt bw buying a 5 year zero coupon bond vs buying a 2 year zero coupon bond (j years out) and reinvesting principal for additional 3 years (k)

2 things that increaseDiscount for Lack of Market Liquidity? 4 things taht decreae DLOM? 3 ways to estimate DLOM? formula for DLOM? total discount formula?

increase DLOM - contractual restrictions on selling stock, greater risk uncertainty about value decrease DLOM - pending IPO or sale, greater pool of buyers, paying dividends, earlier or higher dividend payments 1. use restricted in a firm prior to IPO compared to public shares as this allows you to compare price difference from liquid vs not liquid. 2. compare pre-IPO share price to post-IPO share price 3. estimate DLOM as price of put option on the stock divided by stock price DLOM = value of "at the money put option/value of stock before any discount for lack of mkt-ability = 1 - (1 - DLOC in %)*(1 - DLOM%)

Advantages of algorithmic and high-frequency trading? liquidity? costs? bid-ask spreads? pricing efficiency? markets? competition? disadvantages?

increased lower tighter improved promotes open and competitive increased - excessive order could slow market - increased diff. in policing mkt - DDoS (malicious or non-malicious)

Loan impairment under IFRS 9?

incurred loss model is transferred to Expected Credit Loss model. requires companys to not only evaluate current and hist. info about loan performance but also to use forward looking info and results in early recognition of impoariment.

inflation, diversification, and taxes important points on investment in private RE?

inflation hedge - prop increase with inflation (however unexpected inflation is a risk as RE values may not keep up with inflation as well)..diversification as RE is less than perf. correlated with stocks and bonds..favorable tax treatments, in US depreciatable life is less than actual life so less taxes

Explain the instability of coefficient of time series?

instability refers to the coefficients being different in one period than another. there is a tradeoff between longer and shorter time periods, shorter time periods are more stable than longer time periods but have a lower statistical reliability and vise versa

Is an entity a VIE?

insufficient at risk equity investment? > Yes = VIE > No. = SHers lack desision making rights? Yes = VIE > No > Sharholders do not absorb losses? Yes = VIE, No > Sharholders do not receive residual benefits? Yes = VIE > No = Not a VIE Once it is determined that an entity is a VIE, the entity must be consolidated. The firm that must consolidate the VIE is known as the primary beneficiary. The primary beneficiary is the entity that is exposed to the majority of the loss risks or receives the majority of the residual benefits, or both. Voting control is inconsequential at this point.

Investments in Associates? Accounting Treatment? Ways a firm can exert influence?

interest of 20% to 50%. It is possible to have significant influence with less than 20% interest. it is also possible to not have influence with interest of 20-50%. Accounted for using Equity Method 1. BOD representation 2. involvement in policy making 3. material intercompany transactions 4. interchange of managerial personnel 5. dependence on technology

explain maturity structure of yield volotilities and their effect on price volatility?

interest rate volatility drives price volatility in FI portfolio. securities with embedded options are especially sensitive to IR volatility. short term interest rate are more volatile than LT interest rate. volatility at LT maturity is associated with uncertainty of real economy and inflation volatility at ST maturity is associated with monetary policy.

Naked CDS? Long/short trade? curve trade?

investor with no underlying exposure buys protection with CDS buy protection in one entity and sell protection in another entity betting on spreads changing in your favor type of long short trade but same reference entity of different maturities. Curve steepening trade, used if you believe short-term outlook is better than long-term and you buy protection in long-term CDS and sell protection in short-term CDS. and profit if curve steepens. A curve flattening trade you do the opposite as you believe outlook is better in the long-term

Riding the yield curve?

investors seeking superior returns. investor will purchase bonds with longer maturity than investment horizon with an upward sloping yioeld curve, the bonds yield will decrease as it moves down the curve, and the price wiil increase so the investor can profit from selling the bond

What is key rate duration? Key rate duration measures what risk? 7 generalizations about key rates 1. option-free bond trading at par, ___? 2. option free bond not trading at par (discount or premium) ___? ----and bond with low coupon may have _____? 3. callable bond with a low coupon ___ --- higher coupon callable bonds _____ 4. finally low coupon and high coupon putable?

key rate duration captures the interest rate sensitivity of a bond to cahngs in yields (par rates) of specific benchmark maturities. measures shaping risk. 1. maturity matched key rate duration = effective duration and other year key rate durations are 0 2. maturity matched key rate duration is highest and if it has a low coupon the durations of other maturities may by negative 3. unlikely to be called so maturity matched rate key rate duration is highest ---- higher coupon are more likely to be called so highest key rate duration is the time to exercise 4. low coupon putable is more likely to be called so time to exercise key rate is likely to be highest, and high coupon putable is less likely to be called so highest key rate duration is maturity

Liquidity is more important for P&C or Life ins. companys? Investment return is more important to which?

liquidity has hist. been more important for P&C, however, due to trends in policies, it is becoming of more importance for life insurers as well. Investmetn return is usually a bigger source for life insurance due to longer policy periods

VI Conflicts of Interest VI(B) Priority of Transactions Rule? Guidance? (2) Recommended procedures? (4)

loyalty to client first, then employer, then yourself. So you are last in priority. If you are loyal to the first two, then it is okay to make trades for personal account-can't use knowledge of pending trades for personal gain (1) if you are "beneficial owner" like on behalf of your brother, that should be viewed the same as yourself, so last in line in priority (2) and for family member accounts these should be treated like other accounts, cannot be advantaged or disadvantages - so you can't limit hot IPO shares to Aunt Ruth who is a client of yours bc you think it might look like a conflict (1) limit participation in equity IPOs of employees (2) Restrictions on private placements. (3) have blackout periods when executing large transactions for a client account (4) disclose all personal investments to clients if requested

Equity: Residual Income: market value added?

market value of the firm minus the book value of the capital investment in the firm used to measure mngt's value created since inception of firm

protective put

maximum gain = ST − (S0 + P0) (theoretically unlimited) maximum loss = (S0 − X) + P0 breakeven point = S0 + P0

Covered Call

maximum gain = X − S0 + C0 maximum loss = S0 − C0 breakeven point = S0 − C0

Explain the Standard Error of Estimate (SEE)?

measures the degree of variability between the actual y values relative to the estimated y values. gauges the fit of the line. The smaller the SEE the better the fit.

what is meant and how to account for minority interest under acquisition method? (under equity method there is no minority interest accounting)

minority interest is the portion of the sub that the parent doesn't own. IT IS THE OPPOSITE OF THE PARENT'S OWNERSHIP IN THE SUB. minority interest is the parent's non-controlling interest in the sub, hence it is the value of the sub less their ownership interest under ac. method do not adjust equity account of parent. list the min. int. as seperate account under parent's stockholders equity

PM - 3 types of multifactor models: fundamental factor model formula? statistical factor models - major weakness?

modeel uses firm specific fundamental factors like P/E, formula could be for a different fundamental ratio though. **bi of 2 means P/E is 2 sd away from mean may be no economic interpretation of model

Structural models of corporate credit risk? (2) explain the first option analogy, and the alternative analogy.

model is based on structure of a company's balance sheet. Option analogy considers hypothetical company with assets finaced by equity and signle issue of zero coupon debt. *SHers effectively have a call option on the assets with strike price equal to the fair value of debt b/c if assets > debt at maturity of debt, they will pay the debt and keep the residual. If the assets < debt than they will default on debt, and let the debt holders take the assets. Therefore Value of stock(equity) = max(A(T) - K, 0) and value of debt = min(k, A(T) A = value of assets at maturity of debt T K = face value of debt Alternatively, equity investors can be thought of as long the net assets of the company and long a put option, so when assets < debt, they can sell the assets for X price which = debt. And investors in the debt have a long position in the RF debt and a short postion in that put option Value of risky debt = value of risk debt - value of a put option on company's assets ---and value of the put option is CVA

Detecting multicollinearity?

most common sign is that the t tests indicate that the coefficients are not stat. sign. different from 0 but the f test is stat. sig. and the R2 is high.

What are the steps for restating FS for inflation under IFRS?

non monetary ass and liab are restated for inflation using a price index. multiply the original cost by the change in the price index you don't restate monetary ass and liab common stock is restated by applying the change in the price index from either the beginning of the period or the date of contributions, whichever is later. So if there are no contributions in the period, then use beginning of period. Retained earnings is a plug figure to balance BS. You can use the retained earnings amount (that was calculated after restating BS) to determine net income for the year The income statement items are restated by applying the change in the price index from the date of the transactions Once the IS is restated, you can solve for net purchasing power gain or loss since you have obtained the net income amount from the balance sheet. net purchasing power gain or loss results is recognized on income statement - gain will occur if net monetary liability exposure during this inflation, and loss will occur if net monetary assets are held

plain vanilla intersest rate swap? swap rate curve?

one party makes pmts based on a fixed rate while the other makes pmts based on a floting rate. The fixed rate is known as the swap fixed rate or swap rate. swap rate curve shows the swap rates for various maturities.

VII Responsibilities as a CFA Institute Member or CFA Candidate 7(B) - violations? (2) best practice recom?

over-promising individuals competence or investment results due to holding CFA charter you can state facts such as completed the program in 3 years or finished all exams on first try but you can't claim that these make your abilities superior Recommended - Make sure that members' and candidates' firms are aware of the proper references to a member's CFA designation or candidacy, as this is a common error.

Explain convertible bond period and price? Pros and cons of convertible bonds?

owner of convertible bond has right to convert bond into a fixed number of common shares of issuer during specified timeframe (conversion period) for a specified price (conversion price) +Allow investor to enjoy upside of issuers stock - at the cost of a lower yield +allow issuer to obtain cheaper borrowing -but existing shareholders may face dilution if conversion option is exercised

par rate? Par rate curve? bootstrapping?

par rate is the YTM of a bond trading at par. by definition, the par rate will equal the coupon rate on the bond. par rates for bonds with different maturities make up the par rate curve **remember spot rate is the yield to maturity of zero-coupon bond, this is a bond that trades for less than par since it has no coupon pmts. par rate is the yield to maturity of bond trading at par, trades at par so the ytm is coupon rate (IT IS A COUPON PAYING BOND) using process called bootstrapping spot rates (rates on zero coupon bond) can be derived from par curve. **rule: 1 year spot rate = 1 year par rate we can find spot rate 2 using the coupons for 2 year bond trading at par, we know the coupon payments for par curve. And we know S1 because it is equal to 1 year par, so solve for spot rate 2. To find the spot rate 3, first solve for spot rate 2, then apply same formula. (be sure to use coupon rates for whatever year spot rate you are solving for. par = coupon/(1 + S1) + coupon + par/(1+S2)^2

The Monte Carlo simulation method uses _________ . Explain why to use Monte Carlo simulation for MBSs? Why can you not use binomial tree for MBSs?

pathwise valuation and a large number of randomly generated simulated paths MBSs have prepayment risk which equates to call risk on a callable bond, however unlike call risk prepayment risk means the cash flows are path-dependent (because of refinances) Binomial valuation assumes cash flows are not path dependent. Therefore since MBSs are path dependent, you cannot use the binomial valuation model

underlying earnings? Molodovsky effect? 2 methods for normalized earnings?

persistent continuing core earnings excluding non-recurring gains/losses, asset write-downs, provisions for future losses high P/Es in recession due to low earnings and low P/Es in economic boom due to high EPS 1. method of historical average EPS using most recent business cycle 2. method of average ROE, which is = average ROE x current BVPS *this is the preferred method

what is ownership perspective in the FCFE approach? why would analyst prefer FCFE over DDM? (3)

perspective is that of Control over dividends. compared to DDM where no control over dividends. If investors value control there will be a difference bw DDM and FCFE valuations. (+) some firms pay low dividend (+) dividends are discretionary and may not be aligned with LT profits, FCF better measures LT profitability (+) more appropratie for acquirer than DDM

straight bonds have ___ effective convexity, meaning? Callable bonds have positive convexity when ___? When call option is at or near the money, effective convexity is ____, meaning? Putable bonds have ___ convexity?

positive convexity (price is more sensitive to down rates) rates down 1% price up 1.5%, rates up 1%, price down -0.5% when rates are high call options can have positive convexity bc they are unlikely to be called when call option is at or near the money, convexity becomes negative-more sensitive to rising rates(rates go up 1% price goes down -10% (price decrease is unlimited) rates go down 1% price goes up 0.5% putable bonds have positive convexity throughout

✔ PORTFOLIO MANAGEMENT 49: ECONOMICS AND INVESTMENT MARKETS Interest rates are ___ related to GDP growth and level of savings rate are ___ related to GDP growth? and ___ related to expected GDP volatility? in recession policy rates tend to be ___. And what causes rates to increase?

positively related positively related due to higher risk premium low -- Investor expectations about higher future GDP growth and inflation as the economy comes out of recession lead to higher longer-term rates. This leads to positive slope of the yield curve

Adjusted pre-tax income? (pension expense)

pre tax income + (actual return on plan assets - exp return on plan assets)

✔ 37: FIXED INCOME: CREDIT ANALYSIS MODELS Exposure? Recovery Rate? Loss given default?(%) Prob. of survival? Prob. of default? Credit valuation adjustment? Value of a credit risky bond?

present value of bond % recovered in event of default LGD(%) = 100 - RR 1 - Hazard rate^t Prob of Default = hazard rate x Prob of survival t -1 expected loss = probability of default x LGD CVA = sum of PV of expected loss for each period risk free bond - CVA *or present value of expected loss = value of credit risky bond - value of otherwise identical risk free bond

✔ 31 EQUITY: MARKET BASED VALUATION What is justified price multiple? method of comparables vs method of forecasted fundamentals with justified price multiples Forward vs trailing P/E? and formulas?

price multiple, is stocks price compared to a fundamental variable like earnings. justified price multiple is what the multiple should be if the stock is fairly valued. comparables is a relative valuation approach where you can see if stock is under or over valued forecasted fundamentals such as using GGM uses DCF to find current value to find a justified price multiple to compare to actual price multiple. Forward or leading P/E is forecasted earnings for next year and current price. Trailing or current P/E is the last 4 quarters of EPS and current mkt price. Trailing P/E = current price/last 4 quarters of EPS Leading P/E = current price/next years expected earnings

adjusted discount rate for prob. of failure in VC financing?

r = [(1+r)/(1-q)] - 1

Continuing residual income: what is persistence factor? What are the 2 things associated with a higher persistence factor? 3 things associated with lower persistence factor? scenarios for when persistence factor is 0, 1, or in between?

rate at which RI is expected to fade over life cycle of firm. higher persistence factor means RI will persist more - higher = better higher persistence factor (1) low div p/o (2) hist. high persistence factor in industry lower pers. factor (1) high ROE (2) sign. non-recurring items (3) high accruals If residual income is expected to persist at the current level forever, ω = 1. If residual income is expected to drop immediately to zero, ω = 0. If residual income is expected to decline over time after year T as ROE falls to the cost of equity capital, then the persistence factor, ω, is between zero and one.

Other than all of the statistical arbitrage high-frequency trading, there are three others: match the term below: algorithm prices stock in real time using price and liquidity information from market and determines the intrinsic value and trades on this information vs the current stock price algorithm monitors news without human interaction to trade on news before humans can self-evolving algorithm to test strategies during the day and then continue updating based on what is working and kill off the losing strategies

real-time pricing of securities Trading on news Genetic tuning

return of conv bond vs stock direct inv. 1. when stock price falls? 2. when stock price rises? 3. stocks price is stable? 4. when current price of stock is very high or very low?

return of conv. exceeds direct inv. in stock (conv. bond return = -3%, stock = -14%) 2. return from stock direct inv. exceeds return from conv. bond (stock +10%, conv. bond return +7%) 3. stock price is stable may result in higher return for convertible bond due to coupon payments 4. if current price of the stock is very high (price = 50, conv. price = 5) it trades like equity, if current stock price is way below the conv. price (price = 5, X = 50), it trades like FI, also known as "busted convertible"

Term structure of credit spreads? Explain the 4 determkinants of term structure of credit spreads? (credit quality, Financial conditions, mkt demand and supply, and equity market volatility)

relationship bw credit spread (YTM on risky bond - risk-free bond) and maturity on bonds issued by same issuer or different bonds with same credit rating the curve is upward sloping if there are higher expected default probabilities in the future (or lower recovery rates in the future) 1. credit quality - higher rated bonds have flat or slightly upward sloping term structures, and lower rated have steeper curves 2. spreads narrow in good times and widen in bad times. During boom, yields are higher but spread bw benchmark and credit risky bond are narrower 3. more liquid maturities have lower credit spreads, so newly issued longer-term maturities can have lower spreads than older issued bonds with shorter maturity 4. increases in equity volatility tend to widen spreads

The three momentum indicators in valuation: earnings surprise? SUE? relative strength?

reported EPS - exp. EPS. ---positive surprises may lead to persistent positive returns Standardized unexpected earnings (SUE) = earnings surprise/sd of earnings surprise =stocks performance/performance of index --patterns of persistence or reversal may exist

High quality cash flows requires __ and ___. Red flag of earnings manipulation? 3 items to check for in the statement of cash flows?

reported cash flows are high, and quality of underlying reporting quality was high sign. diff bw earnings and Operating cf. 1. unusual items or items that have not shown up previously 2. excessive outflows for receivables (aggressive revenue recognition usually involves increasing a/r which involves cash outflow) and inventory due to aggressive rev. recognition (increase in inventory which is cash outflow, when sham sales are reversed which are treated as returns from customers) 3. provisions for and reversals of restructuring changes

Whats included in Residential Real estate? Whats included in non-residential? Whats included in commercial real estate?

residential includes single family owner occupied and multifamily (if for generateing income it is res. CRE)..NR includes commercial prop other than multifamily or farmland..commercial real estate includes retail, parking, office, and multifamily

Detecting serial correlation?

residual plots and durbin Watson statistic

private (equity) real estate indices: NCREIF? (formula) Transaction-based indices? (explain)

return = NOI - cap. exp. + (end mkt value - beg. mkt value)/beg. mkt value **index is made up of quarterly submissions of appraisal data quarterly. repeat ales index regresses data of repeat sales of the same property. And hedonic index developes regression requiring only 1 sale of the same property and creates regression by controlling for differences bw properties

factors associated with investor's willingness and ability to take risk? combining willingness and ability to accept risk? determined by psychological factors of the investor regarding risk? the client's ____ is determined by size of portfolio, time horizon, and liquidity needs.

risk objectives risk tolerance willingness to tolerate risk ability to tolerate risk

How to detect heteroskedasticity?

scatter plot or Breusch-Pagan Chi Square This scatter plot of the residuals indicates that the variance of the errors increases as x increases To perform Breusch Pagan, regress the squared residuals on the independent variables, if conditional heteroskeasticity is present the indepent variables will explain the residuals, test statistic for Breusch Pagan = n*R2 of residuals, critical value is found by using degrees of freedom = k H0: no conditional heteroskedasticity *the Null is actually the desired result, which is backwards compared to most tests *this is a one-tailed test

In evaluating capital allocation to segments of company, what ratio do you use to see proportional amount that firm is allocating to specific segment? What should you compare this to to determine whether company is allocating capital well? Lastly what is a better way to calculate performance by segment?

segments cap ex % (segment cap ex/total cap ex) divided by segment's asset % (segment assets/total assets) *this tells us the relative amount of cap ex being allocated to segment relative to the size of the segment Compare the ranking of above ratio for each segment to the EBIT margin for each segment Use estimated cash flow per segment (EBIT + Depreciation/amortization) divided by average assets per segment. *this gives us cash flow performance which can be compared to cap ex allocation just like the above procedure

Transactions with investee, recognizing income? (2 types of transactions?)

since investor may be able to influence transactions, profit from these transactions must be deferred until profit is confirmed through use or sale to a 3rd party. Upstream transactions are Investee to Investor, in an upstream sale, the investee sells to investor, the investee recognizes all income from the sale, but the investor must reduce equity income from the investee by amount that is unconfirmed. Downstream - investor sale to investee, investor recognizes all income from the sale but investee can only recognize amount confirmed by 3rd party

A ______________ is a legal structure created to isolate certain assets and obligations of the sponsor. The typical motivation of one these is ______.

special purpose entity (SPE) to obtain low-cost financing

private company valuation: income-based valuation: strategic vs financial buyers?

strategic transaction involves synergies, so estimate should include the reduction in costs or increase in revenue financial or non-strategic - for example firm buying firm in dissimilar industry, and does not include synergies

Multiple regression: classification and prediction are accomplished with? clustering and dimension reduction are done with? neural networks are made up of these 3 layers? this provides insight into the volatility contained in the data set and is a(n) ____ learning algorithm.

supervised machine learning unsupervised machine learning 1. input layer 2. several hidden layers 3. output layer Principal component analysis (PCA), unsupervised

high quality earnings are characterized by two elements?

sustainable - expected to recur, and adequate - covers company's cost of capital

Predicting variance of error terms in period t+1? (formula)

t+1 = a0 + a1(εt^2) taken from the equation created from the ARCH model

Optimal amount of active risk in unconstrained active portfolio? (rule and formula) Weight of active portfolio to obtain optimal active risk?

the level of active risk that max. the portfolio's sharpe ratio =σA*/σactive *optimal active risk divided by portfolio's active risk

Investment in associates? What happens if losses reduce investment account to zero?

these are influential investments (20%-50%) Accounted for using Equity Method (initial investment is recorded at cost and reported on the BS as a non-current asset) proportionate share of earnings are recognized on BS in investment account, and this amount is recognized on IS as well. dividends are treated as a return to capital and reduce the investment account on BS (unlike financial assets where dividends are recognized in the IS) If losses reduce the investment account on BS to zero. The investor discontinues the equity method until the proportionate share of earnings exceed the losses that occur during the suspension period.

Fama French Model?

this is a multifactor model that attempts to account for higher returns associated with small cap stocks req. ret. of stock j = RF + βmkt,j × (Rmkt − RF) + βSMB,j × (Rsmall − Rbig) + βHML,j × (RHBM − RLBM) (Rmkt − RF) = market risk premium (Rsmall − Rbig) = small-cap risk premium (RHBM − RLBM) = value risk premium SMB (small minus big) so beta for size) HML (high minus low) so beta for value of high book to mkt vs low book to mkt

Life insurance company ratios include (2)

total benefits paid/net premiums written and deposits commissions and exp/net premiums written and deposits

in regards to using multifactor factor models in portfolio mngt, passive mngrs can invest in a ___, and active can do ___.

tracking portfolio long or short factor portfolios

How do you adjust pension expense on the income statement of a GAAP company to compare to an IFRS company?

under GAAP the entire pension expense is an operating expense, which includes the interest cost portion. Under IFRS, periodic pension cost can be included in various line items. Analysts can adjust GAAP reported P&L by adding back pension expense to operating income and only subtracting service cost from operating income. Interest cost should be added to interest expense. And actual return should be added to other income/non-operating income

Goodwill for business combinations? GAAP and IFRS?

using acquisition method, he purchase price is allocated to the identifiable assets and liab of the acquired firm on the basis of FV. Any remainder is reported on BS goodwill. Under GAAP the full goodwill approach is required. Allowed under IFRS. Full Goodwil -= Total FV of sub - FV of subs identifiable net assets. Under IFRS, partial goodwill is used. Goodwill=purchase price - parents proportionate share of the FV of subs identiable net assets.

exposures to local currency under both methods? (subs position, exposure, gain or loss from what?)

under current rate method, if sub has net asset position, the parent will have a gain if local currency is appreciating, and loss is local currency is depreciating. if sub has net liability position, parent will have a loss if local currency is appreciating, and a gain if local currency is depreciating net liability position is rare Under temporal, if sub has net monetary assets, gain for appreciating and loss for depreciating local currency, and if sub has net monetary liab, loss for appreciating, and gain for depreciating net monetary asset position is rare since most liability are monetary

how to do IS under acquisition method? differences bw equity method?

under equity method, the acquiring company will report combined revenue and expense of other company. Vs. equity method where the company would report the % ownership x NI. And a minority interest is on IS under acquisition method which is subtracted from operating income to arrive at NI. Under equity method, there is no minority interest amount on IS. NI is the same under acquisition and equity methods.

when is FCFF or FCFE more appropriate in private company income-based valuatoin? 3 income based approaches to valuing private company? 5 factors that may be required in adj. to discount rate for private company's in income based valuation? 3 methods to estimate required return for private company?

use FCFF if sig. changes in CS anticipated b/c WACC is less sensitive to changes from change in CS 1. Free CF 2. capitalzied cash flow (single measure FCFF or FCFE is divided by a cap rate r-g to arrive at value) - appropriate for small private firms when proj. are uncertain. 3. Excess earnings method 1. size premium - add to discount rate for smaller firms 2. availability and cost of debt 3. acquireer vs tartget - acquirers often incorrectly use their own cost of capital rather than the targets higher cost of capital arriving at a value that is too high for the target 4. projectoin risk 5. lifecycle stage 1. CAPM - only appropriate if there is a chance of IPO or acquisition for the firm since beta comes from public market 2. expanded CAPM - adds in premium for size and firm specific factors 3. build up method

leveraged IRR in private RE investment? (how to calculate?

use calculator and solve for I/Y, PV = initial investment, PMT = cash flow, n = holding period, FV = sale price - mortgage balance

3 market based approaches to valuing private company: 1. GPCM? calculate adjusted control premium?

use public companies price multiples then makes adj. for a control premium, as a share in the private company means control and is worth more only adj. the equity portion of firm's value adjusted control premium = (control premium on equity) x (1-DR)

One broad class of high-frequency trading is Statistical Arbitrage. What is the broad definition of this? Match these 6 with their name? 1. When the prices of two securities diverge from their historically correlated movements, the outperforming security is shorted while the underperforming security is purchased. If the relative prices of these securities later converge, a profit will be earned. 2. These algorithms seek out temporary differences in price performance between securities and the sector to which they belong. For example, the price of McDonald's Corporation stock should be correlated with the price of a restaurant sector index. 3. is applying statistical arbitrage strategies to groups of securities, rather than to individual securities. Instead of trading one individual security against another as in pairs trading, we trade one basket of securities versus another basket. 4. type of statistical arbitrage that takes long and short positions in two closely-related futures contracts, on the notion that the spread between the two will change. (4 types of spread trading - and 3 types of multilegged inter-exchange spreads) 5. These algorithms are based on the idea that when the price of a security drifts away from its recent historical mean, its price will likely move back towards that mean. 6. These arbitrage strategies are designed to produce a small profit regardless of whether the market goes up or down. By combining securities such as stocks and options in such a way that the total delta of all of the securities is zero, the strategy may be able to earn a profit from volatility changes or simply as the options approach maturity.

used to identify securities that have historically moved together but have diverged recently 1. Pairs trading 2. Index arbitrage 3. Basket trading 4. Spread trading a. Intra-market spread: (TIME)same futures different months short one long the other. (ie long may hogs, short july hogs) b. Inter-market spread:(COMMODITY) same timeframe different underlying, (e.g., short hogs and long corn feed). c. Inter-exchange spread: (EXCHANGE) different exchange same commodity (short may Minneapolis corn and long may Chicago corn) d. Multilegged inter-exchange spreads: (commodities that come from one another - high correlation) d.i.Crack spread—crude oil vs. petroleum products. d.ii.Spark spread—price of electricity from a gas-fired power plant vs. fuel prices. d.iiiCrush spread—soybean futures vs. soybean oil futures and soybean meal futures. 5. Mean reversion 6. Delta neutral strategies

Taylor Rule? (what is it and formula)

uses economic conditions of employment level and inflation to what interest rate the central bank should set as the policy rate implied policy rate = real policy interest rate + π + .5(π-π*) + .5(y-y*) where π* is target inflation rate and y* is log of central bank's target output

market-based approaches to private company valuation: prior transactions method?

uses sales prices on actual shares in the subject company and is most appropriate for valuing minority interests

Equity valuation is the process of estimating the value of asset by (1)? (2)?

using a model based on the variables the analyst blives determined the fundamental value of hte aset, or compariing it to the observable mkt value of similar asets

Implied land value? (formula) highest and best use?

value after construction is complete - cost to construct a building highest and best use is the property with the highest implied land value

How to get value using Direct Capitalization approach? cap rate? cap rate when it is unknown? cap rate and value if it is a Net Lease? (2 formulas)

value=NOI year 1/cap rate where cap rate = discount rate - growth rate cap rate = expected NOI year 1/ comparable property sales price NET LEASE-> when tenants are expected to pay all expenses you can use rent instead of NOI and ARY instead of cap rate Net Lease Cap Rate (ARY) = Rent/sales price of comparable Net Lease Value = Rent year 1/ARY

Forward Pricing Model?

values forward contrracts based on arbirage free pricing (equates buying a long maturity zzero coupoon bond to entering a forwarrd contract to buy a zero couopon bond that matures at the same time)

What is "vertically integrated"? How does this affect changes in input prices? How does elasticity of demand effect sales?

vertically integrated is when company owns the supplier. costs and profit are less affected by input prices if vertically integrated the more elastic a company's customers the more sales will decrease for increases in prices. threat of substitutes is biggest factor

III - Duties to Clients -(D) Performance Presentation Rule? Guidance? (3) Recommended procedures? (4)

when communicating investment performance information be very careful to be sure that information is FAIR, ACCURATE, AND COMPLETE (1) in a brief presentation, as long as it is Fair, accurate, and complete, you can provide limited information as long as you note and provide additional information (2) cannot misstate or mislead clients about inv. perf. (3) do not state or imply that you can achieve same performance in the future (1) consider sophistication of the audience when giving presentations (2) use weighted composite of similar portfolios rather than single account (3) include terminated accounts in historical perf. (4) Including all appropriate disclosures to fully explain results (e.g., model results included, gross or net of fees, etc.).

Inflection points?

when developing proj beyond the st forecast horizon inflection points are when future may not be like the past b/c 1. overall economic env. or 2. business cycle 3 regulations 4 technology

Forward price evoluation and active bond portfolio mngt?

when spot rates turn out to lower than implied by the forward curve, the forward price will increase. so a trader expecting lower future spot rates than implied by the curve would purchase forward contracts now.

Equity Dividend Rate (in private RE investment)

where cf1 = NOI - debt service

V Investment Analysis, Recommendations, and Actions V(C) Record Retention Rule?

Members and Candidates must develop and maintain appropriate records to support their investment analysis, recommendations, actions, and other investment-related communications with clients and prospective clients. (1) records are firm property cannot take with you after leaving firm unless employer consents (2) if not regulatory requirement, CFA recommends 7 years

describe characteristics of random walk? what are the rules to random walk? What is random walk with a drift? what are the b1 and b0 for both? explain both Random walk and random walk with a drift?

with random walk, the predicted value of dependent variable in one period is equal to the value of previous period plus a random error. xt = xt-1 + e, so the best forecast of xt is xt-1 in random walk the expected value of each error term is 0 (hence why best forecast of xt is xt-1), the variance of the error terms is constant, and there is no serial correlation in the error terms the time series does not have an intercept of 0, but does have a b1 of 1 so the timeseries is expected to increase or decrease by a set amount each period b0 = 0 for RW b0 ≠ 0 for RW w/ a drift b1 = 1 for both neither RW or RW w/ a drift exhibit covariance stationary. b/c the mean reverting level is b0/1-b1, the mean reverting level for both are undefined. this breaks the rule of a finite mean reverting level, both exhibit unit root by definition since the b1 is = 1

6 requirements of CFA code of ethics?

•Act with integrity, competence, diligence, and 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.

V Investment Analysis, Recommendations, and Actions V(A) Diligence and Reasonable Basis Rule? Guidance? (5)

Diligence, independence, thoroughness in analyzing investments, making investment recommendations, and actions. have a reasonable and adequate basis supported by research and investigation for analysis, recommendation, action (1) level of diligence depends on product or service, make effort to cover all relevant issues before recommendation ( may include Global and national economic conditions. A firm's financial results, operating history, and business cycle stage. Fees and historical results for a mutual fund. Limitations of any quantitative models used. A determination of whether peer group comparisons for valuation are appropriate. (2) we can use secondary or 3rd party research but you are responsible for soundness of the research. -- Members should encourage their firms to adopt a policy for periodic review of the quality of third-party research (3) consider scenarios outside typical downside risk (4) must be able to explain basic nature of quantitative research - Standard requires greater diligence of members who create quantitative techniques compared to those using quant. tech. created by others (5) in group research, a member that doesn't agree with view of group DOES NOT have to decline to be identified in the report AS LONG as there was a reasonable basis in the recommendation of the group

3 Duties to Client (b) Fair Dealings Rule? Guidance? (3) Recommended procedures? (4)

Members and Candidates must deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities. (1) no discrimination against any clients when disseminating information to clients -fair does not mean equal-different levels of service are ok (2) different levels of service doesn't mean you can disadvantage the lower tier clients -- you can provide more hand holding to higher tier but you cant get a new IPO and say only top tier clients get any of these shares (3) be sure to give all clients fair chance to act upon every recommendation - just issued sell recommendation, client calls you to buy before they see the recommendation make sure they know of the sell rating before letting them buy (1)develop written trade allocation procedures (2) limit number of people aware of recommendatoin change before (3) shorten timeframe from decision to dissemination (4) deviations from strict pro rate allocation of IPO is sometimes okay -- the system used should be fair to all clients though like when there is a "minimum lot size"

III - Duties to Clients -(E) Confidentiality Rule? Guidance? (2)

Members and Candidates must keep information about current, former, and prospective clients confidential unless: 1. The information concerns illegal activities on the part of the client or prospective client-not required if you suspect illegal activity but not a violation to disclose illegal act. 2. Disclosure is required by law - money laundering example of when you have to, or 3. The client or prospective client permits disclosure of the information - client tells you to disclose the info (1) of course extends to former clients (2) you may provide confidential info. to conduct program of CFAI - but you don't have to

2. Integrity of capital mkts (b) Market Manipulation Rule? Guidance?

Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants. (1) This Standard applies to transactions that deceive the market by distorting the price-setting mechanism of financial instruments or by securing a controlling position to manipulate the price of a related derivative and/or the asset itself. (2) Spreading false rumors is also prohibited.

1. Professionalism (c) Misrepresentation Rule? Guidance? (3)

Members and Candidates must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities. (1) do not lie or give false impressions (2) this includes guaranteeing investment performance and plagiarism (3) models and analysis developed by others at the firm are property of the firm and can be used without citing, however a report written by another analyst cannot be released as another analyst's work -- Information from recognized financial and statistical reporting services need not be cited.

1. Professionalism (b) Independence and objectivity. Rule? Guidance? (6) Recommended procedures for compliance? (4)

Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another's independence and objectivity. (1) do not accept gifts, except modest gifts are ok. -- distinguish bw gifts from clients and gifts from parties trying to influence decisions -- in either case disclose gifts to employer (2) allocation of shares of oversubscribed IPOs in personal account is not permitted (3) must be good firewalls bw investment bankers and analysts, they only be working together if conflicts are managed and disclosed. (4) travel is a complicated one, if the travel is not lavish and it is practical than it may be okay for the analyst to allow for the subject company to pay for (non-lavish travel may be in the form of chartered flights) best practice is for analysts to pay for their own travel when attending info about firm being analyzed but may not be a violation if it is practical and doesn't impair judgment (5) issuer-paid research is fraught with potential conflicts. Analysts' compensation for preparing such research should be limited, and the preference is for a flat fee, without regard to conclusions or the report's recommendations. (6) Members and candidates must exercise independence and objectivity when they select investment managers. They should not accept gifts or other compensation that could be seen as influencing their hiring decisions, nor should they offer compensation when seeking to be hired as investment managers. The responsibility to maintain independence and objectivity applies to all a member or candidate's hiring and firing decisions, not just those that involve investment management. Recommended procedures for compliance: (1) ◾Restrict employee investments in equity IPOs and private placements. Require pre-approval of IPO purchases. (2) Firms should impose clear value limits on gifts. --token items only (3) ◾Create a restricted list and distribute only factual information about companies on the list.(4) ◾Restrict special cost arrangements

Correcting Heteroskedasticity?

Most common remedy is to calculate the White Corrected Standard Errors. These standard errors are used to calculate a different t-stat to perform a test of stat. significance.

Explain Heteroskedasticity? And what are the two types of heteroskedasticity?

Occurs when the variance of the residuals is not the same across all observations, this violates one of the assumptions of regression. Unconditional heteroskedasticity - occurs when the heteroskedasticity is not related to the level of the independent variables. violates the asumtpion of constant variance but does not cause significant problems. Conditional heteroskedasticity - occurs when it is related to the level of independent variables. For example the residual variance si greater for higher x values than for lower x values

Calculate R2 and SEE from Anova Table for simple linear regression?

R2 = RSS/SST = (SST-SSE)/SST SEE = sqrt of MSE = sqrt of SSE/n-2

Calculate the R2, F-stat, SEE, and Adjusted R2 from the Anova table?

R2 = RSS/SST F-stat= MSR/MSE SEE=sq rt of MSE, Adjusted R2 = 1 - (n-1)/(n-k-1)*(1-R2)

Interpretation of adjusted R2?

R2 almost always increases as more independent variables are added to the model, even if the additional variables do not add stat significance, adjusted R2 adjusted for the number of independent variables

VI Conflicts of Interest VI(C) Referral Fees What are these? Rule? Guidance? (2) Recommended procedures? (4)

Referral fees are when you are sending someone money or football tickets for them referring a client to you. Or when you are receiving a referral fee for providing client to another firm if paying or receiving anything of value must disclose to employer, clients, and prospective clients any compensation, consideration, or benefit received from, or paid to, others for the recommendation of products or services. (1) so if you say to a client that they should talk to investment mngr down the street, and you are receiving something from Mary for this referral than it must be disclosed to client and firm PRIOR to entering into agreement (1) employer should require quarterly disclosure of referral fee compensation be provided to them from investment professionals

Formula for mark-to-market value of forward contract? Forward rate given forward points?

V = (FPt - FP)x(contract size)/[1 + R(days/360)] where: Vt = value of the forward contract at time t (to the party buying the base currency), (t < T) denominated in price currency FPt = forward price (to sell base currency) at time t in the market for a new contract maturing at time T FP = forward price specified in the contract at inception (to buy the base currency) days = number of days remaining to maturity of the forward contract (T − t) R = interest rate of price currency Forward rate = spot + forward points/10,000

ETHICS: 1. Professionalism (a) Knowledge of the law CFA Rule? Guidance keys? (2) Recommended procedures? (4)

understand and comply with all applicable laws, rules, and regulations (including the CFA Institute Code of Ethics and Standards of Professional Conduct). In the event of conflict, comply with the more strict law, rule, or regulation. You must not knowingly participate or assist in and must dissociate from any violation of such laws, rules, or regulations. Guidance 1. Do not violate Code or Standards even if the activity is otherwise legal. Always adhere to the most strict rules and requirements 2. disassociate even if it involves leaving an employer (an extreme case).While a member may confront the involved individual first, he must approach his supervisor or compliance department. Inaction with continued association may be construed as knowing participation. Best practice 1.Members should seek advice of counsel or their compliance department when in doubt. 2.Members should document any violations when they disassociate themselves from prohibited activity and encourage their employers to bring an end to such activity.3. There is no requirement under the Standards to report violations to governmental authorities, but this may be advisable in some circumstances and required by law in others.4. Members are strongly encouraged to report other members' violations of the Code and Standards. **fiduciary duties is now covered under this standard **these are 4 of 10 best practice recommendations