CFA Level II Formulas & Def
Accelerated Double Declining Balance Depreciation in Year X
(2 / Depreciable Life) x Book value at the beginning of year X
Manufactured Housing backed securities SMM
(ABS)/(1-(ABS x (M-1)))
Favorable Income Differential per share
(Coupon Interest - (Conversion ratio x common stock dividend per share)) / Conversation Ratio
Premium over straight value
(Market price of convertible bond / straight value) - 1
Straight Line Depreciation Expense
(Original Cost - Salvage Value) / Depreciable Life
Single monthly mortality rate (SMM(t))
(Prepayment in month t)/(Beginning mortgage balance for month t - Scheduled principal payment in month t)
Convexity Calculation
(V(+) + V(-) - 2*V(0))/ (2*V(0)*(Change in Spread^2))
Duration Calculation
(V(-) - V(+))/(2*V(0)*(Change in Spread))
Effect on Financial Statements of Expensing: Initially when item is expensed
- Net income decreases by the entire after-tax amount of the cost - No related asset is recorded on the balance sheet and therefore, no depreciation or amortization expense is charged in future periods - Operating cash flow decreases - Expensed costs have no financial statement impact in future years
Effect on Financial Statements of Capitalization: In future periods when the asset is depreciated or amortized
- Noncurrent assets decrease - Net income decreases - Retained Earnings decrease - Equity decreases
Effect on Financial Statements of Capitalization: Initially when capitalized
- Noncurrent assets increase - Cash flow from investing activities decreases
Return Impact (large changes)
-(Modified Duration x Change in Spread) + (.5 x Convexity x Change in Spread ^2)
Return Impact (small changes)
-Modified Duration x Change in Spread
Conditional Prepayment Rate
1 - (1 - SMM)^12
SMM from the CPR
1 - (1-CPR)^(1/12)
Bond equivalent yield for ABS and MBS
2 * ((1+monthly cash flow yield)^6 - 1)
Average Age of Assets
Accumulated Depreciation / Annual Depreciation Expense
Ending Inventory
Beginning Inventory + Purchases - COGS
Zero-Volatility Spread (Z-Spread): Give benchmark, what it reflects for issuer benchmark
Benchmark: Issuer Spot rate curve Reflects: Liquidity Risk and Option Risk
Nominal Spread: Give benchmark, what it reflects for issuer benchmark
Benchmark: Issuer Yield Curve Reflects: Liquidity Risk, Option Risk
Option Adjusted Spread: Give benchmark, what it reflects for issuer benchmark
Benchmark: Issuer spot rate curve Reflects: Liquidity Risk
Zero-Volatility Spread (Z-Spread): Give benchmark, what it reflects for bond sector
Benchmark: Sector Spot Rate Curve Reflects: Credit Risk, Liquidity Risk, Option Risk
Nominal Spread: Give benchmark, what it reflects for bond sector
Benchmark: Sector Yield Curve Reflects: Credit Risk, Liquidity Risk, Option Risk
Option Adjusted Spread: Give benchmark, what it reflects for bond sector
Benchmark: Sector spot rate curve Reflects: Credit Risk, Liquidity Risk
Option-Adjusted Spread: Give benchmark, what it reflects for treasury market
Benchmark: Treasury Spot Rate Curve Reflects: Credit Risk, Liquidity Risk
Zero-Volatility Spread (Z-Spread): Give benchmark, what it reflects for treasury market
Benchmark: Treasury Spot Rate Curve Reflects: Credit Risk, Liquidity Risk, Option Risk
Nominal Spread: Give benchmark, what it reflects for treasury market
Benchmark: Treasury Yield Curve Reflects: Credit Risk, Liquidity Premium, Option Risk
COGS (FIFO) is lower than COGS (LIFO) during periods of rising prices by:
COGS (LIFO) - (Change in LIFO Reserve during the year)
Financial Statement Effects of Capitalizing versus Expensing: Cash flow from operating activities
Capitalizing: Higher Expensing: Lower
Financial Statement Effects of Capitalizing versus Expensing: Net Income (First Year)
Capitalizing: Higher Expensing: Lower
Financial Statement Effects of Capitalizing versus Expensing: Shareholder's Equity
Capitalizing: Higher Expensing: Lower
Financial Statement Effects of Capitalizing versus Expensing: Total Assets
Capitalizing: Higher Expensing: Lower
Financial Statement Effects of Capitalizing versus Expensing: Cash flow from investing activities
Capitalizing: Lower Expensing: Higher
Financial Statement Effects of Capitalizing versus Expensing: Debt to equity ratio
Capitalizing: Lower Expensing: Higher
Financial Statement Effects of Capitalizing versus Expensing: Income Variability
Capitalizing: Lower Expensing: Higher
Financial Statement Effects of Capitalizing versus Expensing: Net Income (future years)
Capitalizing: Lower Expensing: Higher
Net Income after tax under FIFO will be greater than LIFO net income after tax by:
Change in LIFO Reserve x (1-tax rate)
Distribution of Risk in Sequential Pay CMO for A Tranche
Contraction Risk: High Extension Risk: Low
Distribution of Risk in Sequential Pay CMO for Z Tranche
Contraction Risk: Low Extension Risk: High
Annualized Standard Deviation
Daily Standard Deviation x (Days in Year)^.5
Expected Loss
Default Probability x Loss severity Given Default
Parties of the securitization of an ABS: Seller Description and example
Description: Originates the loans and sells loans to the SPV, ABS Company
Parties of the securitization of an ABS: Servicer Description and example
Description: Services the loans, servicer
Parties of the securitization of an ABS: Issuer/Trust Description and example
Description: The SPV that buys the loans from the seller and issues the asset-backed securities, SPV
Impact of Inventory Write-Down on Various Financial Ratios: Inventory Turnover
Effect on Numerator: COGS increases Effect on Denominator: Average inventory decreases Effect on Ratio: Higher (improves)
Impact of Inventory Write-Down on Various Financial Ratios: Net Profit and Gross Profit Margins
Effect on Numerator: COGS increases so profits fall Effect on Denominator: Sales remain the same Effect on Ratio: Lower (worsens)
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Inventory Turnover Ratio
Effect on Numerator: COGS is higher under LIFO Effect on Denominator: Average Inventory is lower under LIFO LIFO: Higher
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Current Ratio
Effect on Numerator: Current assets are lower under LIFO Effect on Denominator: Current Liabilities are the same LIFO: Lower
Impact of Inventory Write-Down on Various Financial Ratios: Current Ratio
Effect on Numerator: Current assets decrease (due to lower inventory) Effect on Denominator: Current liabilities remain the same Effect on Ratio: Lower (worsens)
Impact of Inventory Write-Down on Various Financial Ratios: Debt to equity and debt ratio
Effect on Numerator: Debt levels remain the same Effect on Denominator: Equity decreases (due to lower profits), and current assets decreases (due to lower inventory) Effect on Ratio: Higher (worsens)
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Net Profit and Gross Profit Margins
Effect on Numerator: Income is lower under LIFO because COGS is higher Effect on Denominator: Sales are the same under both methods LIFO: Lower
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Quick Ratio
Effect on Numerator: Quick assets are higher under LIFO as a result of lower taxes paid Effect on Denominator: Current liabilities are the same LIFO: Higher
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Total Asset Turnover Ratio
Effect on Numerator: Sales are the same Effect on Denominator: Lower total assets under LIFO LIFO: Higher
Impact of Inventory Write-Down on Various Financial Ratios: Total Asset Turnover
Effect on Numerator: Sales remain the same Effect on Denominator: Total assets decrease Effect on Ratio: Higher (improves)
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Debt to Equity and debt ratio
Effect on Numerator: Same debt levels Effect on Denominator: lower equity and assets under LIFO LIFO: Higher
Ending Inventory (FIFO)
Ending Inventory (LIFO) + LIFO Reserve
Cash Flow Effects of Lease Classification: CFO
Finance Lease: Higher Operating Lease: Lower
Income Statement Effects of Lease Classification: EBIT (operating income)
Finance Lease: Higher Operating Lease: Lower
Income Statement Effects of Lease Classification: Net Income (later years)
Finance Lease: Higher Operating Lease: Lower
Income Statement Effects of Lease Classification: Total Expenses (early years)
Finance Lease: Higher Operating Lease: Lower
Income Statement Effects of Lease Classification: Nonoperating Expenses
Finance Lease: Higher (interest expense) Operating Lease: Lower (none)
Income Statement Effects of Lease Classification: Net Income (early years)
Finance Lease: Lower Operating Lease: Higher
Income Statement Effects of Lease Classification: Total Expenses (later years)
Finance Lease: Lower Operating Lease: Higher
Income Statement Effects of Lease Classification: Operating Expenses
Finance Lease: Lower (Depreciation) Operating Lease: Higher (Lease Payment)
Estimated Depreciable Life
Gross investment in fixed assets / Annual depreciation expense
When converting from LIFO to FIFO assuming rising prices current assets (inventory) increases by:
LIFO reserve
When converting from LIFO to FIFO assuming rising prices equity (retained earnings) increases by:
LIFO reserve x (1-tax rate)
When converting from LIFO to FIFO assuming rising prices liabilities (deferred taxes) increases by:
LIFO reserve x tax rate
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: COGS
LIFO: Higher
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Total Cash Flow
LIFO: Higher
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: EI
LIFO: Lower
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Income Taxes
LIFO: Lower
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Income before taxes
LIFO: Lower
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Net Income
LIFO: Lower
LIFO and FIFO Comparison with Rising Prices and Stable Inventory Levels: Working Capital
LIFO: Lower
Yield Spread
Liquidity Premium + Credit Spread
Conversion Ratio
Market Price of common stock x Conversation ratio
Market conversation premium ratio
Market conversation premium per share / Market price of common stock
Premium payback period
Market conversion premium per share / favorable income differential per share
Market conversion price
Market price of convertible security / conversation ratio
Give Summary of Relationship between Benchmark, OAS, and Relative Value for Bond Sector with lower credit rating than security
Negative OAS: If security OAS > required OAS, then Underpriced; if security OAS = required OAS, then properly priced; if security OAS < required OAS, then Overpriced Zero OAS: Underpriced (cheap) Positive OAS: Underpriced (cheap)
Give Summary of Relationship between Benchmark, OAS, and Relative Value for Issuer's own securities
Negative OAS: Overpriced (rich) Zero OAS: Fairly Valued Positive OAS: Underpriced
Give Summary of Relationship between Benchmark, OAS, and Relative Value for Bond Sector with higher credit rating than security
Negative OAS: Overpriced (rich) Zero OAS: Overpriced (rich) Positive OAS: If security OAS > required OAS, then Underpriced; if security OAS = required OAS, then properly priced; if security OAS < required OAS, then Overpriced
Give Summary of Relationship between Benchmark, OAS, and Relative Value for Treasury Market
Negative OAS: Overpriced (rich) Zero OAS: Overpriced (rich) Positive OAS: If security OAS > required OAS, then Underpriced; if security OAS = required OAS, then properly priced; if security OAS < required OAS, then Overpriced
Remaining Useful Life
Net investment in fixed assets / Annual depreciation expense
Prepayment Risk in different PAC Tranches
PAC 1 - Senior: Low PAC 2 - Junior: . PAC II: . Support: High
Yield on a Corporate Bond
Real risk-free interest rate + Expected Inflation Premium + Maturity Premium +Liquidity Premium + Credit Spread
Prepayment in month t
SMM x (Beginning mortgage balance for month t - scheduled principal payment in month t)
Manufactured Housing backed securities ABS
SMM/(1+(SMM x (M-1)))
Convertible callable and putable bond value
Straight Value + Value of call option on the stock - Value of call option on the bond + Value of the put option on the bond
Convertible Security Value with Call option
Straight Value + Value of the Call Option on the stock
Convertible Callable Bond Value
Straight Value + Value of the Call Option on the stock - Value of the Call option on the Bond
Average Life of Mortgage
Sum from t = 1 to T, (t x projected principal received at time t)/(12 x total principal)
Value of Call Option
Value of Option Free Bond - Value of Callable Bond
Value of put option
Value of putable bond - Value of Option-free bond
Historical Yield Volatility
X(t) = 100 x ln(y(t)/y(t-1))
Option cost using spread models
Z-Spread - OAS
Market conversation premium per share
market conversion price - current market price
Variance of Daily Yield Changes (assuming heavier weight for recent changes)
sum from t = 1 to T of (W(t) * X(t)^2) / T-1
Variance of Daily Yield Changes (assuming equal weight)
sum from t =1 to T of X(t)^2 / T-1
