CFA Level One
A portfolio is 30% invested in stocks, Standard Dev=20%, with the remainder in bonds, Standard dev=12%. The correlation of bond returns with stock returns is .60. what is the standard deviation of portfolio returns?
W1=30% ST=20%, W2=70% ST=12% (30%^2+20%^2)+(70%^2+12%^2)=2*30%*70%*.6*20%*12% =1.67% (if this was the covariance we would not need to sqrt the answer) =1.67% Sqrt=12.9 Portfolio standard deviation
Which of the following methods for estimating the weights for calculating a firms WACC is least acceptable A. Current proportions of debt and equity based on balance sheet values B. Industry average weights for debt and equity C. Firms announced target capital structure
answer is A. Current proportions of debt and equity based on balance sheet values *Best If the company has a target capital structure, use the weights in the target capital structure If the firm does not have a target capital structure: 1. Assume that the company's current market weighted capital structure 2. Review company's capital structure trend to obtain an inference about the target capital structure 3. Use the averages of comparable company's capital structure as the companies target capital structure Based on Market values not Balance Sheet values, worst choice
Duration Gap
difference between a bond's Macaulay duration and the bondholder's investment horizon
Matching Principle
recognize expenses in the same period as the revenues they help to generate
Standard VI(C) Referral Fees
requires members and candidates to disclose any compensation received for referrals and the nature of the compensation, to their employers and to any clients or prospects they refer to others with the expectation of compensation in any form.
Negotiable Certificates of Deposit (CDs)
fixed-maturity interest-bearing deposits with face values of $100,000 or more that can be resold in the secondary market
Monopolist will expand output until:
marginal revenue equals marginal cost *A monopolist seeks to maximize profit, not price
Convexity is greatest for bonds that.......
with long maturities and lower coup rate i.e everything else equal a 10 year zero coupon bond will have a greater convexity than a 2 year 3% coupon bond
Cash Flow From Operations (CFO)
Includes CF from interest received and paid, dividends received -Includes all income taxes paid
Income Tax Expense Formula
Income tax expense=Taxes payable+change in DTL- changes in DTA
Basic EPS
(Net Income - Preferred Dividends)/(Weighted Average of Shares Outstanding) -Ignore common dividends Weighted-Average # of Shares: Stock splits and stock dividends retroactively applied for full year
Cash Flow From Financing (CFF)
*Difference between the lenders and the company -Cash raised from equity and debt -Cash spend on repurchasing equity or redeeming debt -*Dividends paid
Call market vs Continuous trading market
-Call Market: Stocks trade at specific times at one price that clears the market for the stock -Continuous market: Trades occur at any time the market is open at prices set by auction or by dealer quotes
Cash flow from Investing (CFI)
-Cash spent on long-term assets -Proceeds from the sale of long-term assets -Cash flows from investments in joint ventures, affiliates, and long-term investments in securities (trading securities are CFO)
Indenture (Trust Deed)
-Contract between issuer and bondholder -Administered by trustee -Affirmative covenants: actions issuer is required to take Negaive coventants: restrictions on issuers actions
GIPS requirements
-Discontinued portfolios must be included in composites -Portfolios must be assigned to composites before the returns are known -Assigning them at the end of the year is not acceptable -Must be asset weighted, not simple average (equal-Weighted) -Document in writing the policies and procedures used to comply with GIPS -Specifically define what constitutes the form that is claiming compliance
GIPS Portfolios Composite
-Each composite must include all discretionary portfolios that the firm has managed according to that particular composite strategy or style, including closed accounts -*Model results may not be included in composite results
IFRS CFO, CFI and CFF -Interest Received------ -Dividends Received--- -Interest Paid------------ -Dividends Paid--------- -Overdraft---------------
-Interest Received------CFO/CFI -Dividends Received---CFO.CFI -Interest Paid------------CFO/CFF -Dividends Paid---------CFF/CFO -Overdraft---------------Cash, not CFF
Limit for Investment grade bonds & non-investment grade
-Investment grade-Bonds graded Baa3/BBB- -Non-Investment grade-Ba1/BB+ or lower *Analyst should not rely exclusively on credit ratings to draw conclusions about the credit risk or loss severity of bond investments*
Maintenance Margin
-Investors minimum required equity position (% of the stock price) -If stock price goes below the maintenance margin level, this triggers a margin call formula original price *[(1-initial margin %)/(1-maintance margin %)]
Payback and discounted payback
-Number of years to recover the investment cost -Payback period is a measure of LIQUIDITY, not value or return; should use NPV or IRR i.e the PI is 2, the project will have a will recover its initial investment in 2 years -You can have a negative NPV and a positive IRR and a PI of 2
Internal Rate of return (IRR) Definition
-The discount rate which gives NPV=0
Asset-based models
-Value of equity=fair value of assets-fair value of liabilities -Useful for firms with large proportion of tangible assets that have readily available market values (e.g., short term securities, natural resources) -Less reliable for firms with significant intangible value (e.g., service reputation); asset-based valuation may be viewed as floor value for firm
Duration of a bond portfolio
1) Weighted average of time to receipt of the aggregate cash flows - Theoretically correct but rarely used - Based on cash flow yield, IRR of portfolio cash flows - Can't be used if bonds have embedded options 2) Weighted average of the individual bond's durations - May be used with effective durations - Assumes parallel shifts in the yield curve Formula: Bond A (Full Price/Par value)*Duration+.....+Bond X (Full Price/Par value)*Duration
1. Additional rule of probability 2. Total rule of probability 3. Multiplication rule of Probability
1. Additional rule of probability: Is used to calculate the probability that at least one of two events will occur - P(A or B)=P(A)+P(B)-P(AB) 2. Total rule of probability: is used to calculate the unconditional probability of an event given conditional probabilities -P(A)=P(A|B1)P(B1)+....+P(A|BN)P(BN) 3. Multiplication rule of probability: used to calculate the joint probability that two events will occur together: P(AB)=P(A|B)*P(B) I.e the probability that it will rain and an earthquake will occur
1. Arithmetic mean 2.harmonic mean 3. Geometric Mean
1. Arithmetic mean: used to forecast next years return -Best estimate of a single years return 2. Harmonic mean: compute the average cost of shares purchased over time -Nit typically used to compute the historical performance or forecast the expected performance of an investment 3. Geometric mean: Best estimate of future mulit year annual compound returns Formula GM=[(1+X1)(1+X2).....(1+XN)]^(1/N)-1
1. Capital rationing 2. Project sequencing 3. Capital preservation
1. Capital rationing: or prioritizing projects to maximize the increase in company value -Necessary when a firm only ahs a limited amount of funds to invest 2. Project sequencing: Involves more than one project sequenced over time, and an unfavorable outcome for one project can cause cancellation of the next project in the sequence 3. Capital preservation: is an investment return objective that involves an investment return at least equal to the inflation rate with minimal chance of loss
3 fiscal accounts 1. Current Account 2. Capital Account 3. Financial Account
1. Current Account (Similar to the income statement) -Merchandise and services -Income receipts -Unilateral Transfer 2. Capital Account -Capital transfer -Sales, purchases of non-financial assets 3. Financial Account (Debt + Equity) -Government-owned assets abroad -Foreign-owned assets in the country Current Account must equal Capital Account+Financial Account
Drag on liquidity vs. Pull on liquidity
1. Drag on liquidity: Either delay or reduce cash inflows -Inventory obsolescence -Uncollected receivables 2. Pulls on liquidity: Accelerate cash outflows or limited access to credit -Paying vendors to soon -Reduction in credit
Industry Life Cycle 1. Embryonic stage 2. Growth Stage 3. Shakeout stage 4. Mature stage 5. Decline stage
1. Embryonic stage: slow growth, high prices, large investment required, high risk of failure 2. Growth Stage: Rapid demand growth, low competition, falling prices, increasing profitability 3. Shakeout stage: slower growth, intense competition, increasing overcapacity, declining profitability, cost cutting, increased failure 4. Mature stage: Slow growth, industry consolidation, high barriers to entry including brand loyalty and efficient cost structure 5. Decline stage: Negative growth, excess capacity leads to price competition, higher production costs as demand falls, weak companies merge or exit
4 Roles of PMs in Efficient Market
1. Establish portfolio risk/return objectives 2. Portfolio diversification 3. Implement asset allocation based on risk/return objectives 4. Tax minimization
1. Hard hurdle rate 2. Soft hurdle rate 3. High water mark
1. Hard hurdle rate: means that incentive fees are earned only on returns in excess of the benchmark return 2. Soft hurdle rate: Means that incentive fees are calculated on the entire return, but are only paid if the return exceeds the hurdle rate 3. High Water mark: specifies that incentive fees are only paid on returns that increase an investors account value above its highest previous value
How to find the cost of Capital for a Company
1. If the company has a target capital structure, use the weights in the target capital structure 2. Do not know the target capital structure A. Assume that the company's current market weighted capital structure is the target capital structure *NOT what the current proportions of debt and equity based on balance sheet values* B. Review company's capital structure trends to obtain an inference about the target capital structure C. Use the averages of comparable companies capital structures as the company's target capital structure -Companies in the same industry not just similar size
LM vs. IS curve economics (IS-LM Model)
1. LM Curve: Illustrates a positive relationship between real income and the real interest rate, holding the real money supply constant 2. IS Curve: illustrates a negative relationship between real income and the real interest rate, holding the marginal propensity to save constant
External factors (Industry and Company analysis) 1. Macroeconomics 2. Technology 3. Demographics 4. Social Influences 5. Government
1. Macroeconomics: Economic output, interest rates, credit availability, inflation 2. Technology: New or improved products 3. Demographics: Age distribution, Population 4. Social Influences: How people conduct their lives and choose to spend their income 5. Government: Tax rates, business regulation, purchases
Accept or Reject: 1. NPV 2. Profitability index (PI) 3. IRR
1. NPV: If NPV>0, accept project NPV<0, Reject Project 2. PI: If PI>1, accept project PI<1, reject project Formula PI=1+{(NPV)/(Initial investment)} 3. IRR: If IRR>Required return, accept project IRR<Required return, reject project
Central Bank Policy rate tools
1. Open Market Operations (MOST USED) 2. Required Reserve Ratio 3. Discount Rate: rate that the central bank charges other banks
Operating Cycle vs. Cash Conversion Cycle
1. Operating Cycle: days of inventory+Days Receivables 2. Days of inventory+ days of receivables-Days payable *Also called Net Operating cycle -Days of inventory= 365/Inventory turnover -Days of receivables=365/receivables -Days of payable=365/payables turnover *The shorter these cycles, the greater a company's ability to generate cash and less need for outside finance*
1. Organizational infrastructure 2. Contractual infrastructure 3. Legal infrastructure
1. Organizational infrastructure: refers to a company's corporate governance procedures and includes its internal systems and practices that address how it MANAGES its STAKEHOLDER relationships 2. Contractual infrastructure: refers to CONTRACTS between a company and its STAKEHOLDERS 3. Legal infrastructure: refers to lows that govern STAKEHOLDER relationships
1. Positive Screening 2. Full integration 3. Active ownership 4. Thematic Investing
1. Positive screening: -Best-in-class is an example of positive screening Best-in-class: portfolio manager selects the stocks within each industry/sector that have the most favorable ESG characteristics, without excluding the industry 2. Full integration: refers to including ESG factors in fundamental analysis 3. Active ownership: is using share voting and access to company management to pursue ESG objectives 4. Thematic Investing: strategies are based on a single ESG factor
3 Key advantages of derivatives
1. Provide price information 2. Reduce Transaction Costs 3. Shift risk among market participants
1. Quality of reported results 2. Financial reporting quality
1. Quality of reported results: Adequacy and sustainability of earnings 2. Financial reporting quality: refers to issues related to the relevance and faithful representation of financial reports
The four categories that credit rating agencies look at are
1. Scale and diversification 2. operational efficiency 3. margin stability 4. Leverage Larger companies and those with more different product lines and greater geographical diversification are better credit risk. High operating efficiency is indicative of better credit risk *Sally Operates Mary's Leverage*
GDP 1. The sum-of-value-added 2. Total GDP
1. The sum-of-value-added: Method of calculating GDP records the sum of the increases in value of goods and services at each stage of their production and distribution 2. The resulting total for GDP is the same as that reached by the Value-of-final-output method because the sum of value added to a good at all stages of processing is equal to its selling price. **Both methods calculate GDP based on expenditures**
the nine major sections of GIPS
1. fundamentals of compliance 2. input data 3. calculation methodology 4. composite construction 5.disclusures 6. presentation and reporting 7. real estate 8. private equity 9. wrap fee/separately managed account (SMA) portfolios
4 steps in the capital budgeting process
1. generate ideas 2. Analyzing projects proposals 3. creating the firm-wide capital budget 4. monitoring decisions and conducting post audit *Raising additional capital is not a step*
3 functions of money
1. medium of exchange 2. unit of account 3. store of value
U.S. GAAP Sales type lease:
A lessor will recognize the lease value as revenue and the carrying value of the asset as cost of goods sold if the lease is classified as a sales-type lease
Management discussion and analysis (MD&A)
A section of the annual report that presents management's views on the company's ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations. -Material changes in the firms cost of debt capital will be included
A trader who owns a stock that is trading at 48 and would like to buy more shares if it increases in value to 52 should enter: A. A limit buy order at 52 B. A market buy order at 52 C. A stop buy order at 52
A stop buy order at 52 A limit buy order at 52 and a market buy order would both be executed immediately
Pannonia Enterprises, Inc. (PEI) has a target capital structure of 40% debt with 60% equity. PEI's pretax cost of debt will remain at 9% until the firm raises more than $200,000 in new debt capital, at which point its pretax cost of debt will increase to 9.5%. PEI's cost of equity will increase when more than $400,000 in equity capital is raised. PEI's break point for debt capital is closest to: A. $200,000 B. $500,000 C. $666,667
Answer B. $500,000 Capital component breakpoint=(Value at which components cost of capital changes)/(Components weight in WACC Debt Breakpoint=(200,000)/.40=$500,000
The market value of equity for a company can be calculated as enterprise value A. Minus market value of debt, preferred stock, and short-term investments B. Plus market value of debt and preferred stock minus short-term investments C. Minus market value of debt and preferred stock plus short term investments
Answer C. Minus market value of debt and preferred stock plus short-term investments EV=Market value equity+ market value preferred+ Market value of debt- Short-term investments & Cash For finding the equity you subtract what is added and add what is subtracted for the market value of the equity
Analysist has generated the following data: Tax Rate=35% Equity Multiplier=2.7 Net profit Margin=4.6% Equity turnover=5.2 ROE is closest to: A. 13% B. 17% C. 24%
Answer c. 24% Net income/Sales*Sale/Equity Net income/Equity=4.6*5.2=23.92%
A stock is expected to pay a dividend of $2.00 in one year and $2.50 two years from now. The dividend is then expected to grow at 5% for the foreseeable future. If the required rate of return is 10%, the value of the stock today is closest to: A. $45.00 B. $47.00 C. $50.00
Answer is 47.00 D0=2.00 D1=2.50 (will grow for ever at a constant rate two years from now) 2.00/1.10=1.818----D1/(K-g) 2.50/(.10-.05)=50 Holding period of n years Dn+Pn/(1+ke)=1.818+50/1.10=47.0909
The continuously compounded annual rate of return of return that would increase the value of an investment by 20% in three years is closest to: A. 5.7% B. 6.1% C. 6.7%
Answer is 6.1% ln(1.20)/3=0.0608 or 6.08%
An analyst develops the following information to value a common stock. Last year's earnings per share = $4.00 Real risk-free rate = 4% Inflation premium = 5% Return on equity (ROE), expected to remain constant in the future = 10% Dividend payout, expected to remain stable in the future = 30% Stock's beta = 1.4 Expected market return = 14% The value per share is closest to: A. $14.39 B. 21.28 C.31.39
Answer is A. 14.39 1. RFR nominal=(1+rf)(1+Inflation)-1 -(1.04)(1.05)-1=9.20% 2. CAPM (Use the RFR nominal instead of just Rf) -RFR+B(Rm-RFR)=15.92% 3. Find the dividend -Earnings per share*Dividend payout=4*.30=1.20 4. find the growth rate -Retention Rate*ROE=.70*10=7% 5. formula D1/Ke-g 1.20(1.07)/{15.92%-7%)=14.39
The Following information is for Perla Corp -Inventory at cost=8.45 -Completion cost=1.4 -Selling expenses=4% -Normal profit margin=12% IF Perla reports under IFRS, its inventory value is: A.7.77 Million B. 8.45 Million C. 9.17 Million
Answer is A. 7.77 Million. Cost vs. NRV (Net Realized Value) 8.45m 7.77m Expected sales price=9.55 million, strip out the selling expense -9.55m*96%-1.4m =7.77m under IFRS you can pick the lower value=7.77m *Only need to use the Normal profit margin if you're using US GAPP and LIFO
The following information is for Perla Corp · Inventory at cost=8.45 million · Completion costs=1.4million · Expected sales price=9.55million · Selling expenses=4% · Normal profit margin=12% IF Perla reports under IFRS, its inventory value is: A. 7.77 million B. 8.45 million C. 9.17 million
Answer is A. 7.77 million · Inventory at cost=8.45 million, use Inventory at cost if NRV higher than inventory at cost · Completion costs=1.4million · Expected sales price=9.55million · Selling expenses=4% · Normal profit margin=12% Use the NPM for Retail or LIFO NRV=9.55(1-.04)-1.4=7.768
If a researcher conducting empirical tests of a trading strategy using time series of returns finds statistically significant abnormal returns, then the researcher has most likely found: A. A market anomaly B. Evidence of market inefficiency C. A strategy to produce future abnormal returns
Answer is A. A market anomaly Evidence that does not fit into the accepted model Abnormal returns
In major developed bond markets, newly issued sovereign bonds are most often sold to the public via a(n): A. Auction B. Private placement C. Best effort offering
Answer is A. Auction Sovereign bonds are sovereign bonds and major governments issue with an auction for the primary offering
Shirley Shea has evaluated an investment proposal and found that its payback period one year, it has a negative NPV, and it has a positive IRR. Is this combination of results possible? A. Yes. B. No, because a project with a positive IRR has a positive NPV. C. No, because a project with such a rapid payback period has a positive NPV.
Answer is A. yes Ex. CFO=(-100) CF1=100 IRR=0 we invest 100 and get 100 CFO=(100) CF1=100 CF2=10 we would have a positive IRR, if the required rate of return is 20 we would get a negative NPV with a positive IRR
An investor buys a stock on margin at a price of $70. The initial margin requirement is 40%, and the maintenance margin is 25%. Below what stock price will the investor receive a margin call? A. $52.00 B. $56.00 C. $59.50
Answer is B $56.00 Formula =Original stock price*[(1-Initial Margin %)/(1- Maintenance Margin%)]
Using historical index returns for an equities market over a 20-year period, an analyst has calculated the average annual return as 5.60% and the holding period return as 170%. The compound annual index return over the period is closest to: A. 2.69% B. 5.09% C. 5.24%
Answer is B. [(1+HPR)^(1/n)] [(1+1.70)^(1/20)]-1=.050916
Last year Acme Corp. bought an asset for $72,000, depreciation expense was $15,000 accumulated depreciation increased by $5,000, and gross PPE increased by $32,000. If a gain on an asset sold during the year was $13,000, the sales proceeds on the asset sale were: A. $30,000 B. 43,000 C. 48,000
Answer is B. $43,000 We our looking at PP&E which is a cashflow from investing 1st Depreciation Depreciation Expense=$15,000 Accumulated Depreciation=$5,000 *Accumulated Depreciation on the asset sold 10,000 2nd Gross value PP&E Asset Original price=$72,000 Increase in price=$32,000 Gross value (Cost of asset)=40,000 3rd Net book value of Asset Gross Value=40,000 Accumulated Depr=10,000 Net book value=30,000 30,000+13,000=43,000 (Sale proceeds)
Jason Williams purchased 500 shares of a company at $32 per share. The stock was bought on 75 percent margin. One month later, Williams had to pay interest on the amount borrowed at a rate of 2 percent per month. At that time, Williams received a dividend of $.50 per share. Immediately after that he sold the shares at $28 per share. He paid commissions of $10 on the purchase and $10 on the sale of stock. What was the rate of return on this investment for the one month period A. -12.5% B. -15.4% C. -50.1%
Answer is B. -15.4% 500*32=16,000, cash margin=.75*16,000=12,000 Purchase commission and sales commission=10+10=20 Loan=4,000*.02=250 (interest) Sale amount=500*28= Dividends=250 Beginning cash=12,000+10=12,010 (10,160)/12,010)-1=-15.4%
The 90-day euro Libor is 3% and the 90-day AUD Libor is 4% (both annualized rates). The spot EUR/AUD rate is 0.7276. The 90-day forward AUD/EUR no-arbitrage rate is closest to A. 1.3877 B. 1.3778 C. 1.3710
Answer is B. 1.3778 (1+Int price/1+int base)*spot .03*.25=.0075, .04*.25=.01 (1.01/1.0075)*(1/.7276)=1.3778
A three-year investment requires an initial outlay of $1,000. It is expected to provide three year-end cashflows of $200 plus a net salvage value of $700 at the end of three years. Its internal rate of return (IRR) is closest to: A. 10% B. 11% C. 20%
Answer is B. 11% CF0=-1,000 CF2=200 IRR=11.0258 CF1=200 CF3=200+700 Or (Annuity style) N=3 PV=-1000 PMT=200 FV=700 CPT I/Y 11.0285
An analyst gathered the following data about a stock: The stock paid a $1 dividend last year. -Next year's dividend is projected to be 10% higher. -The stock is projected to sell for $25 at the end of the year. -The risk-free rate of interest is 8%. -The expected return on the market is 13%. -The stock's beta is 1.2. The value of the stock today is closest to: A. 19.45 B. 22.89 C. 26.74
Answer is B. 22.89 CAPM 8+1.2(13-8)=14% P0=(P1+D1)/1+K=26.10/1.14=22.89
Information from the 20x1 financial statements Revenue=500 Cost of goods sold=100 Decrease in accounts receivable=20 Increase in ending inventories=15 Increase in accounts payable=40 Calculate cash received from customers and paid to suppliers Cash received from customers Cash paid to suppliers A. 500m 60m B. 520m 75m C. 535m 85m
Answer is B. Cash received from customers 520, cash paid to suppliers is 75m 500+20 (decrease in accounts receivable) Decrease in AR is a source of cash Cash paid to suppliers (100)+15-40=75m Increase in inventories is a use of cash increase in AP is a source of cash
A deferred tax asset would most likely be created by. A. Using straight-line depreciation for financial reporting and using an accelerated method for tax returns B. Differing treatment of warranty expenses for taxes and for financial reporting C. Utilizing an existing tax loss carryforward to reduce a given year's taxes payable
Answer is B. Differing treatment of warranty expenses for taxes and for financial reporting A. Using straight-line depreciation for financial reporting and using an accelerated method for tax returns (This would be a deferred Tax Liability) C. Utilizing an existing tax loss carryforward to reduce a given year's taxes payable (would bring down the DTA)
For the issuer, a sinking fund arrangement is most similar to a: A. Term maturity structure B. Serial maturity structure C. Bondholder put provision
Answer is B. Serial maturity structure Sinking bond provision: allow the firm to save up and retire the bond on a schedule which is a serial structure *With a sinking fund or a serial maturuity structure, the issuer retires some portion of the outstaind bonds periodically.*
A researcher who concludes that a market is not semi-strong form efficient will be most likely to also conclude that the market A. Is not weak-form efficient B. Is not strong-form efficient C. May be strong-form efficient
Answer is B. is not strong-form efficient If it is not Semi strong it means you can use public information to beat the market, which means that it would not be strong strong If it is not semi strong it can not be strong form
Which of the following is most likely considered a weakness of present value models? A. Present value models cannot be used for companies that do not pay dividends B. Small changes in model assumptions and inputs can result in large changes in the computed intrinsic value of the securities C. The value of the security depends on the investors holding period; thus, comparing valuations of different companies for different investors is difficult
Answer is B. small changes in model assumptions and inputs can result in large changes in the computed intrinsic value of the security A. False, Present value models can be used for companies that do not pay a dividend (i.e. Discounted cash flow model, Dividend Discount model is just one Present value model) B. True, G and K maybe different with different investors, D can be off but it tends to be very close C. The present value looks at the value of discount cashflows for investors not just you a. Has nothing to do with holding periods
Which of the following statements regarding corporate shareholders is most accurate? A. Cross-shareholders help promote corporate mergers B. Dual-class structures are used to align economic ownership with control C. Affiliated shareholders can protect a company against hostile takeover bids
Answer is C Affiliated shareholders can protect a company against hostile takeover bids A. Cross-shareholders help promote corporate mergers Cross shareholders are across multiple firms B. Dual-class structures are used to align economic ownership with control: Is when you have two classes of stock a. Ex Facebook, you have one share that trades and you have another class of founder shares, that get more votes than the other classes C. Affiliated shareholders can protect a company against hostile takeover bids: Affiliated shareholders have a working relationship with the board, affiliated can vote inline with management
The internal rate of return (IRR) is best described as the: A. Opportunity cost of capital B. Time-weighted rate of return C. Discount rate that makes the net present value equal to zero
Answer is C Discount rate that makes the net present value equal to zero · We do not know what the opportunity cost of capital is · Time-weighted rate of return: money Weighted return is part of the IRR time-weighted rate of return is a geometric mean return
A company will pay a dividend of $1 per share at the end of the next 8 years. After that, the dividend will grow at the rate of 4% per year. If the required rate of return on equity is 8%, the current value of the stock according to the dividend discount model is closest to: A. $18.72 B. $19.30 C. $19.79
Answer is C. $19.79 D7/Ke-g 1/(.08-.04)=25 CF0 = CF1= 1 CF2=1 CF3=1 CF4 =1 CF5 =1 CF6=1 CF7(25+1) =26 I=8 NPV=19.79 *Take The dividend that will grow at a constant rate for ever and slap that into the formula and discount it back to the present value* *D8/k-g=P7 similar to an annuity problem
Jan 1 10,000 shares Mar 1 3,000 shares July 1 20% stock dividend Nov 1 3,000 shares repurchased The weighted average number of shares outstanding over the year equals A. 12,000 B. 11,300 C. 14,500
Answer is C. 14,500 shares *Dividends and stock splits added retroactively Jan 1 10,000 shares*20% div 10,000*1.2=12,000 Mar 1 3,000 shares*1.2=3,600*(10/12)=3000 July 1 20% stock dividend Nov 1 3,000 shares repurchased 3,000(2/12)=(500) 12,000+3000-500=14,500
Using the dividend discount model, what is the cost of equity capital for Zeller Mining if the company will pay a dividend of $2.30 net year, has a payout ratio of 30%, a return on equity (ROE) of 15%, and a stock price of $45 A. 9.61 Percent B. 10.50 percent C. 15.61 percent
Answer is C. 15.61% (D1/P0)+G G=Retention Rate*ROE Retention rate= (Payout rate-1) G=(.70*.15)=10.50% (2.30/45)+10.50%=15.61
A firm has a constant growth rate of 7% and just paid a dividend of $6.25. If the required rate of return is 12%, what will the stock sell for two years from now based on the dividend discount model? A. 133.75 B. 149.80 C. 153.13
Answer is C. 153.13 value @ t=2= D3k−g=D0(1+g)3k−g=$6.25(1.07)^3/0.12−0.07=$153.13
The EUR/USD exchange rate fell from 0.897 to 0.874. Relative to the USD, the EURO has appreciated by: A. 2.36% B. 2.56% C. 2.63%
Answer is C. 2.63% (1/.874)/(1.897) Divide by one since we are looking for the value of the EUR not USD
A project with an initial cost of 300 will generate cash flows of 100 in year 1, 125 in year 2, and 150 in year 3. Using a discount rate of 6%, this project's net present value is closest to and the IRR: A. 29.75 NPV, 20.8% IRR B. 30.25 NPV, 11.9% IRR C. 31.50 NPV, 11.2% IRR
Answer is C. 31.50 IRR 11.2% CFO=-300 CF2=125 I=6 CF1=100 CF3=150 NPV=31.532 CPT IRR=11.218
An investors purchases an annual coupon bond with a 6% coupon rate and exactly 20 years remaining until maturity at a price equal to par value. The investors investment horizon is eight years. The approximate modified duration of the bond is 11.47 years. The duration gap at the time of purchase is closest to: A. -7.842 B. 2.470 C. 4.158
Answer is C. 4.158 The I/Y that we use for the Macauley duration is 1.06 because price is equal to par MacDur=ModDur*1+I/Y MacDur=11.470*1.06=12.158 Similar to ModDur=MacDuc/(1+YTM) just rearranged Duration Gap=12.158-8=4.158
Dot.Com has determined that it could issue $1,000 face value bonds with an 8 percent coupon paid semi-annually and a five-year maturity at $900 per bond. If dot.com's marginal tax rate is 38 percent, its after tax cost of debt is closest to: A. 6.2 percent B. 6.4 percent C. 6.6 percent
Answer is C. 6.6% N=10 (semi annual) PV=(900) PMT 40, FV=1000 CPT I/Y=5.3149*2=10.6299(1-.38)=6.6 Percent
Jack is considering purchasing a bond that is currently priced at 85.50. After performing a scenario analysis, Jack computed the following prices for the bond for 50bp shifts in the benchmark yield curve: +50bp 82.51 -50bp 88.63 This bond's effect duration is closet to: A. 3.6 B. 6.0 C. 7.2
Answer is C. 7.25 88.63-82.51/2*85.50*.05 Remember that effective duration is also used for bonds with options looking at the change in the yield curve
Which of the following statements regarding corporate shareholders is most accurate? A. Cross-shareholdings help promote corporate mergers B. Dual-Class structures are used to align economic ownership with control C. Affiliated shareholders can protect a company against hostile takeover bids.
Answer is C. Affiliated shareholders can protect a company against hostile takeover bids. -Affiliated shareholders are friends with management Cross-shareholdings (i.e company A. holds shares in company B. and B. holds shares in company A.) -Used to help protect against M&A Dual-Class structure: you have to classes of shares -One has voting rights and one does not, does not align economic ownership with control (you can be an owner and not have control)
Free cash flow to equity would be best measured as A. CFO minus fixed capital investment minus net borrowing B. Total cashflow plus financing cash flow minus investing cash flow C. CFO minus debt principal payments plus debt issued minus fixed capital investment
Answer is C. CFO minus debt principal payments plus debt issued minus fixed capital investment A. Should be plus net borrowing FCFE=CFO-Fixed capital investment+Net borrowing
Which of the following is an indication that a company may be recognizing revenue prematurely? Relative to its competitors, the company's: A. Asset turnover is decreasing. B. Receivables turnover is increasing C. Days sales outstanding is increasing
Answer is C. Days sales outstanding is increasing A. Asset turnover is decreasing. Sales/Assets if it was increasing would be assign of premature B. Receivables turnover is increasing Credit (sales)/Accounts receivable C. Days sales outstanding is increasing an increase in days sales outstanding may indicate premature or even fictitious revenue
Since 20x1, the price index in Island has increase by 22.4%, while the price index in Mainland has increased by 33.4%. Over the period, the nominal exchange rate (ISL/Main) has decreased by 10% the real exchange rate over the period has: A. Decreased by approximately 17% B. Increased by approximately 1% C. Decreased by approximately 2%
Answer is C. Decreased by approximately 2% (1-10%)*1.334/1.224-1=.019% 1st .90*1.334 2nd 1.2006/1.224=.9809 3rd .9809-1=.019 or 2%
Which of the following is most likely to reflect conservative accounting choices? A. Decreased reported earnings in later periods B. Increased reported earnings in the current period C. Increased debt reported on the balance sheet at the end of the current period
Answer is C. Increased debt reported on the balance sheet at the end of the current period Conservative accounting choices tend to decrease reported earnings in the current period and increase debt reported on the balance sheet
Which of the following best describe a negative bond covenant? The requirement to: A. Insure and maintain assets B. Comply with all laws and regulations C. Maintain a minimum interest coverage ratio
Answer is C. Maintain a minimum interest coverage ratio Question A. "Insure and maintain assets" would be a positive covenant, because they require the company to do some thing - C. is tell the company to not leverage up too much
Accounting policies, methods, and estimates used in preparing financial statements are most likely to be found in the: A. Auditors report B. Management commentary C. Notes to the financial statements
Answer is C. Notes to the financial statements Management Commentary only has the most significant notes Notes to the financial statement: will have method for depreciation, what is in COGS
For financial assets classified as available for sale, how are unrealized gains and losses reflect in shareholders equity? A. They are not recognized B. They flow through retained earnings C. They are a component of accumulated other comprehensive income
Answer is C. They are a component of accumulated other comprehensive income
Consider a bond trading at full price of 980: - YTM increases 0.5%, full price decreases to 960 - YTM down by 0.5%, full price increases to 1,002 The approximate Modified duration is A. Equal to 4.4 B. Greater than 4.4 C. Less than 4.4
Answer is C. less than 4.4 Approximate Modified duration=(V_-V+)/(2*V0-Change{in basis point}) (1,002-960)/(2*980*.005)=4.29 On the exam you might need to first calculated 960 and 1,002 first
an investor short sells at 100, the price goes down to 90 or the stock price goes up to 110 what type of order would the investor place at 90 and at 110? A. stop loss at 90, limit buy at 110 B. stop loss at 110, limit buy at 90 B. market order at 110, limit buy at 90
Answer is b. stop loss at 110, limit buy at 90 -the investor would want to buy the stock back at a lower price than 100, limit buy (unleveraged) would be a profit of $10
For analytical purposes an analyst would prefer to use: A. LIFO COGS and FIFO inventory. B. FIFO COGS and FIFO inventory C. FIFO COGS and LIFO inventory
Answer: A. LIFO COGS and FIFO inventory Analyst wants the current value FIFO gives a current value of inventory -Will give the year end value
A float-adjusted market-capitalization-weighted index weights each of its constituent securities by its price and: A. its trading volume B. The number of its shares outstanding C. The number of its shares available to the investing public
Answer: C. The number of its shares available to the investing public Float-adjusted----When you calc the market cap you do not want to count all shares only the shares to the public
When calculating the mean absolute deviation use the:
Arithmetic mean approach
Auditor/Audit Opinion
Auditor/Audit Opinion 1. Independent review 2. Reasonable assurance statements are presented fairly, free from material error 3. Conformity with accounting standards, consistency and reasonableness of accounting methods and estimates 4. Sarbanes-Oxley (US only): Opinion on Internal Controls 1) Unqualified opinion (good); 2) Qualified opinion (followed GAAP except for...); 3) Adverse opinion (bad) 4)Disclaimer of Opinion (unable to form an opinion)
Short-run disequilibrium is most likely to be associated with a decreasing price level if it results from a decrease in: A)both aggregate demand and short-run aggregate supply. B)aggregate demand, if short-run aggregate supply is unchanged. C)short-run aggregate supply, if aggregate demand is unchanged.
B)aggregate demand, if short-run aggregate supply is unchanged. A decrease in aggregate demand, holding short-run aggregate supply constant, would decrease the price level. A decrease in short-run aggregate supply, holding aggregate demand constant, would increase the price level. If both aggregate demand and short-run aggregate supply decrease, the price level may increase or decrease.
With respect to the capital asset pricing model, the market risk premium is: A. Less than the excess market return B. Equal to the excess market return C. Greater than the excess market return
B. Equal to the excess market return (Rm-Rf)=Market risk premium
Which of the following derivatives is least likely to have a value of zero at initiation of the contract? A. Futures B. Options C. Forwards
B. Options you must pay a premium for options
Based on the binomial model, an increase in the actual probability of an upward move in the underlying will result in the options price: A. decreasing B. Remaining the same Increasing
B. Remaining the same -Does not look at the actual probability, uses the RISK NEUTRAL probabilities
Assume a call option's strike price is initially equal to the price of its underlying asset. Based on the binomial model, if the volatility of the underlying decrease, the lower of the two potential payoff values of the hedge portfolio: A. Decreases B. Remains the same C. increases
B. Remains the same Example: strike $20 Up move 25% down move 25% -up move 20*1.25=25 -Down move 20/1.25=16 ($0) Change the volatility 20% upmove=20*1.2=24 Downmove 20/1.2=16.67 (less than 20=0) Regardless of the volatility the lower of the two moves=0
If a bond has a convexity of 120 and a modified duration of 10, the convexity adjustment (to a duration-based approximation) associated with a 25 basis point interest rate decline is closest to: A. -2.875% B. -2.125% C. +.0375
C. +.0375 convexity adjustment to % change P=.5*Convexity measure *[(ChangeYTM)^2*100 .5(120)(-.0025)^2(100)=.0375
Accounting policies, methods, and estimates used in preparing financial statements are most likely to be found in the: A. Auditor's report B. Management commentary C. Notes to the financial statements
C. Notes to the financial statements Auditors report--- will look at the notes to the financial statements to make sure these are fair and accurate Management Commentary----- giving more detail and outlook of the company
An effective risk management process used by alternative investment funds most likely includes: A. In-house valuations B. Internal custody of assets C. Segregation of risk and investment process duties
C. Segregation of risk and investment process duties -You want one person to be analyzing the risk and one person identifying the investment opportunities You want valuations from the market prices
CAPM Definition and formula
CAPM: the fair return for the security given its risk value relative to Beta E(Ri)=Rf+B[E(Rm)-Rf] Country risk Premium: K=Rf+B(Rm-Rf+CRP) Inflation risk Premium: (1+inflation)(1+RF)
What type of risk does the issuer of Commercial papers (CD's) have?
CDs have roll over risk which is the risk that an issuer who relies on the commercial paper market as a funding source may not be able to issue new commercial paper when an outstanding issue matures -Default risk and reinvestment risk are faced by bondholders
Collaterized Debt Obligation (CDO)
Collaterized Debt Obligation (CDO): are just mortgage backed securities bundled together with different tranches and different levels of risk (Return based on the borrower paying its payments. 1. Senior-Lowest level of risk, lowest yield 2. Mezzanine-Medium risk medium yield 3. Equity-Highest risk, Highest level of yield *Considered a waterfall structure (Gives some bondholders a higher priority of claims than others) -Synthetic CDOS: Have portfolios of CREDIT DEFAULT SWAPS as the underlying collateral
Ricardian Model
Comparative advantage results from differences in labor productivity; labor is only factor considered
Heckscher-Ohlin model
Comparative advantage results from different relative amounts of labor and capital in each country -International trade increases price of, and wealth of owners of, less scarce factors
Credit Default Swap
Credit Default Swap: is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default or other credit event. That is, the seller of the CDS insures the buyer against some reference asset defaulting -CDS short the(Bet against) the MBS market. They pay out if the value of an MBS drops CDO Tranche 1. Senior-Low Risk, Cheap CDS 2. Mezzanine-Medium, Average CDS cost 3. Equity-High risk-Expensive CDS
Expected price to earnings formula
D1/E1/(K-g) or D1-Retention rate/(K-G) D1=Dividend E1=Expected retention ratio K=Required rate of return G=Expected growth rate of dividends
When is a DTA and DTL created
DTA= Tax expense < Taxes payable DTL=Tax expense > Taxes payable Deferred tax liability refers to balance sheet amounts that are created when tax expense is greater than taxes payable
Degree of total leverage (DTL)
DTL=Degree of Operating leverage*Degree of financial leverage DTL: measures the sensitivity of earnings per share to a change in sales
Dealer buys at ________. price and sells at __________. Price
Dealer buys at Bid price Dealer sells at Ask price
Decreasing LIFO Reserve vs. LIFO liquidation
Decreasing LIFO Reserve: Decreasing prices can cause LIFO reserve to decrease even when the inventory quantity is stable or increase LIFO Liquidation: Is a decrease in the quantity of inventory
Private equity Drawdown period
Drawdown period: is the span of time over which the fund will draw down its committed capital and use it to invest in portfolio companies -Time PE will select investments and direct committed capital to them
Enterprise Value (EV)/EBITDA
EV=Market value of common stock+Market value of debt-cash and short-term investments -EV represents total market value of firm -EBITDA represents total earnings to both debt and equity investors Most useful when: 1. Firm have different capital structures 2. Earnings are negative and P/E ratio cannot be used
Trading instructions 1. Execution 2. Validity 3. Clearing
Execution: How to Trade -i.e market or limit order Validity: When to trade -Good-till-cancelled, immediate, day orders -Stop orders: Execute if price reaches specified level Clearing: How to settle trade
FCFF Formula
FCFF=CF from operations+Interest expense net of tax-Net capital expenditures -Interest=Interest (1-.35) -Net capital expenditures -PPE=minus -Add sale of land *Depreciation and amortization do not have to be added when calculating FCFF from CFO. They are added when calculating FCFF from net income
Flat price or Clean price vs. Full price or dirty price
Flat price (clean price): does not include accrued interest -Full price (Dirty price) includes accrued interest
Forward rate curve
Forward rate curve: is composed of forward rates of the same tenor at different future periods i.e 1-year forward rate one year and two years from now
Grey market bonds
Grey market bonds: Bonds that have not been issued yet -bonds on a when-issued basis
Standard I(A) Knowledge of the Law
Holds members and candidates responsible for violations in which they knowingly participate or assist. The standard is not limited to violations that are proven by a regulatory authority. - Although the standard strongly encourages members and candidates to report potential violations of which they are aware, the standard does not require them to do so.
Index-linked bond 1. Interest-index 2. Capital index
Index-Linked:Coupon or principal adjusted based on published index 1.Interest-index: Coupon rate adjusted for inflation, principal remains fixed 2. Capital indexed: Principal adjusted for inflation, coupon rate remains fixed (e.g. TIPS in U.S.)
The first requirement of the code of the Ethics:
Is that members and Candidates "act with integrity, competence, diligence, respect, and in an ethical manner with the public, clients, prospective clients, employees, colleagues in the investment profession, and other participants in the global capital markets
significance level
Is the probability that a true null hypothesis will be rejected (Type I error) by chance because the test statistic is from a sample and may take on a value that is outside the range of critical values because of sampling error i.e given a significance level of 5%, a test will reject a true null hypothesis 5% of the time
management buyout (MBO)
Management buyout: refers to a situation where an investor group that includes the firm's key management purchases all the outstanding shares (not just a controlling interest) of a public company in order to take it private. -Once this is done, the shares are no longer registered for public trading and, as a result, are no longer traded on exchanges or in other public markets.
Net Present Value Definition
NPV: Present value of expected cash inflows less the present value of cash outflows
Monetary Policy Neutral Interest Rate
Neural Interest Rate: Trend growth rate of real GDP+Inflation target - Expansionary: Policy Rate<Neutral rate -Contractionary: Policy Rate>Neutral Rate (Fed makes the Policy Rate)
Mosaic Theory
No violation when analyst combines public information with items of NONMATERIAL information (such as seeing two CEOs have lunch). -Not in violation even if the combined info makes it Material
Inventory costs
Normal cost of getting inventory into current condition and location Excludes: 1. Abnormal costs 2. Storage costs 3. Selling costs 4. Admin overheads
nonparametric tests
Often transform the original data into ranks or signs
You have 5 stocks and want to sell 3, one at a time. How many ways are there to choose the 3 stocks to sell in order? A. 10 B. 15 C. 60
Permutation formula since it needs to be in order n!/(n-r)!=5!/(5-3)!=60 If it does not need to be in order use n!/(n-r)!r!
Cost of preferred equity:
Preferred dividend divided by the market price of preferred share -*Use market price NOT PAR VALUE
Following indicates the market demand function Q=84-3.1P+8I+0.9Px P=$38, I=$100, Px=18 Compute Price -Cross Price Elasticity -Price Elasticity
Q=84+(-)117.8+80+16.2=62.4 -Cross Price Elasticity=16.2/62.4=.3 Since it is positive if Px goes up quantity demand will go up (substitute goods) -Negative means they are complement goods Price Elasticity=-117.8/62.4=-1.9
economics Quantity theory of money:
Quantity of Money: Hypothesizes that a change in the money supply, at full employment, will cause a proportional change in the price level because VELOCITY and REAL OUTPUT will be UNAFFECTED. According to the equation MV=PY, output of goods and services produced (Y) at full employment cannot change, so the price level (P) must increase
Elmer has won his state lottery and has been offered 20 annual payments of $200,000 each beginning today or a single payment of $2,267,000. The annual discount rate used t calculate the single-payment amount is closet to? A. 6.15% B. 6.75% C. 7.00%
Question 1 Answer: C 7.00% Use BGN mode N=20 PV=-2,267,000 FV=0 PMT=200,000 CPT I?Y=7.00%
Returns on an index of 100 stocks are approximately normal, have a mean of 9%, and a std. dev. Of 15%. A 99% confidence interval on next year's index return is: A. -20.4 to 38.4% B. -29.7% to 47.7% C. 5.1% to 12.9%
Question 10. Answer B. -29.7% to 47.7% # of ST 2.58 M=9%, SD=15% 2.58*15%=38.70% 9%+38.70=47.7 9%-38.70=-29.7%
Annual returns on energy stocks are approximately normally distributed with a mean of 9% and standard deviation of 6%. A 90% confidence interval on the mean of the annual returns for a sample of 12 energy stocks is closest to: A. -1 to 18% B. 2% to 16% C. 6% to 12%
Question 11. Answer 6% to 12% SD/sqr of 12 9%+-1.65(6/sqr12), 6.14% to 11.86% Since we have more than one stock the movement of the stock decreases and why we add SD/sqr of N
In testing the hypotheses that the mean monthly return on an investment strategy is less than or equal to zero, a researcher reports a p-value of 5%. The test statistic the researcher found is closest to: A. 1.65 B. 1.96 C. 2.55
Question 12. Answer A. 1.65 This is one tail test, a test statistic of 1.65 has a p-value of 5%
Which of the following statements about hypothesis tests of the equality of two population means is least accurate? A. The statistics used to test the equality of two population means follow a t-distribution B. The test statistic for a difference in means test uses a pooled variance if the population variance is unknown C. Equality of population means can be tested whether the samples are dependent or independent
Question 13. Answer B. The test statistic for a difference in means test uses a pooled variance if the population variances are unknown Only pool the two variances when they are equal not unknown One of the t distributions is used when they are independent and one when they are dependent
What is the appropriate test statistic for a hypothesis test concerning the variance of a normally distributed population? A. The t-statistic B. The chi-square statistic C. The F-statistic
Question 14. Answer B. The Chi-square statistic
The Market demand function for four-year private universities is given by the equation Qd=84-3.1P(Private)+0.8Income+0.9P(public) Assume that P(private)=38, income =100, and P(public) is equal to 18 The price elasticity of demand for private universities is closest to: A. -3.1 B. -1.9 C. .6
Question 15. Answer B. -1.9 Plug in formula 84-3.1(38)+0.8(100)+0.9(18)=62.4 %ChangeinQ/%change in pgood Price elasticity=(-3.1*38)/62.4=-1.89
Th short-term shutdown point of production for a firm operating under perfect competition will most likely occur when: A. Price is equal to average total cost B. Marginal revenue is equal to marginal cost C. Marginal revenue is equal to average variable costs
Question 16. Answer C. Marginal revenue is equal to average variable costs Under prefect competition marginal revenue=Price (MR=P) Demand curve for Prefect competition is horizontal (Showing no pricing power)
When the economy is operating at full-employment GDP, the short-run and long-run effects of an increase in the rate of growth of the money supply are to: A. Decrease real interest rates in the sort run and increase real GDP in the long run B. Increase real GDP in the short run but not in the long run C. Increase the price level and real GDP in both the short and long run
Question 17. Answer is B. Increase real GDP in the short run but not in the long run You can not increase GDP above the full employment rate
Question 18. Based on typical labor utilization patterns across the business cycle, productivity (output per hours worked) is most likely to be highest: A. At the peak of a boom B. Into a maturing expansion C. At the bottom of a recession
Question 18. Answer C. At the bottom of a recession Takes business time to fire and hire people
The least likely limitation t o the effectiveness of monetary policy is that central banks cannot: A. Accurately determine the neutral rate of interest. B. Regulate the willingness of financial institutions to lend C. Control amounts that economic agents deposit into banks
Question 19. Answer A. Accurately determine the neutral rate of interest. A. Accurately determine the neutral rate of interest. a. Neutral rate: Trend growth rate of real GDP +Inflation target i. Expansionary Policy rate<Neutral rate ii. Contractionary Policy rate>Neutral rate Regulate the willingness of financial institutions to lend: Is of the last recession, banks would go A. out and by safe assets instead of lending to the public B. Control amounts that economic agents deposit into banks Central banks can not control how much economic agents deposit
Cliff Corporation's dividends the past six years where $0.31, $0.12, $0.40, $0.50, $0.60, and $.70. The compound annual growth rate of dividends over this period is closet to: A. 14.5% B. 17.7% C. 46.7%
Question 2. Answer B 17.7% Geometric Mean (End Value/Bgn Value)-1=Compound Growth Rate (.70/.31)^(1/5)-1=17.69
If country A has relatively more labor than country B, which produces many labor-intensive goods, the most likely result of opening their economies to free trade will be: A. Increase wealth of the owners of capital and wages in country B. B. Increase the wealth of the owners capital in Country B. C. Increase wages in Country B
Question 20. Answer is B. Increase the wealth of the owners capital in Country B. Looking at Labor productivity and capital using the Heckscher-Ohlin Model instead of Ricardian Model (Looks at just labor productivity)
The sale of mineral rights would be captured in which of the following balance of payments components A. Capital Account B. Current Account C. Financial Account
Question 22. Answer is A. Capital Account Current account=Goods & Services Financial account=Financial securities Capital Account=Physical securities, PPE, Mineral rights none financial assets
A mutual fund had the following returns over 5 years: 6%, 11%, -3%, 8%, 15%. What is the average annual compound rate of return? A. 7.14% B. 7.23% C. 7.40%
Question 3. Answer B. 7.23% Geometric Mean= [(1.06)(1.11)().97)(1.08)(1.15)]^(1/5)-1
Returns on an index of 100 stocks over four years are 15%, -5%, 12% and 22%. The estimated annual standard Deviation of returns is closest to: A. 9.84% B. 11.46% C. 12.14%
Question 4. Answer B. 11.46% X=(15-5+12+22)/4=11% S=[15-11)^2=(-5-11)^2+(12-11)^2+(22-11)^2/(4-1)=131.3 Square root of 131.3=11.46%
The probability that a random variable will be within: A. 1.96 Standard Deviations of the mean is at least 74% B. 1.65 Standard deviations of the mean is at least 90% C. 2.5 Standard deviations of the mean is at least 85%
Question 5. Answer is A 1.96 Standard Deviations of the mean is at least 74% Problem says random variable not normal [1-1/1.96^2]=74%
An investment was purchased 18 months ago for $88. The investment is now worth $165. The stated annual rate of return with continuous compounding is closest to: A. 42% B. 63% C. 88%
Question 6. Answer is A. 42% ln(165/88)*(12/18)=42%
You have been asked to select 4 of 10 energy stocks in a portfolio to be sold to reduce exposure to that industry. How many different groups of four could you select? A. 210 B. 420 C. 5,040
Question 8. Answer A. 210 n!/(n-r)!r! 10!/(10-4)!x4!=210 Order does not matter
P(Interest rate increase)=70% P(Recession|Increase) 60% P(Recession|No interest rate increase)=20% What is the (unconditional probability of recession? A. 80% B. 62% C. 48%
Question 9. Answer C. 48% P(Recession)=0.60*0.70+.20*.30=48% P(R|I)P(I)+P(R|Id)P(Id) (.30 comes from .70-1=.30)
Quick ratio formula (acid test)
Quick ratio=(Cash+marketable securites+Accounts receivable)/Current liabilities
Recessionary gap VS. Inflationary gap
Recessionary gap: causes downward pressure on prices, when the short fun, real GDP is less than its full employment level Inflationary gap: causes upward pressure on prices when GDP is more than its full employment *Long-run macroeconomics equilibrium, actual real GDP is equal to potential real GDP and these is no upward or downward pressure on the price level*
Standard IV(B) Additional Compensation Arrangements
Requires that members and candidates obtain WRITTEN consent from their employers to enter into the agreement for additional contingent compensation from a client
Non-financial risks
Risks that arise from sources other than changes in the external financial markets, such as changes in accounting rules, legal environment, or tax rates. -solvency risk -Tail risk -Operation risk -Legal risk
Macroeconomics S=I+(G-T)+(X-M) X-M=S+(T-G)-I
S=Private Savings T=Taxation G=Government Spending X=Trade exports M=Trade Import's -In order to be a net exporter you also need to be a net saver
Spot vs. Forward Rates
Spot rate: discount rate for single payment in the future *To find the future spot rate use the geometric or arithmetic mean Forward rate: Rate today for a loan to be made in the future Example 2Y1Y 2(When you start investing, start in year two)1Y(how long you will invest) -Starting in year two and will be invested for two years
Portfolio management Invest $1,000 in account at time zero -value at end of year is 1,200, investor adds $800 -Value at end of year 2 is $2,200 Calculate the annual time weighted return and Money Weighted Return
TWR: 0------------------1------------------2 1200/1000= 2,200/2,000= 20% 10% (1.2*1.1)^1/2-1=14.89 MWR 0------------------1------------------2 (1,000) (800) +2,200 CFO=(1000) CPT IRR=13.62% CF1=(800) CF2=2,200
Taxable income>Pretax income, DTA or DTL? Taxable income<Pretax income, DTA or DTL When will be permanent difference?
Taxable income>Pretax income, DTA Taxable income<Pretax income, DTL Permanent difference between taxable income and pretax income is when it will not be reversed
Ricardian Equivalence
Taxpayers increase savings in anticipation of higher future taxes in an amount to just offset higher spending
The current 1-year spot rate is 6%, the 2 year spot rate is 7%, and the 3 year spot rate is 6% The 1 year forward rate for a loan two years from now is Closet to: A. 6% B. 5%
The answer is C 4% Y(period ahead)y(length of time) 2 year spot rate=7%+7%=14% 6%*6%*6%=18% 18%-14%=4% Or (1.6^3/1.07^2)-1=0.04028=4.028% Or 3*6-2*7=18-14=4
Equity Constant Growth Formula
V0=D0(1+g)/(ke-g) or D1/Ke-g -Assumes constant growth and ke>g g=RR*ROE Retention Rate=(1-DPR), RR is the amount that the company does not pay out as a dividend K is unknown use CAPM
Equity Two-Stage DDM formula
V0=Dt/(1+Ke)^t+Vn/(1+ke)^n If companies experience rapid high growth>Ke use Two-Stage DDM -break away the high growth and the normal growth part
Standard IV(B) Additional Compensation Arrangements
To comply with Standard IV(B) Additional Compensation Arrangements, because the additional compensation is contingent on future performance, Nelson must disclose this additional compensation to her employer and must receive WRITTEN consent, which can be email or any other form of communication that can be documented.
Inventory costs reversals U.S. GAAP and IFRS
U.S. GAAP: subsequent reversal prohibited IFRS: Subsequent reversal allowed
Equity Holding period of n years formula
V0=(D1/1+ke)+(D2/1+ke)^2+.....+(Dn+Pn/1+ke)^n
equity one-year holding period formula
V0=([D1+P1)/(2+ke)]
Diluted EPS
[(Net Income - Preferred Dividends) + Convertible Preferred Dividends + Convertible Debt Interest * (1-t)] / [Weighted Average Shares + Shares from Conversion of Preferred Shares + Shares from Converted Debt + Shares from Issuable Stock Options]
Business risk is
sales risk and operating risk Sales risk: which is the variability of a firms Operating risk: which is the additional variability in operating earnings (EBIT) caused by fixed operating cost
Appropriate test for an F test
the larger sample variance is placed in he numerator F test=Larger sample variance/smaller sample variance
