CFA Level 1 UFE

Price Multiples

+Price-to-Earnings +Price-to-Book Value +Price-to-Cash Flow

Private Equity in Comparison to Public Equity

*Less liquid *Share price negotiated between firm and investor, not the market *No government or exchange requirement for disclosures *Lower reporting costs since they are less frequent *Weaker corporate governance since there is less public scrutiny *Greater focus on long-term prospects since no public pressure for short-term results *Potential for large return once firm goes public

Reasons to Overstate Earnings

*Meet earnings expectations *Remain in compliance with lending covenants *Receive higher incentive compensation

Steps in a Fixed-For-Fixed Currency Swap

*Notional principal is swapped at initiation (Party A gets Currency B and Party B gets Currency A) *Full interest payments are exchanged at each settlement date, each in a different currency *Notional payment is returned at the final settlement date

Reasons to Understate Earnings

*Obtain trade relief in the form of quotas and protective tariffs *Negotiate favorable terms from creditors *Negotiate favorable labor contracts

Benefits of Intermediaries

*Savers fund entrepreneurs *Companies share risk

Current account components

-Merchandise and services -Income receipts -Unilateral transfers

4 types of ADR's (chart page 268 bk 4)

-OTC -NYSE, NASDAQ, AMEX -NYSE, NASDAQ, AMEX -Private

Types of Dividends

-Regular dividends -Special dividends -Liquidating dividends -Stock dividends -Stock splits -Reverse stock splits

Segment Reporting

1) if 50% of its revenue is earned externally 2) if a business area has at least 10% of a firm's: Revenue; or Operating profit; or Use of asset 3) Business and geographical segments

DTA Issues

1) will only benefit on reversal if there is sufficient taxable earnings. 2) can only utilize loss carryforwards if we have future profits 3) If asset cannot be utilized in full it is reduced by a contra "valuation allowance". REDUCE DTA, REDUCE NI

Total Leverage

= Degree of Operating Leverage * Degree of Financial Leverage

Return on Capital

= EBIT / Capital

Int. Coverage

= EBIT/Interest Expense

Defined Contribution Pension Expense

= Employer's Contribution

Asset Beta

= Equity Beta * [1/1 + (Debt/Equity)(1 - Tax Rate)]

Gross Profit margin

= Gross profit/ revenues LIFO = lower, FIFO = higher

Money Market Yield

= HPR * (360/days until maturity)

FIFO ending inventory

= LIFO ending inventory + LIFO reserve \FIFO after-tax profit

proceeds on sale formula

= NBV +/- gain or loss

Target zone

A set range a currency is allowed to fluctuate relative to another currency; Larger movement range than a fixed peg

Permutational Ordering

A specific ordering of a group of objects and answers the question of how many different groups of size r in specific order can be chosen from n objects; P = (n!) \ (n - r)!

Deferred Tax Liability and Asset Adjustments

Adjusted for changes in expected tax rates under the liability method

Cash Flow: Logic (A = L + E)

A: Increase = use cash (-), Decrease = source cash (+) L: Increase = source cash (+), Decrease = use of cash (-) E: Increase = source cash (+), Decrease = use of cash (-)

Annual Equivalent Yield

AEY = [1 + (YTM/2)]^2 - 1 OR AEY = [1 + (BEY/2)]^2 - 1

Use of Solvency Ratios

Ability to pay back long-term obligations

Liquidity Pull

Accelerate cash outflows

T-Bonds

Bonds have maturity of more than 10 years (20 to 30 years). Non-Callable.

Treasury Notes and Bonds

Bonds pay semi-annual coupons at a rate fixed at issuance; Notes have maturities of 2, 3, 5, and 10 years; Until 1984, were callable every 5 years; Bonds have maturities of 20 or 30 years

IFRS/US GAAP Frameworks: Measurement of Elements:

Both: Broadly consistent, lack fully developed concepts FASB: Assets revaluations prohibited (except some financial instruments)

Form 10-K

Annual report

What role does Arbitrage play in determining prices and promoting market efficiency?

Arbitrage keeps prices in line across markets, products. If arbitrage opportunities are available, they will be taken advantage of until the prices converge - "The Law of One Price"

Which call provision gives investors protection against call risk?

Call protection period.

options which benefit issuer

Call provisions, prepayment options, sinking fund provisions, and caps. CAPPAID=issuer

Value of a Callable Bond

Callable Bond Value = Value of Option Free Bond - Value of Call

Dividend Discount Model

Cost of Equity = (Expected Constant Growth Rate) + [(Next Year's Dividend)/(Stock Price)]

Bond Yield + Risk Premium

Cost of Equity = Risk Free Rate + Risk Premium

Coupon & YTM Relationship to Duration

Cpn and YTM are inversely related to Dur. low cpn then longer dur. high cpn then shorter dur.

Arbitrage CDO

Created by a sponsor seeks to profit from the spread between the rate earned on the underlying assets and the rate promised to CDO holders

Chapter 7 versus Chapter 11 bankruptcy protection

Ch. 7 = protection for liquidation Ch. 11 = protection for reorganization

Geometric Mean

Compounded annual rate of return for an investment

Creative Cash Flows Accounting: Technique

Delay Supplier pymt: boost CFO; review days' sales in AP; Financing of payables: use N/P to pay off AP; manipulate timing of CFO; Securitization of A/R: accelerates appearance of collection, boosts CFO; Tax benefit of stock options: lower tax paid on option exercise; Buybacks to offset dilution: net flows treated as CFF not CFO.

Credit Spread Risk

Diff btwn a Bd's Yld and comparable Risk Free Bd's Yld. All else equal the riskier the bd the higher the spread.

Flotation Costs

Fees charged by investment banks when raising equity capital; Correct way to account for flotation costs is to include them in the initial project cost

Mezzanine Financing

Financing enables the company the financing to go public

Differentiation Strategy

Firm's products are distinct; Cost of differentiation must be less than the premium customers will pay for it; Pricing premium must be sustainable; Require extensive market research and creative personnel

Price-book value

Firms stock price divided by book value of equity per share

Finance (capital) Lease criteria GAAP vs. IFRS

GAAP: more quantitative rules IFRS: more qualitative approach based on whether the risks and reward of the asset have tranferred.

Bond Issuance Cost under GAAP/IFRS

GAAP: shown as a separate prepaid asset and amortized. IFRS: Deducted from proceeds and liability therefore effective interest rate is HIGHER under IFRS than GAAP.

Define intrinsic value and time value, explain their relationship.

Intrinsic value is what an option is worth if exercised at expiration in the current conditions. Time value: the difference between intrinsic value and the market price of the option. As it gets closer to expiration, time value goes to zero and all that is left is intrinsic value.

Convexity Coupon, Yield, and Maturity

Inverse relationship btwn cpn & convexity,if yld and mat constant. Inverse relationship btwn yld & convexity,if cpn and mat constant. Direct relationship btwn mat & convexity,if yld and cpn constant.

Money Market Fund

Invest in short-term debt securities and provide interest income with low risk; NAV is set at $1.00

Traveling for Business/to a Client

It is not required the each person pays for their own room

Extraordinary Item

Item that is both unusual and infrequent; Allowed only by GAAP

Inventory mangement: High T/O (low DOH) and sales growth below industry average

Lost sales from stock outs

Amortizing Securities

Make periodic principal and interest pmts (i.e., MBS & ABS).

Market Premium

Difference between the risk free rate and the market return

Long Lived Assets: IFRS v. GAAP

Disclosures are more extensive under GAAP

Why were GIPS created?

Discourage: +Showing a top performing portfolio as representative of a firms total performance +Survivorship bias +Varying time periods

Activity Based Restrictions

Divdends and share repurchases Production and investment M&A New debt issuance Payoff pattern and liquidation priority Maintenance of assets used as collateral

Incremental Cash Flow

Does not include financing costs

How is the expected return for a portfolio calculated?

ERportfolio = Σ(ERstock)(W% of funds invested in each of the stocks) ER = w1ER1 + w2ER2, where ER = Expected Return and w = % invested in each stock.

IASB

EU 1) Int'l Accounting Standards Board; 2) Unified int'l frameworks of accounting standards (IFRS); 3) Addopted by EU in 2005

IOSCO

EU & US 1) Int'l Org. of Securities Commission; 2) Goal: uniform regulation; 3) Core objectives: Protecting investor, Fair, transparent, efficient markets, Reduction of systematic risk

Effective Convexity versus Modified Convexity

Effective Convexity takes into account changes in cash flows due to embedded options, while modified convexity does not. The difference between modified convexity and effective convexity mirrors the difference between modified duration and effective duration.

F-Test Statistic

Examines two sample variances, with the larger in the denominator and smaller in the numerator

continuous compounding

FV = PV x e ^ (rate * time period)

Contingent Claim

Options - Give a buyer the right but not obligation to buy/sell a security at a predetermined price and date. Includes OTC and exchange traded options.

Hidden Orders

Orders where only the broker knows the trade size

Primary Market

Market for newly issued securities secondary market is for subsequent sale of securities

Headline inflation

Measures inflation of all goods

Health Care

Pharmaceuticles Biotech

What is the relationship between interest rate volatility and Call or Prepayment Risk?

Positive.

Form DEF-14A

Proxy statement

Debt Securities

Promises to repay borrowed funds

Put Option Z Spread

Put Option Z-spread < OAS.

Peak

Real GDP stops increasing and starts decreasing Inventory to sales ration increases

Increasing Required Rate of Return and Decreasing Dividend Payout

Reduce a company's PE

Security (Prime) Brokers

Provide loans to investors who purchase securities on margin

Seed Stage

Providing capital in the earliest stage of business; Helps fund research and development

Long-Term Fixed Income

Securities that have maturities more than 5 years; Usually called bonds

Insurance Contract

Security that pays a cash amount if a future event occurs; Used as a hedge

Resale

Sell the swap to another party with the permission of the counterparty

Marginal Cost of Capital Break Points

Show changes in the cost of capital

Coefficient of Variation

Standard deviation divided by the mean

Performance Presentation

Statements about performance must be accurate, fair and complete.

Potentially Dillutive Securities

Stock options, Warrants, Convertible debt, Convertible preferred stock

Maximum Price of a Call Option

Stock's current price

Index Amortizing Notes

Structured Note with fixed coupons but pay back some principal early based on a reference rate

Muni Revenue Bonds

Supported only through revenues generated by projects that are funded with the help of the original bond issue.

Total Risk =

Systematic Risk + Unsystematic Risk

Roy's Safety First Criterion

The optimal portfolio minimizes the probability that the return of the portfolio falls below A minimum acceptable level; = (Historical Return - Return Threshold)/(Volatility) Shortfall risk is the probability of being to the left of the minimum return

After-Tax Nominal Return

The return after tax liability is deducted

Net Return

The return of a security after fees and expenses are paid

Greenmail

The right of the company to use corporate funds to buy back the shares of a hostile acquirer at a premium to market value

Call Option

The right to buy

Call Option

The right to buy an asset at a certain price by a certain date; Counterparty has the obligation to sell the asset

Put Option

The right to sell

Put Option

The right to sell an asset at a certain price by a certain date; Counterparty has the obligation to buy the asset

Up move factor

U - 1.01

Which set of accounting standards requires firms to disclose estimated amortization expense for the next five years on intangible assets?

U.S. GAAP

Properties of Estimators

Unbiased - Low sampling error Efficient - Small variance Consistent - Accuracy increases as sample size increases

Exchange Rate Risk

Uncertainty about the value of foreign currency cash flows to an investor in terms of his domestic currency

Z-Test

Used to calculate a mean when population is known to be normally distributed

Formal dollarization

Using another country's currency; Country can't set its own monetary policy

Paasche index

Weights its basket based on current consumption

Null Hypothesis

What you are testing

Best Efforts IPO

When a bank agrees to distribute shares but if undersubscribed, bank does not buy unsold portion

Cash-Settled Forward Contract

When the party with a negative value pays the party with the positive value in cash

Operating Cycle

The time it takes to produce or purchase inventory, sell it, and collect the cash

Frictional unemployment

The time lag necessary to match employees to employers

Measures of Operating Performance - Efficiency Ratios:

Total assets TO = Revenue/Avg. total asset Fixed asset TO = Revenue/ Avg. net fixed assets Working Cap TO = Revenue/Avg. working captial

Net Asset Value

Total net value of its assets divided by the shares outstanding

Gross Return

Total return in a security before fees and expenses

Financial Assets: US GAAP/Fair Market Value

Trading securities Available-for-sale Derivatives (standalone or embedded in non-derivative intrument) Assets with fair value exposure hedged by derivatives

Financial Risk

additional risk that a firm's common stockholders must bear when a firm uses fixed cost (debt) financing. LT leases also introduce risk.

Operating Risk

additional uncertainty about operating EARNINGS caused by fixed operating costs.

correlation

covariance divided by the product of the two standard deviations

IRR decision rule

determine required rate of return for given project. IRR > required rate return, accept IRR < required rate return, reject

Sampling error

difference between a sample statistic and its corresponding population parameter

Internal rate of return

discount rate that makes the PV of the expected incremental after-tax cash inflows just equal to the initial cost of the project. PV (inflows) = PV (outflows)

Cumulative distribution function (cdf)

distribution function, defines the probability that a random variable, X, takes on a value equal to or less than a specific value, x. Represents the sum, or cumulative value, of the probabilities of the outcomes up to and including a specific outcome. F(x) = P(X ≤ x)

Effective annual rate =

e^Rcc - 1

Flotation Costs

fees charged by investment bankers when a company raises external equity capital. incorrect treatment increase the WACC by a fixed percentage and will be a factor for the duration of the project because future project cash flows are discounted at this higher WACC to determine NPV

Callable common shares

firm the right to repurchase the stock at a pre-specified call price

income elastic normal good

ie >1

Standard error of sample mean =

known pop. variance: σx = σ / √n unknown pop. variance sx = s/√n

Commercial paper

large creditworthy companies can issue short-term debt securities called commercial paper. Firm sells paper directly to investors (direct placement) or sells through dealers (dealer-placed paper), interest costs slightly less than rate can get from bank

Drag on liquidity delay

reduce cash inflows, or increase borrowing costs -uncollected receivables and bad debts, obsolete inventory

Parametric Test

rely on assumptions regarding distribution of population and are specific to population parameters.

Cash flow ratios

same as other ratios using NI in this case substitute NI for CFO.

Peer group

set of similar companies an analyst will use for valuation comparisons

Putable common shares

shareholder the right to sell the shares back to the firm at a specific price. places a floor under the share value.

Cumulative voting

shareholders can allocate their votes to one or more candidates as they choose. Benefits shareholders.

min efficent scale

smallest qty of output for which your lrac is minimized

Price-cash flow

stock price / cash flow per share (operating or FCF)

Discounted cash flow models

stocks value is estimated as the PV of cash distributed to shareholders (DDM) or the PV of cash available to shareholders after the firm meets its necessary capital expenditures and working capital expenses (FCF to Equity Model)

Multiple year HP DDM

sum PV of estimated dividends over holding period. value = D1 / (1+Ke),,,,,

Market value of equity

total value of a firms outstanding equity shares based on market prices and reflects the expectations of the investors about the firms future performance.

Liquidating dividends

when a company goes out of business and distributes the proceeds to shareholders. Treated as a return of capital and amounts over the investors tax basis are taxed as capital gains

Cash Flow From Financing (USA) (Source of Cash)

"Equity" -Chg in debt - Cash raised from equity and debt -Chg in c/s - Cash spent on repurchasing equity or redeeming debt -Dividends paid Calculate dividend declared: NI -*Div.Declared = chg in R/E *Div. Declared +(-) chg in div. payable = cash dividend paid

Correlation coefficient formula

(Cov of A and B) / [(STD of A) x (STD of B)

DBY (discount-basis yield)

(Face - purchase price / Face) x 360 / DTM DTM = days to maturity

Treynor Measure =

(Portfolio Return - Risk Free Rate)/Portfolio Beta; Most appropriate when a fund has multiple managers and only has systematic risk

Ways Hedge Funds Use Leverage

*Borrow through a margin account *Borrow externally *Utilize derivatives that do not require trading in cash

Firm Specific Credit Factors

*Past payment history *Quality of management and their ability to adapt to changing conditions *Industry outlook and firm strategy *Overall debt level of firm *Operating cash flow and ability to service debt *Sources of liquidity *Competitive position, regulatory environment and union history *Financial management and controls *Susceptibility to event and political risk

Reasons Floating Rate Might Reset at Par

*Placing a cap on a floating rate can increase the interest rate risk *There is time until the next reset *If the spread in indenture no longer reflects the credit and liquidity risk of the bond

Uses of Ratio Analysis

*Project future earnings and cash flow *Evaluate a firms flexibility *Assess managements performance *Evaluate changes in the firm and industry over time *Compare firms within an industry

Swap and Forward Commonalities

*Require no payment at initiation *Custom instruments *Not traded in a secondary market *Mostly unregulated *Default risk matters *Large institutions are the main players

Porter's 5 Forces

*Rivalry among competitors; *Threat of new entrants; *Threat of substitute products; *Bargaining power of buyers; *Bargaining power of suppliers;

Stages of Venture Capital

*Seed stage *Start-up financing i *First stage financing *Formative stage *Later stage financing *Second stage investing *Third stage investing *Mezzanine financing

Ways to Issue Sovereign Debt

*Single price, regular auction cycle *Multiple price, regular auction cycle *Ad hoc auction services *Tap system

Principles of Capital Budgeting

+Decisions are based on cash flows, not accounting income +Cash flows are based on opportunity costs *Opportunity costs need to be analyzed +Cash flow timing is important +Cash flows are analyzed after taxes +Financing costs are incorporated in the required rate of return

GAAP PP&E Disclosures

+Depreciation expense by period +Balances of major asset classes by nature and function +Accumulated depreciation +General description of the methods used

Advantages of ETFs

+Efficient diversification +Traded like a stock +Better risk management by having options and futures markets +Investors know the exact composition of the fund throughout the day +Low expense ratios +No worry about trading a a premium or discount to NAV +Dividends can be reinvested immediately +Low capital gains tax liability

Features of preparing financial statements

+Fair presentation +Going concern basis +Accrual basis +Consistency +Materiality +Aggregation of only similar items +No offsetting of assets against liabilities or revenues against expenses unless explicitly stated by a standard +Reporting frequency is annual

Types of unemployment

+Frictional +Structural *Different +Cyclical

Shareholders' Equity

+Owner's Equity +Contributed Capital +Par Value is the stated legal value, has no relationship to fair value, and is reported separately in the statement +Shares +Preferred Stock +Non-Controlling Interest +Retained Earnings +Treasury Stock +Accumulated Other Comprehensive Income

Benefits of Derivatives

+Provide price information +Allow risk to be managed and shifted among market participants +Reduce transaction costs

Lags of fiscal policy

+Recognition lag +Action lag +Impact lag

Uses of Market Indices

+Reflection of market sentiment +Benchmark of manager performance +Measure of market risk and return +Measure of beta risk adjusted returns +Model portfolio for index funds

Categories of Capital Budgeting Projects

+Replacement projects to maintain the business +Replacement projects for cost reduction +Expansion projects +New product or market development +Projects mandated by governments or agencies +Projects not easy to analyze under capital budgeting

Premium Bond Effects

+Reported on the balance sheet as above face value +As the premium is amortized the book value of the bond will decrease until it equals par value at maturity

Officer can do:

+Request written response +Interview subject +Interview complainant +Collect documents relevant to the investigation

SEC Forms

+S-1 +10-K +10-Q +DEF-14A +8-K +144 +Forms 3, 4, 5

Causes of Low Quality Earnings

+Selecting legal accounting measures that don't accurately represent the economics of a business +Structuring transactions to get a favorable outcome +Using aggressive or unrealistic estimates and assumptions +Exploiting the intent of an accounting principle

CFA designated officer looks into inquiries raised by:

+Self disclosure of civil litigation, criminal investigation, or written complaint +Written complaints to CFA +Media reports +CFA exam proctor

Inventory Valuation Methods

+Specific Identification +First-in, first-out +Weighted average cost +Last-in, first-out

Markets for Commodities

+Spot +Futures +Forwards

Federally Related Institutions Not Guaranteed

+Tennessee Valley Authority +Private Export Funding Corporation

CMO Creation Motivation

1) Redistribute the prepayment risk 2) Create security with different maturity.

How Central Govts Issue Sovereign Bonds

1) Regular Cycle Auction-Single Price 2) Regular Cycle Auction - Multiple Price 3) Ad Hoc auction System 4) Tap System.

The 4 Qualitative Characteristics of FASB:

1) Relevance & Reliability 2) Comparability 3) Understandability - user specific

Trade-Offs Qualitative Characteristics of IFRS

1) Relevance vs. reliability; 2) Benefit > cost; 3) Excludes intangibles and non-quantifiable info.

Sarbanes-Oxley Management Report:

1) Responsibility to establish and maintain adequate internal controls 2) Mgmt's framework for evaluating internal controls 3) Assessment of the effectiveness of internal controls over the last operating period 4) Statement of auditor's attestment 5) Certify that f/s are fairly presented

4 General Categories for Creditworthiness/Capacity:

1) Scale & Diversification 2) Operational Efficiency 3) Margin Stability 4) Leverage

Short Term Rates and Yield Curve

1) Short Term rates expected to rise then Upward Sloping Curve 2) Short Term rates expected to fall then have a downward Sloping Curve 3) Short Term rates expected to rise then fall then have a Humped Yield Curve 4) Short Term rates expected to remain constant then have a Flat Yield Curve.

Common Size Statement

1) Show each item as a % of Net Revenue 2) Show each inflow as a % of total inflows 3) Show each outflow as a % of total outflow

Types of trade restrictions

-Tariffs -Quotas -Export subsidies -Minimum domestic content -Voluntary export restraint

Discounted Cash Flow Model Advantages

-based on fundamental concept of discounted PV and well grounded in finance theory -Widely accepted in analyst community

Advantages of price multiple valuation based on fundamentals

-based on theoretically sound valuation models -correspond to widely accepted value metrics

Minimum Option Price

0

relatively inelastic

0<|ep|<1

Indirect Cash Flow Method Process

1. Begin with net income 2. Subtract gains or add loses from financing or investing cash flows 3. Add back all noncash charges to income and subtract all noncash components of revenue 4. Subtract increases in operating assets and add back decreases 5. Add increases in operating liabilities and subtract decreases

Porters 5 forces that determine industry competition

1. Rivalry among existing competitors 2. Threat of new entrants 3. Threat of substitute products 4. Bargaining power of buyers 5. Bargaining power of suppliers

Inventory turnover

= COGS / Avg inventory

Inventory TO

= COGS / Avg. Inventory LIFO = Higher, FIFO = Lower

Profitability Index

= Present Value of Cash Flows/Initial Investment = 1 + NPV/Initial Cash Flow

Sustainable Growth

= Retention Rate * ROE

Financial leverage ratio

= Total Assets/Total Equity

free cash flow to the firm calculation

= cfo +int exp(1-t) - CAPEX

Covariance of Op. Inc

= std dev. EBIT/ Mean EBIT

Covariance of Revenue

= std. dev Rev/ mean Rev.

Total Debt to EBITDA

= total debt / EBITDA

Total debt to total debt + equity

= total debt/ total debt + equity

Confidence Interval

A range of values the population parameter is expected to fall under; When a distribution has a known population variance, found by: (sample mean) (+\-) (z-statistic) * (standard error); When distribution population variance is not known, found by: (sample mean) (+\-) (t-statistic) * (standard error)

Operating Lease

A rental agreement; Lessee recognizes rental expense each period and an operating cash outflow; Lessor does not remove asset from balance sheet, recognizes rental income and continues to depreciate the asset

Leveraged Return

A return that is a multiple of the return on the underlying asset

Golden Parachute

A rich severance package for managers who lose their jobs after a takeover

Affirmative Covenants

Actions that the borrower promises to perform.

Factoring

Actual sale of receivables at a discount from their face values. Size of discount will depend on how long it is until the receivables are due, creditworthiness of firms credit customers, and firms collection history on receivables.

Actual/360 Day Count Convention

Actual/360 convention is most commonly used when calculating the accrued interest for commercial paper, T-Bills and other short-term debt instruments that have less than one year to expiration. It is calculated by using the actual number of days between the two periods, divided by 360.

Actual/365 Day Count Convention

Actual/365 convention is the same as the actual/360, except that it uses 365 as the denominator. This is used when pricing U.S. government Treasury Bonds.

Gross Profit

Amount that remains after the direct costs of producing a good are subtracted from revenue

Asset's Tax Base

Amount that will be deducted on the tax return in the future as economic benefits are realized

Average days purchases =

Annual purchases / 365

Repo

Arrangement where an institution sells a security with a commitment to buy it back at a later date at a specified higher price.

Accelerated Depreciation

Applies depreciation more at the beginning of an assets life

Duration/Convexity Approach

Approximates the actual interest rate sensitivity of the bond

Investment Bank's IPO Conflict of Interest

As an agent, they should set a high price to maximized the funds raised for the issuer but, as underwriters, they want the price to be low so the whole issue sells

Impairments recognition (IFRS)

Asset is impaired if carrying value > recoverable amount. One-step process 1) Compare carrying value to: recoverable amount = the greater of the two. a) Fair value - selling costs b) Value in use = (PV of future cash flow from cont. use) *Loss reversal is limited to original impairment loss

Asset Capitalization

Assets held for continuing usage in the business NOT for resale ( Invoice price, Sales Tax, Freight & Insurance, and Installation costs) 1) capitalize costs that result in higher future earnings 2) expense costs that have uncertain/NO impact on future earnings

Effects of Lease Classification on F/S - Finance Lease

Assets: higher Liabilities: Higher NI (Early yrs): Lower CFO: Higher (b/c only interest portion is classed as CFO) CFF: Lower (b/c principal repayment portion) Total CF: Same *Since Int. exp + depre > lease pymt in the early years. This decreases NI, and Profitability ratios.

Effects of Lease Classification on F/S - Operating Lease

Assets: lower Liabilities: lower NI (Early yrs): higher CFO: lower (b/c entire pymt is classed as CFO) CFF: higher Total CF: Same

Standard Costing Inventory

Assigns predetermined amounts of materials, labor, etc to each unit produced

Lagging economic indicators

Average duration of unemployment Inventory to sales ratio Labor cost per unit of output Average prime rate Commercial and industrial loans Consumer installment credit to income ratio Consumer price index

Leading economic indicators

Average hours worked weekly Weekly unemployment claims New manufacturer orders Index of supplier deliveries New building permits Stock prices Money supply Interest rate spreads Consumer expectations index

Mean Absolute Deviation

Average of the absolute values of each deviation

Identifiable Tangible Asset

Capable of being separated from the firm, controlled by the firm and expected to provide future economic benefit

B/S - Stockholders' Equity

Contributed capital = c/s @ par plus add'l paid-in capital Treasury stock (reaquired by from but not yet retired, contra-equity account) R/E = Accum' NI less dividends Minority (non-controlling) interest Comprehensive income items = all chg in SOE not in I/S or from issuing stock, reacquiring stock, & paying dividends.

Cost-push inflation

Caused by a decrease in supply

Demand-pull inflation

Caused by increase demand

Shifts in aggregate demand curve

Change in price level/inflation Consumer income and wealth increases Higher expectations for economy in the future Expansionary monetary and fiscal policy Favorable exchange rate movement

Direct Cash Flow Method

Converts each line item of the accrual-based income statement into cash receipts and payments; Begins with cash inflows from customers and deducts cash outflow from purchases, operating expenses, etc

Convexity

Convexity is a measure of the degree of curvature or convexity in price/yield relationship. It accounts for the amt of error in estimated duration price. Price yield curve more convex at low yld segment.

Product Costs

Costs capitalized under the Inventories account on the balance sheet; Purchase costs less trade discounts and rebates; Conversion costs including labor and overhead; Other costs necessary to bring the inventory to its present location and condition

Period Costs

Costs that are expensed in the period incurred; Abnormal waste of materials, labor or overhead; Storage costs; Administrative overhead; Selling costs;

Balance Sheet CDO

Created by a bank to reduce its loan exposure on its balance sheet

Stratified sampling

Classification system to separate the population into smaller groups based on one or more distinguishing characteristics. From each subgroup a random sample is taken and results are pooled. often used in bond indexing because of the difficulty and cost of completely replicating the entire population of bonds.

Autarky

Closed economy

CMO

Collateralized Mtge Obligation Defines pmt structure that distributes pmt risk among various investors.

Subjective Probability

Comes from a personal judgement

Price multiples based on comparable

Compare price multiple such as P/E for a firm to those of other firms based on market prices

Treasury Bill Future

Based on $1 million face value and 90 day maturity; Quote is 100 minus the annualized discount rate in percent of the bill; Heavily influenced by monetary policy; Eurodollar futures are more popular now; 1 tick move is equal to $25

Eurodollar Future

Based on 90 day LIBOR Cash settled; Price quote is 100 minus the annualized interest rate of the bill; One tick move is equal to $25

Payment of Interest Rate Option

Based on a stated nominal amount and the difference between the reference rate and the strike rate times the fractional interest period

Asset Based Models

Based on the equity value of a firm being the fair market value of the assets minus the fair market value of the liabilities; Market value and intangible assets make this difficult

Put-Call Parity

Based on the payoffs of two portfolio combinations, a fiduciary call and protective put Call with Strike X + Present Value of X = Stock Price + Put with Strike X

Finance (Capital) Lease

Basically a purchase of an asset that is financed by debt; Lessee adds equal parts asset and liability to the balance sheet at inception; Lessee includes principal payments is an investing cash outflow while the interest payment is an operating cash outflow under GAAP; Depreciation expense is recognized on the asset and interest expense on the liability; Lessor takes asset off of balance sheet and replaces it with a lease investment account; Leads to higher EBIT calculations and net income will be lower in early years and higher in later years

Beta Project =

Basset [ 1 + ((1-t) D/E) ]

Reinvestment Risk Embedded Call Options

Bds w/ embedded call options have greater reinvestment risk. All or part of principal can be repaid in low int rate environment.

Ending Inventory =

Beginning Inv. (BI) + Purchases (P) = Available for Sale Available for sale - COGS = Ending Inventory (EI)

New Classical

Believe in Real Business Cycle Theory; Argue that governments shouldn't try to fight business cycles; Emphasize the effect of external shocks and technology on aggregate demand

Beta Asset =

Bequity x [ 1 / 1 + ((1-t) D/E) ] D/E: comparable company's debt-to-equity ratio t : marginal tax rate

Complying to Preservation of Confidentiality

Best way is to only share information with someone in the company working with that client

Leptokurtic

Bigger peak and smaller tails than a normal distribution (k>3)

Discount Bond

Bond priced below its par value; Yield required in the market rises, causing prices to fall

Cumulative Coupon Bond

Bond traded with next coupon attached.

Collateral Trust Bonds

Bonds backed by financial assets.

Premium Bond

Bonds priced above the bond's par value; Yield required in the market decreased, causing prices to rise

Bootstrapping Spot Rates

Bootstrapping spot rates from existing cpn bds using known ST spot rates. For example: Know one period rate at 4% Given two year 8% cpn bd w/ price of 100 Layout arb-free price relationship 100 = 8/(1.04)^1 + 108/(1 + Zˇ2)^1 Then compute two period zero-coupon bd spot rate Zˇ2 = [108 / 92.3077]^0.5 - 1 = 8.167% Solve for Zˇ3 given Zˇ1 and Zˇ3, along w/ three period cpn bd.

Forward Rate

Borrowing/lending rate for a loan to be made at a future date; Borrowing for three-years at a three year rate or for 1-year periods, three in succession, should cost the same

IFRS/US GAAP Frameworks: underlying assumptions:

Both: Recognize going concern & accrual assumptions IASB: Going concern & accruals given more prominence in framework FASB: Going concern assumption not well developed in framework.

Swapation

Buy an option to enter an offsetting swap and exercising it would cancel the original swap

Buyout Funds

Buy entire public companies and take them private to restructure or resell later to gain a profit; Company typically purchased largely from debt; Time horizon is 3-5 years

Direct Investing

Buying a firm's securities in a foreign market; Denominated in foreign currency; May be less liquid than domestic markets; May have less strict reporting procedures

Protective Put

Buying a stock and a put on the stock to protect the decline of a stock's price; Can be replicated by buying a bond that pays the strike price minus the premium at expiration and a call with the strike price

Operating Breakeven Quantity of Sales

Consider only fixed operating costs and ignore fixed financing costs. Qobe = fixed operating costs / (price - variable cost per unit)

Valuation Allowance

Contra asset account used to reduce DTA for probability that it will NOT be realized. Increase in valuation = decrease in DTA and NI Decrease in valuation = increase in DTA and NI

Bond Indenture

Contract that specifies all the rights and obligations of the issuer and owners of a fixed income security.

Payment Date

Date the dividend checks are mailed out - sent electronically

Convertible Debt

Debt an investor can exchange for a specified number of equities in the issuing firm

Sovereign Debt

Debt of a country's govt. Sovgn debt rating depends on govt's willingness and ability to repay debt.

Unit of Production Depreciation

Depreciates the assets based on the actual usage of the asset

Credit Spreads

Diff in spread btwn two issues that are identical in all respects but credit rating. Function of state of economy.

Temporary Difference

Difference between the tax base and the carrying value of an asset or liability that will result in either taxable amounts or deductible amounts in the future

Sentiment Indicators

Discern the potential views of buyers and sellers

Leptokurtic distribution

Distribution with positive excess kurtosis that has more returns clustered around the mean and fatter tails

Standard Error

Dividing the sample variance by the square root of the number of observations since the populations standard deviation is rarely known

Kps =

Dps / P Preferred dividends / market price preferred

risk premium

E(R)= (1+RFRreal)(1+IP)(I+RP)-1

approximation formula for nominal required rate

E(R)≅RFR+IP+RP

expected return of 2-stock portfolios

E(Rp) = W₁E(R₁) + W₂E(R₂) var(Rp) = w₁²δ₁² + w₂²δ₂² + 2w₁w₂δ₁δ₂p(R₁.R₂) δ₁δ₂p(R₁.R₂) = Cov₁,₂ According to the formula: - risk ↓ benefit is possible if correlation < + 1 - if corr = 1 → no risk reduction benefit - ↓ correlation, ↑ diversification & risk reduction benefit - max diversification benefit when corr = - 1 because opposite movements ↓ volatility.

Treasury Stock Method

Equates the net increase in the number of shares outstanding to the number of shares created by exercising the option minus the number of shares repurchased with the proceeds of the exercise; Assumes the funds received by the company from the exercise of the options would be used to purchase shares of the company's common stock at the average market price

Maturity or Term to Maturity

Length of time until loan contract or agreement expires. Remaining life of bond.

What are some common investment contstraints?

Liquidity needs, time horizon, tax concerns, legal and regulatory factors and unique needs and preferences

LIBOR

London Interbank Offering rate. Determined each day and published by the British Bankers' Association for several currencies, including the U.S dollar ,Canadian dollar, Australian dollar, the Euro, Japanese yen, British pounds, and Swiss francs, among others.

What does it mean to be long vs. short in a forward contract?

Long = Buyer Short = Seller

Interest Rate Risk and Bond Features

Long TTM = higher int rate risk (longer time to get your $$) Smaller cpns = higher int rate risk (longer time to get your $$) Low cpn then high price vol. High cpn then low price vol. LT to Mat then high price vol. ST to Mat then low price vol.

Negative Skew

Long tail to the left and Mean < Median < Mode

Market-Neutral Fund

Long/short funds where the short exposure nets out the long

Beta Pure Play Method

Looking at a publicly traded security of a company involved directly in the business the project is engaged in; Company's beta is also a product of its capital structure and must be adjusted accordingly to fit the need of the project; Delever the comparable beta and relever for the project in question

Macaulay Duration

Macaulay Duration is an estimate of a bond's interest rate sensitivity based on the time, in years, until promised cash flows will arrive. Not useful measure for bonds with embedded options.

Global Macro Funds

Make bets on the direction of a market, currency, interest rate or some other factor; HIghly levered through the use of derivatives

Convexity

Makes so a bond's rate of devaluation fall the more yields rise

Indecent entry floating exchange rate

Market determined and only influenced by monetary authorities to slow the rate of movement, not keep them at a certain level

Traditional Investment Market

Market for debt and equity, alternative markets, alternatives markets are for everything else

Spot Market

Market with immediate delivery

Operational Efficiency

Market with low trading costs; Will make markets more informationally efficient because low trading costs encourage trading on new information

Traditional Finance

Markets are rational even if individuals aren't

What is the measure of risk used in Markowitz portfolio theory?

Markowitz Portfolio Theory relies on your understanding of basic statistics. You need to understand and be able to calculate the mean, the standard deviation and the correlation coefficient. The measure of risk used is the standard deviation of the returns for an individual investment =s = [S(R actual - ER)^2(Probability)]^1/2

Index Fund

Match returns of a particular index

Form S-1

Filed before sale of a new security

Credit Default Swap

Form of insurance pays if an issuer defaults on its bonds

Full Price

Full Price (Dirty) = Clean Price + Accrued Interest.

Start-Up Financing

Funding used for completion of product development and fund initial marketing efforts

Fisher index

Geometric mean of a Laspeyres index; Used to eliminate bias from substitution

Putable Common Shares

Give the shareholder the right to sell back shares to the company at a specific price; Puts a floor on the share price; Shareholders implicitly pay for put option because putable shares sell for more than non-putable; Raise more capital for firm when issued

Poison Pill

Giving certain rights to existing shareholders if a certain amount of the stock is acquired

Sector Classification

Global Industry Classification Standard (GICS) Russell Global Sectors (RGS) Industry Classification Benchmark

Responsibilities of regulatory authorities

Government agencies with legal authority to enforce compliance with financial reporting standards

Put Provision

Grants right to sell (put) the bond to the issuer at a specified price prior to maturity.

Yield Curve

Graphical plot of yld on a particular bd flavor against its mat. Differentiate btwn on-the-run and off-the-run yld curves.

Net Operating Income

Gross operating income minus estimated vacancy, collections and other operating expenses

Multi-Step Format

Gross profit is included

Bankers Acceptances

Guarantees by a bank that a loan will be repaid. They are created as part of commercial transactions, especially international trade.

European Option

Only can be exercised on the expiration date

Offsetting Contracts

Open a swap with an opposite exposure with the same terms with the same counterparty

Discontinued Operation

Operation that management plans to get rid of, or already has; The measurement date is the date management made a plan of discontinuation; The phaseout period is the time between the measurement period and the actual disposal date; Income must be separated on the income statement, past income statements must be restated

Spearman Rank Correlation Test

Order all of the data and examine its correlation to see if there is any relationship at the extremes ; Used when data isn't normal

Money-Weighted Return

IRR of a portfolio

Amortizing Bonds

Pay periodic interest and principal payments over the life of a bond; Payments are equal with the proportion of interest and principal changing with each payment

In the context of the SML, when is a security over/under priced?

In the context of the SML, a security is underpriced if the required return is less than the holding period (or expected) return, is overpriced if the required return is greater the holding period (or expected) return, and is correctly priced if the required return equals the holding period (or expected) return.

Non-controlling/Minority Interests

In the equity section of the balance sheet; Represents the portion of the subsidiary that is not owned by the reporting firm

Future Income and Interest Rates Relationship

Increases in expected future incomes will increase the equilibrium interest rate.

Tariff

Increases the domestic price; Decreases the quantity imported and increases the domestic quantity supplied; The government gains by the amount of the tariff revenues

CFI Analysis:

Increasing CFI, may indicate growth OR Decreasing CFI or sell capital assets to conserve or generate cash. May result in higher outflows in the future as older assets are replaced or growth conts.

Project Selection

Independent projects can be evaluated based on its own profitability; Mutually exclusive projects allow for only one to be selected from the group; Some projects may need to be completed in sequence, and if the preceding project wasn't profitable, the next might not be undertaken; At times only a set amount of capital might be available and rationing decisions must be made

Increased Collection Period

Indicates that customers are taking longer to pay their outstanding accounts; Represents a drag on the company's liquidity

Unqualified auditor's opinion

Indicates the auditor believes the statements are fine

Amortization of Bond Discount = (in/out flow) in the indirect method CFO

Inflow (bringing bond UP to par)

Cash Flow From Operations (CFO) - IFRS

Interest Rec'd - CFO/CFI Divs Rec'd - CFO/CFI Interst Paid - CFO/CFF Divs Paid - CFF/CFO Overdraft = cash, not CFF

Impact on the B/S of a Par Bond:

Interest expense = Coupon rate

Define interest rate caps, floors and collars

Interest rate cap: a series of interest rate calls, expiring on the floating loan reset dates. Interest rate floor: a series of interest rate puts, expiring on the floating loan reset dates. Interest rate collar: Long cap, short floor or Short cap, long floor. The short offsets the cost of the long -- a zero cost collar.

Effect on interest rate risk and duration Coupon Increases

Interest rate risk and duration decreases.

Effect on interest rate risk and duration Maturity increases

Interest rate risk and duration increases.

Accrued Interest

Interest that is either payable or receivable, and that has been recognized, but not yet paid or received. Accrued interest occurs as a result of the difference in timing of a security's cash flows and the measurement of these cash flows.

Behavioral Finance

Investigates investor behavior, it's effect on financial markets, how cognitive biases affect anomalies, and if investors are rational; Says investors have an asymmetric preference towards risk

Second Stage Financing

Investing in a company producing and selling a product that isn't generating income yet

Real Estate Aggregation Vehicles

Investing in a pool of real estate assets

Third Stage Financing

Investing is when a company is going through a major expansion

Ad Hoc Auction Services

Method where central government auctions new securities when market conditions are advantageous

Positive Abnormal Returns By Using Technical Analysis

No form of efficient market hypothesis supports this

Forward Rate Total Return

Investors should receive the same total return from investing in a 2 yr bd as investing in a 1 yr bd, and then rolling the proceeds into a second 1 yr bd. The two 1 year rates multiplied together will equal the 2 year rate squared.

Quote Driven Markets

Investors trade with dealers; Dealers keep an inventory of securities; Most securities other than stocks trade in quote driven markets; Trading is often electronic

Venture Capital Fund

Invests in companies in the start-up phase with the intent that they grow into profitable companies and the investment is sold at an IPO

Event Driven Fund

Invests in response to one corporate action

Stable Value Fund

Invests in short term government securities or other investments that can provide timely principal payments and a set interest rate

A change in accounting estimates...

Is a change due to new information and does not require old statements to reflect it

Income Tax Expense

Is a non-operating item that is reported within "income from continuing operations"

Fisher effect

Nominal interest rate equals the sum of expected inflation and the real interest rate; Consistent with money neutrality; Can be modified to add a risk premium for inflationary uncertainty

Refunding Provisions

Nonrefundable bonds prohibit premature retirement of issue using proceeds of a lower cpn bd. Bds that carry these provisions can be freely callable, but not refundable.

Taxation Analyst Adjustments:

Nonreversal DTL, therefore it is permanent = Equity. therefore decrease in DTL = Increase in Equity Reversal DTL, therefore it is temp = Liability

Multifactor Model

Normally take into account macroeconomic factors along with fundamental factors and statistical factors and estimates the sensitivity of a security to each factor

Panel Data

Observations of the same characteristic of multiple entities over time

Longitudinal Data

Observations over time of multiple characteristics of the same entity

Smoothed Pricing

Occurs because there is not daily pricing of hedge fund assets

Inv. Valuation reporting Inventory ABOVE costs:

It is Rare, but permitted for commodity producer/dealers B/S = NRV I/S = unrealized gains/losses

Maximum Price for European Put

Present value of option's strike

Require Shareholder Attendance to Vote Hold Their Meetings on the Same Day but in Different Locations

Prevents shareholders from attending all the meetings and therefore exercising their full voting rights

Power of Test

Probability of correctly rejecting the null; Found by subtracting the probability of a Type II error from 1

International Standard Industrial Classification of All Economic Activities (ISIC)

Produced by United Nations in 1948 to increase global comparability of data

Profit maximized

Producing up to but not over MR=MC; Producing quantity where TR-TC is at a maximum

Clearinghouses

Provide escrow services, guarantees of contract completion, assurance margin traders have necessary capital, and limits on orders; Reduce counterparty risk

Sinking Fund Provisions

Provide for the retirement of a bond thru a series of predefined principal pmts over the life of the issue. Cash Payment - issuer deposits cash with trustee who retires applicable proportion of bonds at par using lottery selection. Delivery of Securities - issuer purchases the bonds with equal total par value in the market and delivers them to trustee who will retire them.

Purpose and Criticism of Derivative Markets

Purposes: Price discovery - often the contract closest to expiration serves as a proxy for the price of the underlying asset. Hedging - Companies want to lock-in a certain price for a good they either rely on or produce in order to better forecast their prices/costs. Criticisms: Too complex, fail to do their job, legalized gambling

Put/Call Ratio

Put volume divided by the call volume; The higher the ratio, the more negative the sentiment; Sentiment indicator

Maximum Price for American Put

Put's strike price

Value of a Putable Bond

Putable Bond Value = Value of Option Free Bond + Value of Put.

Break Even Quantity of Sales

Quantity of sales for which revenues equal total costs so net income is zero; = (Fixed Operating Costs + Fixed Financing Costs)/(Price - Variable Costs per Unit)

Form 10-Q

Quarterly report

FASB F/S elements

REGLC (think relic) 1) Revenues 2) Expenses 3) Gains 4) Losses 5) Comp Income

Extended DuPont Equation:

ROE = (NI/EBT)x(EBT/EBIT)x(EBIT/Rev)x(Rev/Asset)x(Asset/Eqty) or (tax burden)x(int. burden)x(EBITmargin)x(Aset TO)x(Fin Lvg)

Traditional DuPont Equation:

ROE = (NI/Sales) x (Sales/Assets) x (Assets/Equity) or ROE= Net Profit Margin x Asset TO x Leverage Ratio

Leverage & ROE

ROE is higher using leverage than without. Also increases the rate of change for ROE. ROE varies directly with the change in EBIT.

Mutual Fund Cash Position

Ratio of a mutual fund's cash to its total positions; Increases in a down market, decreases in an up market

Contraction/Recession

Real GDP is decreasing Rates of spending, investment and employment remain positive while inflation accelerates

Global Depository Receipts

Receipts issued outside both the US and the firm's domestic market; Usually denominated in US Dollar; Not subject to capital flow restrictions and allow the firm and investor greater opportunities for foreign investment

Mortgages

Receives monthly principal and interest payments paid by a borrower; If borrower defaults, investor gets ownership

Kondratieff Wave (K Wave)

Recurring cycle of various frequencies in capital markets. Postulates a 54-year cycle to western economies

Special Redemption Prices

Redemption prices from a sinking fund or government mandated sale

Principal Strips (PI)

Refers to bond and note principal payments with the coupons stripped off. Those derived from stripped bonds are denoted (bp) and those from stripped notes (NP).

Types of accounting changes: accounting estimate

Refers to change in mgmt judgement Does NOT require restatement of prior pd earnings; Disclose in footnotes

Types of accounting changes: accounting principle

Refers to changes from one GAAP method or IFRS method to another IFRS & US GAAP require prior year data shown in f/s to be adjusted.

Coupon Strips (denoted as CI)

Refers to strips created from coupon payments stripped from the original security.

Common Shares

Represent an ownership interest, a residual claim on the firm's assets in liquidation, and govern through voting rights; No obligation for firm to pay a dividend; Can proxy their votes to others;

Cash collected from customers

Revenues - Increase in accounts receivable. If accounts rec went up, cash went out. If accounts rec went down cash came in.

Debentures

Unsecured Debts.

Debenture

Unsecured bond

Discrete Uniform Random Variable

Variable where all possible outcomes for a discrete random variable are equal

Continuous Random Variable

Variable where the number of possible outcomes is infinite, even if upper and lower bounds exist

Alternative Hypothesis

What is concluded if null is rejected

Derecognition

When an asset is sold, exchanged or abandoned; When sold, the asset is taken off of the balance sheet and the gain/loss is reported on the income statement; If abandoned, the entire value is listed as a loss on the income statement; If traded, the new asset is put on the balance sheet and the difference in values is put on the income statement

Passive crawling peg

When an exchange rate is adjusted periodically to adjust for higher inflation versus the currency it is pegged to

Long Position

When an investor owns, or has the right to own, an asset

Target independence

When the central bank defines how inflation is computed, sets the target inflation, and determines the time horizon for achieving the target

Nash equilibrium

When the choice of all firms are such that there is no other choice that makes any firm better off; Each decision maker will unilaterally choose what's best for himself

Gross Revenue Reporting

When the cost of goods sold and sales revenues are reported separately; Sales are higher than under Net Revenue Reporting

Embryonic Stage

When the industry has just started; Slow growth; High prices; Large investment required; High risk of failure

Underwritten Offering

When the investment bank agrees to entire issue at a negotiated price; Bank is stuck with position if undersubscribed

Auction Process

When the issuer determines the size and terms of the issue and several banks bid on the interest rate required to sell it; Lowest interest rate bid wins the deal

Synthetic Lease

When the lease is treated like ownership for tax reporting to allow for the deduction of depreciation and interest expenses but the lease does not appear on the balance sheet

Managed floating exchange rate

When the monetary authority tries to influence exchange rates in response to specific economic indicators

Crawling bands

When the width of the bands of permissible exchange rates is increased over time

Call Market

When trades can only be placed during a specific time period; Very liquid when in session because all traders are present but illiquid between sessions; All trades, bids, ands asks are declared and then one negotiated price is set that clears the market for the stock

Price Priority

When trades with the highest bids and lowest asks are given the highest priorities

Locked Limit

When trading stops due to a limit move

Barter Transaction

When two parties exchange goods with no cash payments; GAAP says revenue can be recognized at fair value only if the firm has historically received cash for the goods and use the historical price to determine fair value, otherwise the revenue is recorded at the carrying value of the surrendered items; IFRS says revenues must be based on fair value of revenue from similar transactions with unrelated parties

Active crawling peg

When the adjustments are periodic, announced and implemented

Disclaimer auditor's opinion

When the auditor cannot issue an opinion

Market Segmentation Theory

States that investors and borrowers have preferences for different maturity ranges. Mkt for debt secs is segmented across investor mat preferences. Thus the supply of bonds (desire to borrow) and demand for bond (desire to lend) determine equilibrium yields (level of int rates) for various maturity ranges within each mkt segment.

Liquidity Preference Theory

States that investors require a risk premium, in addition to expectations about future short term rates for holding longer term bonds. Investors prefer greater liquidity and will demand a premium (higher ylds) to invest in LT issues. This is consistent with the fact that interest rate risk is greater for longer maturity bond.

Depreciation Methods

Straight-line depreciation; Accelerated depreciation; Units-of-Production method

Event Driven Funds

Strive to capitalize on some unique opportunity in the market

Inverse Floater

Structured note increase when reference rates decrease and vice versa

Dual Index Floater

Structured note that has two reference rates

How much of the variation in a single portfolio's returns can be explained by its target asset allocation?

Studies have demonstrated that approximately 90% of the variation in a single portfolio's returns can be explained by its target asset allocations. It is very difficult to generate abnormal portfolio returns by market timing and security selection within asset classes.

Limited Tax General Obligation Bonds

Subject to a statutory limit on taxes that may be raised to pay off the obligation; General obligation

M1

Sum of currency in circulation and overnight deposits

Revenue Bonds

Supported by revenues from a specific project that is funded by the proceeds of the issuance; Only required to pay interest and back principal if the project generates a sufficient amount of revenue

Who enforces the Code of Standards?

The Board of Governors

Price Value of a Basis Point

The dollar change in the price/value of a bond or portfolio when the yield changes by one basis point; = Duration * 0.0001 * Bond Value

On-the-run issues

The most recently auctioned Treasury issue, also known as the current issue.

Non-accelerating inflation rate of unemployment (NAIRU)

The natural weight of unemployment

Z-Value of Normal Distribution

The number of standard deviations away a random variable is from the population mean ; z = (variable - population mean)\(standard deviation)

Chebyshev's Inequality

The percentage of the observations that lie within k standard deviations of the mean is at least 1 - (1/k^2) when k > 1

Percentage of Completion Revenue Recognition

The percentage of total cost is how much revenue can be recognized; Revenue is recorded faster, more subjective and better matches revenues and expenses

Global Minimum Variance Portfolio

The portfolio on the efficient frontier with the least risk

Yield Curve Risk

The possibility of changes in the shape of the yield curve. Relation between bond yields and maturity. Non-parallel shift.

Test's Significance

The probability that a true null hypothesis will be rejected by chance

Indirect quote

The amount of foreign currency that can be bought for one unit of home currency

Spot Rates

The appropriate discount rates for individual future payments.

Interest Expense

The book value of the bond times the market rate of interest when the bond was issued

Liability's Tax Base

The carrying value of the liability minus any amounts that will be deducted on the tax return in the future

Portfolio Duration

The combined weighted average duration of all the bonds in the portfolio weighted by their dollar values (based on market value) of the bonds that make up the portfolio. A good measure for bd price sensitivity to parallel shifts in the yield curve.

Strong Form Market Efficiency

Security prices fully reflect all information from both public and private sources

Option Contract

Security that gives its owners a right to buy or sell an asset at a specified price at a specified time in the future

Low Quality Earnings is result of

Selecting accounting principles to distort results Structuring transactions to achieve a desired outcome Using aggressive or unrealistic estimates and assumptions Exploiting the intent of the accounting principle

Classified Balance Sheet

Separates asset and liabilities into current and non-current categories;

Global Registered Shares

Shares that trade in different currencies on exchanges around the world

Dealer-Placed Paper

Sold to purchasers through a commercial-paper dealer.

Forward Dealer

Someone who has a balanced book of positions and make money off of the bid-ask spread

Market Anomaly

Something that would lead to a rejection of the hypothesis that markets are efficient

Responsibilities of Supervisors

Speaking to the employee to determine the extent of the violations and receiving assurances that it will not be repeated is not enough.

Convexity Callable Bonds

Special features of callable bonds are that they have pos convexity when ytm is high; and negative convexity when ytm is low.

Independence and Objectivity

Specifically addresses the requirement of disclosure of the nature of any compensation from the subject company

Strategic Asset Allocation

Specifies the percentage of assets go to each asset class

Global Macro Fund

Speculates on changes in international interest rates and currency rates, often using derivatives and leverage

Beta

The sensitivity of an asset's return to the return of the market and is the standardized measure for the Covariance of the asset's return with the market; = (Covariance of Asset's and Market's Return)/(Variance of Market); = (Correlation of Asset and Market) * (Standard Deviation of the Asset)/(Standard Deviation of Market); Estimated by regressing asset returns with market returns

Qualified auditor's opinion

There is an exception to accounting principles

Oligopolists and Collusion Agreements

There is an incentive to cheat and raise your share of the joint profit

Sources of Differences betweent F/S & T/R

Timing differences (depreciations) Permanent differences:

Taxable-Equivalent Yield

To compare tax exempt bd w/ taxable bd convert tax exempt yld to taxable equivalent. It is the yld offered on a taxable sec to give same after-tax yld as tax exempt. Taxable-Equivalent Yield = Tax-Free Yield / (1 - Marginal Tax Rate)

Motivation to Overstate Assets/Understate Liabilities

To improve liquidity and leverage ratios

Discuss how forward termination alternatives prior to expiration can affect credit risk.

To terminate a forward prior to expiration, an off-setting contract must be established. This exposes the investor to credit risk from both parties.

Full (or Dirty) Bond Price

Total amount paid for bond, including accrued interest.

Inflation Risk

Uncertainty of future inflation rates and decreased real return rates

Capitalized Intangibles:

Under GAAP 1) Purchased patentes, copyrights, franchises, licenses, brands, and trademarks 2) Direct response advertising 3) Goodwill arising from transactions (Proceeds - FMV net assets required = goodwill) 4) Software development costs once feasibility is established

Information Cascades

Uninformed traders watch the actions of informed traders and follow when they are given a lot of unclear information; Consistent with investor rationality and improved market efficiency if they stem from uninformed traders; Said to be fragile if it does not lead towards the correct pricing of an asset

Financial Assets: US GAAP/Amortized at Cost

Unlisted instruments Held-to-maturity investments Loans Receivables

Why Firms Support One Set of Reporting Standards

Would reduce the cost and the time spent on reporting

Price Multiple

analyst compares a stock price multiple to a benchmark value based on an index, industry group of firms, or a peer group of firms within an industry.

Perpetuities

annuities with infinite lives PV perpetuitie = PMT/(discount rate)

TIPS Principal Adjustment and Coupon

cpn pmt = adj principal at beg period * ( 1 + i) * c OR adj principal at end period * c where i = inflation rate and c = cpn rate

Free Cash Flow to Equity

often used in discounted cash flow models instead of dividends because it represents the potential amount of cash that could be paid out to shareholders. Firms capacity to pay dividends. Defined as cash remaining after a firm meets all debt obligations and provides for the capital expenditures necessary to maintain existing assets and to purchase new assets needed to support the assumed growth of the firm.

Change in polarity principle

once a support level is breached in technical analysis, resistance level is Change in PP

Cyclical Firm

one whos earnings are highly dependent on the stage of the business cycle. High earnings volatility and high operating leverage ex) autos, housing, technology

Roy's safety-first criterion

optimal portfolio minimizes the probability that the return of the portfolio falls below some minimum acceptable level. (threshold level)

Industrial and producer durables

produce capital goods for commercial services industries -heavy machinery -aerospace -defense

Cost recovery method:

profit is recognized only when it exceeds estimated total cost.

Installment Method:

profit recognized is the proportion of cash collected x total expected profit. Revenue = (COG provided to date/total COG to be provided) x total expected revenue

Cumulative preferred

promised fixed dividends and any dividends that are not paid must be made up before common shareholders can receive dividends.

Business risk

risk associated with firms operating income and is result of uncertainty about a firms revenues and expenditures necessary to produce those revenues.

Sample selection bias

some data is systematically excluded from analysis, lack of availability

Defensive industries

those that are least affected by the stage of the business cycle and include utilities, consumer staples, and basic services.

Telecommunications

wired and wireless service providers

Node

each possible values along binomial tree

Growth Stock

higher price-to-book

Relative Strength Analysis

identify intermarket relationships. How doing relative to index. not price

Capital Budgeting process

identifying and evaluating capital projects....projects where the cash flow to the firm will be received over a period longer than a year.

income elastic inferior good

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Optimal Capital Budget

intersection of investment opportunity schedule with the marginal cost of capital curve identifies amount.

Asset-based models

intrinsic value of common stock is estimated as total asset value minus liabilities and preferred stock.

change in working capital is inversely/directly related?

inversely. Thus, if working capital goes up, it is subtracted from net income and depreciation when calculating CFO

Leveraged Buyout (LBO)

investors buy all of firms equity using debt financing (leverage). If LBO is firms current management it's a management buyout. (MBO).

Analysis: Market Value of Debt

is more relevant than book value: Recent changes allow more liability to be recorded at FMV (IFRS & GAAP require disclosure of FMV) Downward adj. in liability will Increase equity and decrease leverage ratio. Upward adj in liability will decrease equity and increase leverage ration

Footnote disclosure of reconciliation of opening and closing carrying values:

is required under IFRS but not under GAAP

Global Depository Receipts

issued outside the US and issuers home country. Most traded in London and Luxembourg exchanges.

Kurtosis

measure of the degree to which a distribution is more or less peaked than a normal distribution

Expected value of X = E(X) =

np n trials p success

Payback period

number of years takes to recover initial cost of investment

Time-series data

observations taken over period of time at specific equally spaced time intervals

NPV Profile

A graph that shows a project's NPV for different discount rates; Discount rate on the X axis, NPV on the Y; IRR is where the line intersects the X axis; The point where multiple projects intersect is called the crossover rate

Factors Affecting Market Efficiency

+Number of market participants +Availability of Information +Impediments to trading +Transaction and information costs

Depreciation Methods:

1) SL; 2) Double Decline balance (accelerated); 3) Units of production; 4) Tax code perscribed Modified Accelerated Cost Recovery System (MACRS)

CFO - Indirect method steps:

1) Start with NI 2) Sub Gains or add losses from financing or investing CFs 3) Add non-cash charges (depr't & amort'z) & sub all non cash revenue. 4) Add/ Sub changes to related b/s operating accounts: Increase in an asset: deduct (use of cash) Increase in a liability: add (source of cash) Decrease in an asset: add (source of cash) Decrease in a liability: deduct (use of cash)

Type of Structured Medium Term Notes

1) Step Up Notes 2) Inverse Floaters 3) Deleveraged Floaters 4) Dual Indexed Floaters 5) Range Notes 6) Index Amortizing Notes

Not all CF increase are Sustainable. Example of how Mgmt can Manipulate Cash Flow Statement

1) Stretching A/P (increase in # days in payable) = 365/(AP T/O) = 365/(purchases/ Avg. AP)) 2) Financing payables (allows to great AP as CFF) 3) Securitizing A/R: (allows to recognize gains in I/S) 4) Income Tax Benefit from stock options 5) Buybacks offset dilutive effect of employee stock options

IAS No. 1

1) Summary of accounting policies 2) Statement of changes in OE

FED Interest Rate Tools

1) The discount rate 2) Open market operations (most often used) 3) Bank reserve requirements 4) Persuading banks to tighten or loosen their credit policies

Factors that affect individual's ability to take risk

1) Time horizon 2) Expected income

Sources of Differences: Temporary

1) Timing Differences: Accrual vs. modified cash accounting Differences in reporting methods estimates

Characteristics of an effective framework

1) Transparency; 2) Comprehensiveness; 3) Consistency

Problem in estimation of Cash flow

1) Uncertainty of Principal Cash Flow 2) Uncertainty of Coupon Cash Flow 3) Bond Convertible/exchangeable.

Macaulay Duration

An estimate of a bond's interest rate sensitivity based on years until promised cash flow will arrive; Cannot be used for bonds with options

Interest Rate Swap

An exchange of one loan for another (typically one is a floating rate, the other is a fixed rate); Total loan amount isn't exchanged, just the difference between the liabilities at the end of the period

What is a non-deliverable forward (NDF)?

An exclusively cash settled forward.

Debt Supported by Public Credit Enhancement

An explicit guarantee that the bond is backed up by the state or federal government; General obligation

Margin Debt

An increase in the number indicates bullish sentiment; Sentiment indicator

Cyclical Firms

Earnings highly dependent on the business cycle, a non-cyclical firm has stable demand over economic stages; High operating leverage and earnings volatility

Credit Spreads Contracting Economy

Economic contraction then credit spreads increase. Cash Flows are pressured, then greater possibility of default, and required ylds on low quality issues increase.

Equity Forwards

Have a stock, portfolio, or stock index as the underlying asset; The more stocks covered by the forward, the more cost effective it is; Index forwards are usually cash settled; Dividends normally are not taken into account

Perfect competition

Many firms compete with identical products, low barriers to entry, and the only way to compete is on price; Perfectly elastic demand curves for each firm; A firm will continue to expand production until marginal revenue equals marginal cost, which maximizes profit or where MR = MC; Economic loss occurs when marginal revenue is less than marginal cost; Firm can't make economic profit in long-run; Long-run equilibrium output is where marginal revenue equals marginal cost equals average total cost ; An increase/decrease in market demand will increase/decrease both equilibrium price and quantity; Short-run supply curve is the marginal cost curve above the average variable cost

Operating Lease

Off B/S asset or liability = Footnotes disclosure Lease payments are expensed when due via I/S Payments are CFO outflows

Off-the-run issues

Older issues that have been replaced by a more recently auctioned issue. Treasuries with several subsequent issues are termed well off-the-run.

Cournot duopoly

One firm will look at the other's price and production and adjust accordingly until both firms meet at an equilibrium of the same price and quantity

Shakeout Stage

Growth has slowed Intense competition Increasing Industry overcapacity Declining profitability Increased cut costing Increased failures

Banker's Acceptance

Guarantees by a bank that a loan will be repaid; Part of a commercial transaction; Gives assurance to counterparty that financing is secure for the trade; Counterparty can sell the acceptance in a secondary market or hold until it is paid; Credit risks are the borrower does not repay or the acceptance bank does not pay

Banker's Acceptances

Guarantees from a bank stating that a firm has ordered goods and a payment will be made at the receipt of the goods, which the firm sells at a discount immediately to generate cash

Cumulative Preferred Stock

Has promised fixed dividends and any dividend not paid must be paid before common shareholders are given dividends

Expansion

Real GDP is increasing Increasing employment, consumer spending and business investment The start of each new expansion is called a recovery

Trough

Real GDP stops decreasing and begins increasing Inventory to sales ratio decreases

American Depository Receipts

Receipts denominated in US Dollar and trade in the US; The security it is based on is called the American Depository Share

Role of Nominations Committee

Regularly reviewing performance, independence, skills, and experience of existing board members

Type I Error

Rejecting the null when it is true; Significance level is probability of Type I error

Qualities of useful financial statements

Relevance and faithful representation

Parametric Tests

Rely on assumptions regarding the distribution of the population and are specific to population parameters

Market Value (GAAP):

Replacement cost subject to: Upper limit = NRV Loewr limit = NRV - normal profit margin

Net Revenue Reporting

Reports the difference between the two figures

Asset Backed Securities

Represent a claim to a portion of a pool of assets and the return is passed through to investors with different tranches having different levels of risk and return

Special Purpose Vehicle

SPV is a bankruptcy remote entity; Meaning no claim to SPV if Corporation goes bankrupt. Not a sub of corp, can achieve high credit rating and borrow at lower rates than corp.

FS Analysis Framework

S GPA RU 1) State obj/context 2) Gather data 3) Process data 4) Analyse/interpret data 5) Report conclusions/recs 6) Update analysis

Roys Safety First Ratio

SFRatio = (expected return − minimum return)/(standard deviation of return) the larger the better

Arbitrage-Free Treasury Spot Rates

The rates for different time periods that correctly value a Treasury bond; Discount rates for a zero-coupon bond

Direct quote

The value of one unit of a foreign currency in terms of the home currency

Book Value of Equity

The value of the firm's assets on its balance sheet minus it's liabilities; Market value of equity is a firm's market cap

Asset's Carrying Value

The value reported on the financial statements net of depreciation

FASB

US 1) Financial Accounting Standards Board; 2) Standards form GAAP; 3) Aims, useful, relevant, reliable, consistent and comparable; 4) SEC deems FASB standard authoritative

Funded status of the pension plan (under US GAAP & IFRS) is reported where?

US Gaap: Balance Sheet IFRS:Disclosed in Footnotes May be mentioned in MD&A if mgnt considers it significant

Inventory Valuatoin (LCM)

US Gaap: lower of cost or market value (does NOT allow subsequent reverasals) IFRS: lower of cost or NET realizable value (allows subsequent reversals)

Self Selection Bias

When the only information available for reporting is from managers who had good enough performance to want to report it

Direct Finance Lease

When the present value of the lease payments does not exceed the carrying value of the asset; Typically lessor bought the asset from a third party; Lessor removes asset from balance sheet and creates a lease receivable account in the same amount; The interest portion of each payment is equal to the beginning of period lease receivables times the lease interest rate

Data mining

analysts repeatedly use the same database to search for patterns or trading rules until one that "works" is discovered. bias refers to results where the statistical significance of the patter is overestimated because results were found through data mining.

Do non-callable coupon bonds have reinvestment risk before maturity?

Yes, since the coupon interest payments must be reinvested, those cash flows are subject to reinvestment risk.

If borrowing/lending rates are different, is it still possible to have a straight CML?

Yes. The introduction of a zero-beta (no systematic risk) portfolio with a return that is higher than the risk-free rate can result in a straight CML even with the assumption that borrowing and lending rates are different. Margin accounts represent borrowing, so unless the margin lending rate is the same as the risk-free rate, this does not solve the problem (a kinked CML) that results from unequal borrowing and lending rates in the model.

Yield Ratio

Yield Ratio is the ratio of the yields on the two bonds (Given Security to Benchmark Security). Yield Ratio = [yield on the higher yield bond / yield on the lower yield bond]

Yield on Risky Bond

Yield on Risky Bond = Yield on Default Free Bond + Credit Spread.

Yield on Risky Bond

Yield on Risky Bond = Yield on Default Free Bond + Risk Premium(Credit Spread).

Yield to Refunding

Yield to Refunding refers to a specific situation where the bond is currently callable & current rates make the callable attractive to the issuer, but covenants contain provisions against refunding until some future date.

What do changes in the shape of the Yield Curve tell investors?

Yields are changing by different amounts for bonds with different maturities.

Bond Option Cost

Z-spread - OAS = Option Cost in %.

Distribution is nonnormal but population variance is known

Z-stat can be used as long as sample size is larger than 30

Duration/Convexity Bond Pricing =

[(-Duration * Change in Yield) + (Convexity * Change in Yield ^ 2)] * 100

Bond Equivalent Yield =

[(1 + Annual YTM) ^ (1/2) - 1] * 2; Referred to as the semiannual yield to maturity or semiannual-pay yield to maturity

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]

Present Value Zero Coupon Bond

[Maturity Value]/[(1+i/2)^n*2] Where i/2 is semiannual coupon rate and n*2 is number of compounding periods.

Diluted EPS

[net income - preferred dividends] + [convertible prf.dividends] + [convertible debt int.] (1-t) / (weighted avg. of c/s o/s) + (shares from conversion of conv. pfd. shares) + (shares from conversion of conv. debt) + (shares issuable from stock options) *only income from continuing operations is considered

Pulls in liquidity

accelerate cash outflows. -paying vendors sooner

NPV decision rule (independent projects)

accept any project with positive NPV and to reject any project with a negative NPV

Depository banks

act as a custodian and manages dividends, stock splits, and other events. Investor does not have to convert to the foreign currency, the value of the DR is affected by exchange rate changes as well as firms fundamentals, economic events and other factors

Income Tax Paid

actual cash outflow for taxes paid during current period

Multistage dividend discount model

add the PV of dividends expected during the high-growth period to the PV of the constant-growth value of the firm at the end of the high-growth period Value = D1 / (1+Ke)

Country Risk Premium

added to market risk premium when using CAPM

One major difference between the presentation of deferred tax assets and liabilities under IFRS and under U.S. GAAP is that:

all DTA and DTL are classified as noncurrent under IFRS Under U.S. GAAP, deferred tax assets and liabilities are classified as current or non-current according to the classification of the underlying asset or liability. Under IFRS, deferred tax assets and deferred tax liabilities are all classified as noncurrent, with footnote disclosure about the expected timing of reversals.

Break Point =

amount of capital at which components cost of capital changes / weight of component in capital structure

Leverage

amount of fixed costs a firm has. ex) operating expenses, building, equipment leases -Greater leverage leads to greater variability of the firms after-tax operating earnings and net income

Cost leadership (low cost) strategy

firm seeks to have lower costs of production in its industy, offer the lowest prices, and generate enough volume to make a superior return.

Price multiples based on fundamentals

multiple based on some valuation model and therefore are not dependent on the current market prices of other companies to establish value

indirect method CFO

net inc pr I/S + depre & amort + losses & amort of bond discounts - gains & amort of bond premiums - equity earnings from affiliate + decrease op assets - increase in op assests +increase op liabilities - decrease op liabilities _____________________________________________ = cash flow from op

Free Cash Flow -CFO

net income + non-cash charges - working cap investment

Bernoulli Random Variable

Binomial random variable with only one trial

Fixed Charged Coverage

= (EBIT+Lease Pymts) / Int. exp + Lease payments

Degree of Operating Leverage

= (Percent Change in EBIT)/(Percent Change in Sales) = [Quantity of Units Sold * (Price per Unit - Variable Cost)] /[Quantity of Units Sold * (Price per Unit - Variable Cost) - Fixed Cost] = (Sales - Total Variable Costs) / (Sales - Total Variable Cost - Fixed Costs]

Quick ratio

= (cash + mkt sec + AR) / CL

Defensive interval

= (cash + mkt sec + AR) / Daily Cash Exp

Required Interest Rate

= (risk free rate) + (default risk premium) + (liquidity premium) + (maturity risk premium)

Unrealized Gains/Losses on Securities Available For Sales

Included in comprehensive income

Test Statistic

(Observed value - Hypothesized value) / Standard Error

BASIC EPS

(net income - preferred dividends) / weighted average of common shares out *only income from continuing operations is considered

EPS after buyback =

(total earnings - after-tax cost of funds) / shares outstanding after buyback

Types of Event Risk

+Disasters +Corporate Restructuring +Regulatory Issues

American Depository Receipts

denominated in US dollars and trade in the US.

Units of Production Method

depreciation exp = (cost - residual value) x (# units produced / total expected to produce)

Double-decline balance (DDB)

depreciation exp = (cost - accum depre)/useful life x 2 Does NOT use residual value (salvage value) but depreciation stops when residual value has been reached. * reduce EBIT, NI, Assets, Equity and decrease ROA & ROE

Straight-line depreciation (SL)

depreciation exp = (cost-residual value)/ useful life

Tenor

Length of the swap

Bullet Bonds

Pay entire principal in one lump sum at maturity.

Serial Bonds

Pay off principal thru series of pmts over time.

Capital Allocation Line

Represents the combinations of a risky portfolio and a risk free asset

Investor's Utility Function

Represents the investor's preference in terms of risk and return

Effective Convexity

Takes into account changes in cash flows from embedded options

Sources of Commodity Returns

+Collateral yield +The price return +Roll yield

Enhancements of relevance and faithful representation

+Comparability +Verifiability +Timeliness +Understandability

Impact on the B/S of a Discount Bond:

Interest Expense = Coupon + Amortization = PV of future CF x market yield @ issuance

Impact on the B/S of a Premium Bond:

Interest Expense = Coupon - Amortization = PV of future CF x market yield @ issuance

Securitizers

Pool large amounts of securities or other assets and sell interests in the pool to other investors; The returns from the pool, net of fees, are passed through to investors; Cash flows are segregated by risk into traunches

Mutual Fund

Pooled investments where each investor owns shares representing ownership of a portion of the portfolio

Future Value (FV)

The amount an investment is worth after one or more periods. FV = PV(1 + I/Y)ⁿ

Mental Accounting

When investors classify different investments into separate mental accounts rather than viewing them as one portfolio

Narrow Framing

When investors see events in isolation

Tap System

When issuance and auction of bonds identical to the previously issued bonds

Recognition lag

When it takes time for policy makers to recognize what is happening in the economy and make the appropriate decision

Face Value Discount =

(Fair Value - Price)/Face Value

Desirable properties of an estimator are:

-unbaised -Efficiency -consistence

Discounted Cash Flow Model Disadvantages

-inputs must be estimated -value estimates are sensitive to input values

Credit Enhancements

1) Third Party Guarantees 2) Letter of Credit 3) Bond Insurance.

Available for Sale Securities

Listed at fair value but unrealized gains and loses are not reported

Relative Strength

The asset's price charted against the index price

Value Stock

low price-to-book

Cash Flow From Investing (USA) (Assets)

"Assets" Cash spent on long-term assets Proceeds from the sale of long-term assets Cash flow from investments in JVs, affiliates, and long-term investments in securities (trading securities are CFO) [CFI = Cash additions - cash rcvd on disposal]

How do you calculate the cost of a $10,000, 30 day, 5.25% Eurodollar deposit?

$10,000 x (1 + .0525(30/360)) = $10,043,750 in 30 days. The convention is to use 360 days. The quoted interest over 360 days is pro-rated and then added to the face value. called "add-on interest."

Types of Validity Instructions

*Day orders *Good-till-cancelled orders *Immediate-or-cancelled, or fill-or-kill, orders *Good-on-close orders *Stop-loss orders

Fraud Triangle - 1) Incentive/Pressure

1) 3rd party pressure: 1) analyst/institutional expectations; 2) need to obtain finance; 3) listing requirements; 4) Debt covenants; 5) Transactions 2) Directors' Financial Position: 1) Equity interest; 2) Stock options; 3) Personal debt guarantees. 3) Economic/Industry/Entity Conditions: 1) higher competition, lower margins; 2) Technological change; 3) Decline in demand; 4) Threat of hostile takeover; 5) Negative cash flows; 6) New accounting/regulatory requirements

Balance Sheet - formats

1) Account format (A on left and L & E on right) 2) Report format ( A, L, E presented in one column) 3) Classified B/S (ordered)

Revaluation above historic cost

1) B/S asset increased to FMV 2) Increase above original cost to equity via revaluation surplus account (comprehensive Income)

Derivative

A security that derives its value from the value or return of another asset or security

Commercial Paper

A short-term debt security that can be sold directly to investors or through dealers

Herfindahl-Hirschman Index

Adds up the sum of the squares of the largest firms in the market

Substitution effect

Always acts to increase the consumption of a good that has fallen in price

Development Cost Treatment

Capitalized under IFRS; Expensed under GAAP

Later Stage Financing

Financing when marketable goods are in production and sales are underway

Odds for and against

Find the likelihood of an outcome occuring "x out of y times" based on its probability distribution. Odds for: 1-to-(y-x) Odds against: (y-x)-to-1

Maintenance/Initial Margin & Margin Calls

Initial Margin = 1 / leverage ratio = P0 x (1 - initial margin / 1 - maintenance margin)

Deferred-Coupon Bonds

Initial coupon payment is delayed; Interest accrues and is paid as a lump sum; Coupons paid regularly after the first

Callable Bond Disadvantages

Less Certain Cash Flow, Cap on price appreciation, Reinvestment risk.

Cumulative Preferred Stock Risk ___ Non-Cumulative Preferred Stock Risk

Less than

Beta

Measure of systematic risk

Municipal Bonds

Munis. Cpn Int typically exempt from federal tax in U.S.

Terminal Stock Value

Pn = Dn+1 / Ke -Gc

Sinking Fund

Provisions provide the repayment of principal through a series of payments over the life of the issuance; In a cash payment, the issuer can deposit the required cash amount annually to a trustee, who will randomly call a portion of the issuance back; In a delivery of securities, the issuer purchases bonds with a total par value equal to the amount that is to be retired in that year in the market and deliver them to the trustee who will retire them;

Term Repo

Repo lasting longer than a day

Equity Securities

Represent ownership positions

Stock Index Futures

S&P 500 Index is most popular; Settlement is in cash and based on a multiplier of 250

Conventional Cash Flow Pattern

Signs of cash flows only change once

Distribution is nonnormal and population variance is unknown

T-stat can be used as long as sample size is large (n>30)

flow of funds indicators

TRIN, margin debt, mutual fund cash position, new equity issuance, secondary offerings

After-Tax Yield =

Taxable Yield * (1 - Marginal Tax Rate)

Adverse auditor's opinion

The statements are not presented fairly or don't conform to standards

Market Segmentation Theory

The supply of bonds and demand for bonds determine equilibrium yields for various maturity ranges; Different investors may have strong preferences for maturity ranges that closely match their liabilities

Flat Yield Curve

The yield on all maturities are essentially the same.

Special Redemption

When bonds are redeemed to comply with a sinking fund provision or because of a property sale mandated by government authority.

Declaration Date

date the board of directors approves payment of the dividend

IP

expected inflation rate premium

Consumer Staples

firms are less cyclical and sell goods and services -food -beverage -tobacco

Net borrowing

increase in debt during the period and is assumed to be available to shareholders.

Enterprise Value

measures total company value. Viewed as what it would cost to acquire firm

long-run equilibrium is

p = atc

Global Registered Shares

traded in different currencies on stock exchanges around the world

Share repurchase

transaction in which a company buys back shares of its own common stock.

Sales Risk

uncertainty about firms sales

90%

z = ±1.645 for 90%, 5% in each tail One Tail 1.28 or -1.28

95%

z = ±1.960 for 95%, 2.5% in each tail one tail +1.65 or -1.65

99%

z = ±2.575 for 99%, .5% in each tail One Tail - +2.33 or -2.33

equalibrium elastic in terms of equilibrium price

|ep|=1

relatively elastic

|ep|>1

Debt-to-Capital

= Total Debt/ Total Debt + SHE

Long Term D-to-E

= Total LT Debt / Total Equity

real money supply formula

= nominal supply/price level

Characteristics of a coherent financial framework

+Transparency +Comprehensiveness +Consistency

Types of Treasury Securities

+Treasury Bills +Treasury Notes and Bonds +TIPS

Positive substitution, negative income smaller than positive substitution

Consumption increases

Positive substitution, positive income

Consumption increases

Eurobonds

Issued outside the legal system of a country and not registered with regulatory agencies.

Concentration measures

Nth firm indicator Herfindahl-Hirschman Index

Modified Duration

Similar to Macaulay but takes into account YTM; = (Macaulay Duration)/(1 + Periodic Market Yield)

Buy in open market

companies may repurchase stock in open market at the prevailing market price.

Unconventional Cash flow patter

more than one sign change.

Z score

"standardizes" observation from normal distribution; represents # of standard deviations a given observation is from the population mean z = (obs. - pop. mean) / STD z = x-µ / STD

Cost of trade credit =

(1 + (% discount / 1 - % discount)) ^ (365/days past discount) - 1

Retention Rate =

(1 - dividend payout ratio) proportion of net income that is not paid out as dividends and goes to RE thus increasing equity

Sustainable growth rate =

(1 - dividend payout ratio) x ROE rate of which equity, earnings and dividends can continue to grow indefinitely assuming that ROE is constant, the dividend payout ratio is constant, and no new equity is sold.

Most common Day Counts Used in Bond Markets

(1) 30/360 (2) Actual/360 (3) Actual/365 (4) Actual/Actual

Duration ▲ Price & ▲ Yield Maturity & Coupon

(1) Bd w/ smallest price ▲, given ▲ in yld, has shortest mat and highest cpn. (2) Bd w/ largest price ▲, given ▲ in yld, has longest mat and lowest cpn.

Accrued Interest Clean and Dirty Prices

(1) Clean Price: Bd Price w/out accrued int (2) Dirty Price: Bd Price w/ accrue int clean price = dirty price - AI

Credit Risk Three Types

(1) Default Risk (2) Credit Spread Risk (3) Downgrade Risk

Duration Interest Rate Sensitivity Non Callable Bonds

(1) Duration (int rate sensitivity) is high at low int rates, and (2) Duration (int rate sensitivity) is low at high int rates. This concept holds for non-callable bonds

Bond Pricing Two Methods to Price a Bond

(1) Find PV of all fut cash flows discounting at constant rate applied to all cash flows (YTM). (2) Treat each cash flow as its own zero-cpn bd and find the PV of each 'zero' using spot rate for each cash flow. To prevent arb these two prices must be the same. YTM must be an avg of the spot rates. Zero Coupon Price is the PV of its Par Value. Market convention states semi-annual compounding used when pricing zeros.

International Bonds

(1) Foreign Bds (2) Eurobonds (3) Sovereign Debt

Sample Skew

(1/sample size) * [(Sum of Each Sample Deviation Cubed)/(Sample Deviation Cubed)]; Skewness greater than 0.5 is significant

Effective Duration =

(Bond Price When Yields Fall - Bond Price When Yields Rise)/(2 * Initial Price * Change in Yield in Decimal Form)

What is the formula for beta given covariance and variance to the market?

(Covstock,market)/(Varmarket) -- the trick here is to convert standard deviation to variance by squaring it. Also, the denominator only includes the variance of the market; the variance of the stock itself should be excluded if it's provided

Market Cap Index Value =

(Current Total Market Value of Stocks/Base Year Total Market Value of Stocks) * Base Year Index Value

Expensed Intangibles:

(GAAP) Internally created intangibles 1) (R&D) are expensed 2) Advertising 3) Software (developed to establish feasibility)

Basic EPS

(Net Income - Preferred Dividends)/(Weighted Average of Shares Outstanding)

M-Squared =

(Portfolio Return - Risk Free Rate) * (Market Standard Deviation/Portfolio Deviation) - (Market Return - Risk Free Rate); Most appropriate when portfolio holds no systematic risk and is managed by one manager

Holding Period Return =

(Price Change + Dividend)/(Initial Price)

WACC =

(Wd)[Kd(1-t)] + (Wps)(Kps) + (Wce)(Kce) Wd = % of debt in cap structure Wps = % preferred stock in cap structure Wce = % C/S in cap structure

Qbe (break even quantity) =

(fixed operating costs + Fixed financing costs) / (Price - variable cost per unit)

Quantity theory of money

(money supply)*(velocity of money)=(price level)*(real GDP)

Chi-Square =

(n-1) * observed variance / hypothesized variance

Probability density function

(pdf) function, denoted f(x), than can be used to generate the probability that outcomes of a continuous distribution lie within a particular range of outcomes. For a continuous distribution, it is the equivalent of a probability function for a discrete distribution. PDF - used to calculated the probability of an outcome between two values

What are the assumptions of capital market theory?

* Markowitz investors: All investors use the Markowitz mean-variance framework to select securities. This means they want to select portfolios that lie along the efficient frontier, based on their utility functions.

IFRS Qualifications for a Finance Lease from the Lessee's & Lessor's Perspective

*All rights and risks of ownership are transferred to the lessee *Title is leased asset is transferred to lessee at end of lease *The lessee can purchase the asset at a price significantly lower than the fair value of the asset at some future date *The lease term covers a major portion of the asset's economic life *The present value of the lease payments is substantially equal to the fair value of the leased asset *The leased asset is so specialized that my the lessee cause the asset without significant modification

IFRS Treatment of Impaired Assets

*Assets must be evaluated annually *Impaired if its carrying value exceeds its recoverable amount *An impaired asset must be written down on the balance sheet and the impairment loss of the difference of the carrying value and the recoverable amount is recorded on the income statement *Asset can be revalued up if the recoverable amount rises

Steps of Bootstrapping

*Begin with 6-month spot rate *Set value of the 1-year bond equal to present value of the cash flows with the 1-year spot rate divided by two as the only unknown *Solve for 1-year spot rate *Use 6-month and 1-year spot rates and equate the present value of the cash flows of the 1.5-year bond to its price, with 1.5-year bond as the only unknown *Solve for 1.5-year bond

Differences Between Security Market Line and Capital Market Line

*CML plots total risk on the x-axis and only plots efficient portfolios; SML plots beta on the x-axis *All points on the CML, except point of tangency, represent the risk-return characteristics of portfolios formed by combining the risk free rate and market return or borrowing at the risk free rate to invest more than 100% in the market

Steps of a Multistage Dividend Growth Model

*Determine required return *Project initial size and duration of high initial dividend growth *Estimate dividends during high growth period *Estimate sustainable growth at the end of period *Estimate first dividend that will grow at a constant rate *Use sustainable growth to calculate stock value *Add all present values

Steps for Forming Peer Group

*Determine which companies are in the same industry *Examine firms' annual reports to find competitors *Examine competitors' annual reports to find more competitors *Use trade publications to find new competitors *Confirm comparable firms have comparable characteristics *Adjust financial statements of non-financial companies for any financing subsidiary data they include

Assumptions of Gordon Growth Model

*Dividends are appropriate to measure shareholder wealth *Dividend growth rate and required return never change *Required return is greater than the dividend growth rate

Pro-Forma Statement Steps

*Estimate relationship between changes in sales and the changes in sales-driven income statement and balance sheet items *Estimate the future tax rate, interest rates on debt, lease payments, etc *Forecast sales *Estimate fixed operating costs and financing costs *Integrate estimates into pro forma statement

Drawbacks of Funds of Funds

*Fees are higher than investing in a hedge fund by yourself *Returns can be lowered by diversification

Problems Fixed by Regulation

*Fraud and theft *Insider trading *Costly information *Defaults

Differences Between Futures and Forwards

*Futures are on exchanges, forwards are private *Futures are standardized, forwards are customized *Futures go through clearinghouses *Government regulates futures

Weighted Average Cost of Inventory

*GAAP and IFRS *Dividing total cost of goods available for sale by the total quantity of goods available for sale

FIFO

*GAAP and IFRS *Each unit sold is matched with the unit's actual cost *Most appropriate when items are not interchangeable and when firms have a small number of costly and distinguishable items

Specific Identification

*GAAP and IFRS *Each unit sold is matched with the unit's actual cost *Most appropriate when items are not interchangeable and when firms have a small number of costly and distinguishable items

LIFO

*GAAP only *Values inventory at a historical cost basis *In an inflationary/deflationary environment, earnings are lower/higher

Benefits of Funds of Funds

*Gives access to investors with limited capital resources *Greater diversification *Fund of fund managers have expertise in picking managers

Duration Relationships

*HIgher/lower coupon means lower/higher duration *Longer/shorter maturity means higher/lower duration *Higher/lower market yield means lower/higher duration

Estimations of Dividend Growth Rates

*Historical rate *Industry average rate *Sustainable growth rate

Administrative Steps to Capital Budgeting

*Idea generation *Analyzing project proposals *Create firm-wide capital budget *Monitoring decisions and conducting a post-audit

Covered Call Option P/L

*If stock closes below strike price, the call expires worthless and the writer keeps the premium *Breakeven point is the stock's price minus the call premium *If stock appreciates past the initial price but not as high as the call's strike price, the writer gets the premium as well as the stock's appreciating *Maximum loss is the stock price minus the premium

Implications of Gordon Growth Model

*If the gap between the discount and dividend growth rates grows, stock price falls and vice versa *Small changes in rates can change stock price significantly

Venture Capital Investment Characteristics

*Illiquidity *Long-term investment horizon *Difficult to value *Limited information *Good entrepreneurs don't always make good managers *Market conditions play a big role in venture capital returns *Require extensive operations analysis *Most implant factors are expected payoff at exit, timing of exit, and probability of failure

Real Assets

*Increasingly being held by institutions *Provide income, tax advantages and diversification, but also entail large management costs *Require increased due diligence *Illiquid *Can be bought indirectly through REITs and MLPs *Can get exposure by buying stock in companies that have large real asset ownership

Why Capital Budgeting is Important

*Involves large transactions *Same principles apply to most corporate decision making *Objective way to maximize shareholder value

Considerations When Electing Board

*Majority of Board is comprised of independent members (not managers) *Board meets regularly without management *Chairman is current or former CEO *Independent Board members have a primary or leading Board member in cases when the chairman is not independent *Board members are closely aligned with suppliers, customers, etc

Protective Put Option P/L

*Maximum loss is the premium *Maximum loss occurs when the stock falls below the strike price *The break even point is the strike price plus the premium amount *Losses begin to occur when the stock falls below the break even *Same profit diagram as a long call

Ways to Terminate Swap

*Mutual termination *Offsetting contracts *Resale *Swapation

Limitations of Ratio Analysis

*Not useful when viewed in isolation *Skewed by different accounting treatments *Difficult to find appropriate ratios when companies compete in multiple industries *Conclusions can't be made by looking a a single ratio *Determining a target or comparison value of a ratio is difficult

GAAP Treatment of Impaired Assets

*Only tested for impairment when it is deemed necessary *First tested for recoverability then the loss is measured *No loss recovery is allowed

Functions of Intermediaries

*Organize trading venues *Supply liquidity *Securitize assets *Manage banks, insurance firms and investment advisory services *Providing clearinghouses to settle trades *Manage depositories

Elements of Company Analysis

*Overview of firm's operations, governance, strengths and weaknesses *Industry characteristics *Product demand *Product costs *Pricing environment *Financial ratios *Projected financial statements and firm valuations

Types of Currency Swaps

*Party A pays a fixed rate on Currency A received, Party B pays a fixed rate on Currency B * Party A pays a floating rate on Currency A received, Party B pays a fixed rate on Currency B * Party A pays a fixed rate on Currency A received, Party B pays a floating rate on Currency B * Party A pays a floating rate on Currency A received, Party B pays a floating rate on Currency B

Secured Debt Collateral

*Personal property *Real property *Financial assets

Issue Specific Credit Factors

*Priority of claim being rated *Value/quality of collateral pledged to issuance *Covenants of issuance *Any third-party guarantees or insurance

Objectives of Regulation

*Protect unsophisticated investors *Promote minimum standards of performance reporting *Prevent insider trading *Require common financial reporting standards *Require minimum capital levels so all participants can honor their obligations

Hedge Fund Indices Problems

*Self-selection bias *Backfilling bias *Survivorship bias *Smoothed pricing *Return measures do not account for unlimited downside with limited upside with options *The incentive fees give the manager reason to take extra risk since they have nothing to lose

Things to Consider when Comparing Market and Modeled Valuations

*The bigger the difference between modeled and market valuation, the mover likely it is an investor buys stock *The more confident an investor is in the assumptions in his model, the more likely the investor is to buy stock *Market values should be seen as rational indicators of intrinsic value *Investor must believe market price will eventually move towards his estimated intrinsic value

Restrictions of Board's Business Dealings

*The firm, it's subsidiaries, or former employees *Individuals or groups with a controlling interest *Executive management or their families *Firm's advisors, auditors and families *An entity with a cross directorship with the firm

Unsecured Debt Credit Enhancements

*Third-party guarantees *Letters of credit that a bank will advance the issuer for the service of its debt *Bond insurance

GAAP Qualifications for a Finance Lease from Lessee's & Lessor's Perspective

*Title of asset is transferred to the lessee at the end of period *A bargain purchase option is available to the lessee to buy the asset at a price significantly below market value at some future date *The lease period is 75% or more of the assets economic life *The present value of the lease payment is 90% or more of the assets fair market value *Collection of lease payments is fairly certain (lessor only)

Fiscal policy tools

*Transfer payments (entitlement programs) *Current spending *Capital spending *Direct taxes *Indirect taxes

Components of Net Daily Cash Position

*Treasury bills *Short term agency securities *CDs *Banker's acceptances *Time deposits *Repo agreements *Commercial paper *Money market funds *Adjustable rate preferred stock

Steps of Arbitrage Free Valuation

*Value the security using spot values *Compare the value to the market price

Considerations of Firm Voting Policy

*Whether it is a classified board (staggered multi-year terms) or annual elections *Whether Board filled a vacancy without shareholder approval *Whether shareholders can remove member *Whether the Board is the proper size

Net Periodic Benefit Costs

+ Service Costs (recurring costs (actual)) + Interest Costs (recurring costs (actual)) - Expected return on plan assets (smoothed event) +/- Amort of (gains) and losses (smoothed event) +/- Amort of prior service costs* (smoothed event) +/- Amort of transition (asset)/liability (smoothed event) = Pension Expense on I/S * Prior service costs are expensed immediately under IFRS but deferred and amortized under US GAAP.

Yield Spreads

+Absolute yield spread +Relative yield spread +Yield ratio

Adjustments to Compare Firms' Financial Statements

+Accounting of investment securities +Inventory cost methods +Depreciation schedules +Off-balance-sheet financing +Treatment of goodwill and other intangible assets

Current Liabilities

+Accounts Payable +Notes Payable and Current Portion of Long-Term Debt +Accrued Liabilities +Unearned Revenue

6 components of the Code of Ethics:

+Act with integrity, competence, diligence, respect and in an ethical manner wit the public, clients, prospective clients, employers, employees, colleagues, and all participants in global markets +Place integrity of profession and interest of clients above all else +Use reasonable care and independent professional judgement when conducting investment analysis, making investment recommendations, taking investment action, and engaging in 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 uphold the rules of, the capital markets +Maintain and improve their professional competence of themselves and others

Accounting Warning Signs

+Aggressive revenue recognition +Different growth rates of operating cash flow and earnings +Abnormal sales growth as compared to the economy, industry or peers +Abnormal inventory growth compared to sales growth *Could be signs of obsolete products +Boosting revenue with nonoperating income and nonrecurring gains +Delaying expense recognition +Abnormal use of operating leases by lessees +Hiding expenses by classifying them as extraordinary or nonrecurring +LIFO liquidations +Abnormal gross margin and operating margin as compared to industry peers +Extending the useful lives of long-term assets +Aggressive pension assumptions +Year-end surprises +Equity method investments and off-balance-sheet special purpose entities +Other off-balance-sheet financing arrangements including debt guarantees

Functions of Financial System

+Allow entities to save and borrow money, raise equity capital, manage risks and trade assets +Determine returns required for the supply of savings to equate to the demand for borrowing +Allocate capital to the most efficient uses

Elements of IFRS' Conceptual Framework

+Assets +Liabilities +Equity +Income +Expenses

Par Value Bond Effects

+Assets and liabilities increase by the bond proceeds +Interest expense is equal to the coupon payment +Proceeds are reported as cash inflow from financing activities and coupon payments are reported as cash outflows from operating activities +Repayment of principal is reported as cash outflow from financing activities

Required Financial Statements

+Balance sheet +Income statement +Cash flow statement +Owner's equity +Footnotes

Components of an Order

+Bid-ask spread +Execution order +Validity instructions +Clearing instructions

Types of Equity Indices

+Broad market index +Multi-market index +Multi-market index with fundamental weighting +Sector index +Style index

Ways for Company to Buy Back Stock

+Buy stock in the open market at prevailing market price +Negotiate directly with a large shareholder to buy back it's shares, usually at a premium to the market price +Make tender offer to buy a certain number of shares at a set price

Approaches to Calculating Cost of Equity

+CAPM +Dividend Discount Model +Bond Yield + Risk Premium

Direct Method -> Indirect Method

+Cash Collected from Customers 1. Start with net sales 2. Subtract/add any increase/decrease in accounts receivable 3. Add/subtract any increase/decrease in unearned revenue +Cash Payments to Suppliers 1. Begin with Cost of Goods Sold 2. Add back depreciation and amortization if they have been included in COGS 3. Add/subtract any increase/decrease in the inventory balance 4. Reduce/increase COGS by any increase/decrease in the accounts payable balance 5. Subtract any inventory write off from COGS

Current Assets

+Cash and Cash Equivalent +Marketable Securities +Accounts Receivable +Inventory +Other Current Assets

Components of Direct Cash Flow Method

+Cash collected from customers +Cash used in production of goods and services +Cash operating expenses +Cash paid for interest +Cash paid for taxes

Operating Activities

+Cash collected from customers +Interest and dividends received +Sales proceeds from trading securities +Cash paid to suppliers and employees +Cash paid for other expenses +Acquisition of trading securities +Interest and taxes paid

Cash Flow From Operations (CFO) - FASB

+Cash rcvd from customer +Cash dividends rcvd +Cash interest rcvd +Other cash income ((trading securities) - Payment to suppliers - Cash expenses (wages etc) - Cash interest paid - Cash taxes paid

Sanctions are:

+Condemnation by peers +Suspension of CFA membership

Inventory Disclosure

+Cost flow method used +Total carrying value of inventory, with carrying value by classification if appropriate +Carrying value of inventory recognized at fair value minus selling costs +Total COGS for the period +Amount of inventory write downs during a period, as well as any write ups with a description of the event +Carrying value of inventories pledged as collateral

Factors Increasing Reinvestment Risk

+Coupon is higher so interest cash flows are higher +A call feature +Is amortizing +Contains prepayment option

Sources of Bond Return

+Coupon payments +Recovery of principal at maturity +Reinvestment income

Dividend Dates

+Declaration date +Ex-dividend date +Holder-of-record date +Payment date

Deferred Tax Disclosures

+Deferred tax liabilities and assets, valuations allowance and the net change in the valuation allowance over a period +Any unrecognized deferred tax liability for undistributed earnings of subsidiaries and joint ventures +Current year effects of each temporary difference +Components of income tax expense +Reconciliation of reported income tax expense and the tax expense based in the statutory rate +Tax loss carryforwards and credits

Ways to Terminate a Futures Contract

+Delivery +Cash settlement +Make an offsetting trade +Exchange for physicals

Contents of Investment Policy Statement

+Description of Client +Statement of Purpose of IPS +Statement of Investment Manager's Duties and Responsibilities +Procedures to Update IPS +Investment Objectives +Investment Constraints +Investment Guidelines +Evaluation of Performance +Appendices

Reasons for Differences Between Effective and Statutory Tax Rate

+Different tax rates in different jurisdictions +Permanent tax differences (tax credits, tax-exempt income, non deductible expenses) +Changes on tax rates and legislation +Tax holidays in some jurisdictions +Deferred taxes provided on reinvested earnings of foreign and unconsolidated domestic affiliates

Investment Analysis, Recommendations and Actions:

+Diligence and Reasonable Basis +Communications with Clients +Record Retention

Ways to Invest in Foreign Companies

+Direct Investing +Depository Receipts +Global Depository Receipts +American Depository Receipts +Global Registered +ETF of Depository Receipts

Conflicts of Interest:

+Disclosure of Conflicts +Priority of Transactions +Referral Fees

Interest Rate Tools of the Fed

+Discount rates +Open market operations +Bank reserve requirements +Persuading banks to change credit policies

Equity Valuation Models

+Discounted Cash Flow +Multiplier Model +Asset Based Models

Interpretations of Duration

+Duration is the slope of the price-yield curve at the bond's current YTM +Duration is a weighted average of the time until each cash flow +Duration is the approximate percentage change in price for a 1% change in yield

Stages of Industry

+Embryonic +Growth +Shakeout +Mature +Declining

Cyclical Sectors

+Energy +Financials +Technology +Materials +Consumer discretionaries

Steps of Valuing a Bond

+Estimate cash flows +Determine appropriate discount rate +Calculate the present value of the estimated cash flow

Elements of a Through Industry Analysis

+Evaluate the relationships between macroeconomic variables and industry trends +Estimate industry variables using different approaches and scenarios +Compare with other analysts to confirm conclusion or find instances of misvaluation due to group think +Determine relative valuation of different industries +Compare valuations of industries over time to determine their volatilities over business cycles +Analyze industry prospects based on strategic groups +Classify industries by life-cycle stages +Position the industry on the experience curve, which shows cost per unit relative to output +Consider forces that affect industries +Examine forces that determine competition within industries

Risks of ETFs

+Exposed to market risk +Only invest in only a portion of the market, opening up investor to asset class and sector risk +If market isn't liquid enough, won't stick to NAV +If doesn't replicate index exactly, there is tracking error risk +Can be levered and opened to credit risk by using derivatives +Can be exposed to country or currency risk

Reasons to Invest in Commodities

+Exposure to economic growth +Hedge against inflation +Diversification

Cost Method Ratio Effects

+FIFO/LIFO produces higher/lower profitability measures +FIFO/LIFO produces higher/lower Current and Working Ratios +FIFO/LIFO produces lower/higher Inventory Turnover and higher/lower Days of Inventory On Hand +FIFO/LIFO produces lower/higher solvency ratios

Disadvantages of ETFs

+Few indices for ETFs to track +Intraday trading might not matter for long-term investors +Low volume may result in inefficient markets +Institutions can get same exposure with lower expenses and tax consequences by investing directly in the index

Trade blocs

+Free trade areas +Customs unions +Common market +Economic union +Monetary union

Shapes of Yield Curve

+Normal (upward sloping) +Inverted (downward sloping) +Flat +Humped

Differences Between IFRS and GAAP Cash Flow Statements

+GAAP lists dividends paid under financing activities and interest paid in operating activities. IFRS allows them to be listed as either operating or financing activities +GAAP lists dividends and interest received under operating activities. IFRS allows them to be listed as either operating or investing activities +GAAP lists taxes paid under operating activities. IFRS lists taxes as operating activities unless they are associated with an investing or financing activity

Lease Disclosures

+General description of leasing arrangement +Nature, timing, and amount of payments to be paid or received in each of the next 5 years (payments can be aggregated) +Amount of lease revenue and expense reported in the income statement for each period presented +Amounts receivable and yearned revenues from lease arrangement +Restrictions imposed by legal agreements

Takeover Defenses

+Golden parachute +A poison pill +Greenmail

Non-Cyclical Sectors

+Healthcare +Utilities +Telecom +Consumer staples

IFRS PP&E Disclosures

+Historical cost +Useful life and depreciation rates +Gross carrying value and accumulated depreciation +Reconciliation of carrying amounts from beginning to end of period +Title restrictions and assets pledged as collateral +Agreement to acquire any PP&E in the future

Differences between IFRS and GAAP

+IASB lists income and expenses as elements related to performance, GAAP includes revenues, gains, loses and comprehensive income +GAAP defines an asset as having future economic benefit, IASB defines an asset as a resource for which a future economic benefit is probable +GAAP doesn't allow for the upward valuation of most assets

Risks of Hedge Funds

+Illiquid +Hard to value underlying assets +Counterparty credit risk +Short squeezes +Margin calls

Qualities of central bank

+Independence +Credibility +Transparency

Contents of Auditor's Opinion

+Independent view of the firms financial statements +Generally accepted accounting policies were used and judgements were reasonable +Explanation when accounting policies change from year to year

Types of Investors

+Individual investors +Institutions +An endowment fund +A bank +Insurance companies +Investment companies +Sovereign wealth funds

Risks of Bonds

+Interest rate risk +Yield curve risk +Call risk +Reinvestment risk +Credit risk +Liquidity risk +Exchange rate risk +Inflation risk +Volatility risk +Event risk +Sovereign risk

Benefits of a Lease

+Less costly financing +Reduced risk of obsolescence +Less restrictive provisions +Off-balance-sheet financing +Tax reporting advantages

Investment Constraints

+Liquidity +Time horizon +The tax treatment +Legal and regulatory constraints +Ethical or personal preferences

Criteria for Capital Budgeting Method

+Location (Europeans use payback period a lot more) +Size of company (Larger companies are more likely to use NPV or IRR) +Public vs Private (Private companies prefer payback period, public companies prefer NPV or IRR) +Management education (The more education management has, the more they will use IRR or NPV)

Non-Current Liabilities

+Long-Term Financial Liabilities +Deferred Tax Liability

Duties to Employers:

+Loyalty +Additional Compensation Agreements +Responsibilities of Supervisors

Duties to Clients:

+Loyalty, Prudence and Care +Fair Dealing +Suitability +Performance Presentation +Preservation of Confidentiality (unless unlawful)

Factors Influencing Industries

+Macroeconomic +Technology +Demographics +Government policies +Social influences

Board Member Qualifications

+Make informed decisions about the firm's future +Have made public statements indicating their ethical stance +Have not had any legal or regulatory problems as a result of working for or serving on a board +Have other board experience +Will regularly attend meetings +Do they have significant stock positions and are committed to shareholders +Have they served on the board for a long time and become too close to management

Types of Execution Orders

+Market order +Limit order +All or nothing order +Hidden order

Integrity of Capital Markets:

+Material Nonpublic Information +Market Manipulation

Characteristics of Commercial Paper

+Maturities of 270 days or less +Pure-discount security +Typically issued by corporations with strong credit ratings +Directly placed paper is sold to large investors without going through a broker +Dealer placed paper is sold to purchasers through a commercial paper dealer

Put Option P/L

+Maximum loss for the buyer is the premium +Maximum profit is the strike price minus the premium +Maximum loss to writer is the strike price minus the premium +Break-even is the strike price minus the option premium +Maximum profit for the writer is the premium +Zero-sum game between buyer and writer

Call Option P/L

+Maximum loss is the premium +Break-even price is the premium plus the strike price +Profit to the buyer is unlimited, loss to the writer is unlimited +Call holder will exercise when stock price is greater than the strike price +Maximum profit for the writer is the premium +Zero-sum game between buyer and writer

Fixed Income Financial Statement Disclosures

+Nature of liabilities +Maturity dates +Stated and effective interest rates +Call provisions and conversion privileges +Restrictions imposed by creditors +Assets pledged as security +The amount of debt maturing in each of the next 5 years

Officer can decide:

+No sanctions +Cautionary letter +Issue sanction

Measurement Scales

+Nominal scales are arbitrary ways of coding data +Ordinal scales are coding data categorically based on some sensical order that is relative +Interval scales are coding data in an order that has an equal distance between scale values +Ratio scales provide ranking, equal distance between values, and a true 0

Portfolio Management Process

+Planning step begins with the analysis of the investor's risk tolerance, return objectives, time horizon, tax exposure,liquidity needs, income needs, and any other preferences +Execution step is an analysis of the risk return characteristics to determine how the fund should allocate (top-down analysis) +Feedback step is rebalancing the portfolio and adjust the investor's IPS

Non-Current Assets

+Plants, Property, and Equipment +Investment Property +Intangible Assets +Goodwill +Financial Assets

Central bank tools

+Policy rate +Reserve requirements +Open market operations

Cycle Theory

+Presidential Cycle = 4 years +Decennial Cycle = 10 years +Kondratieff Wave = 54 years

Financing Activities

+Principal from issued debt +Proceeds from issued stock +Principal paid on debt +Payments to reacquired stock +Dividends paid to shareholders

Situations Where Estimating Cash Flows is Difficult

+Principal repayment stream is not known with certainty +Coupon payments are not known with certainty +Bond is convertible

7 Standards of Professional Conduct:

+Professionalism +Integrity of Capital Markets +Duties to Clients +Duties to Employers +Investment Analysis, Recommendation and Action +Conflicts of Interest +Responsibilities of a CFA Member/Candidate

Professionalism:

+Professionalism +Integrity of Capital Markets +Duties to Clients +Duties to Employers +Investment Analysis, Recommendation and Action +Conflicts of Interest +Responsibilities of a CFA Member/Candidate

Objectives of International Organization of Securities Commissions

+Protect investors +Ensure market fairness, efficiency and transparency +Reduce systemic risk

Interest Rate Theories

+Pure Expectations Theory +Liquidity Preference Theory +Market Segmentation Theory

Sanctioned candidate can:

+Reject sanction and refer it to a panel of CFA members +Accept sanction

Ways to Value Real Estate

+Replacement cost +Comparable sales +Income method +Discounted after-tax cash flow model

Discount Bond Effects

+Reported on balance sheet as less than face value +Discount is amortized over time and eventually the value of the bond liability will increase until it equals face value at maturity

Investing Activities

+Sales proceeds of fixed assets +Sale of debt and equity instruments +Principal from loans made to others +Acquisition of fixed assets +Loans made to others +Acquisition of debt and equity investments

Components of Credit Rating

+Scale and diversification +Operational efficiency +Margin stability +Leverage

Characteristics of Medium-Term Notes

+Shelf-registered and they do not need to be all sold at once +Provide a range of maturities and yields the issuer would like to sell +A best-effort issuance and agent does not buy bonds unsold +No typical structure or terms

Roles of central banks

+Sole supplier of money +Banker to the government and other banks +Regulator and supervisor of payments system +Lender of last resort +Holder of gold and foreign exchange reserves +Conductor of monetary policy

Process for Testing Hypothesis

+State Hypothesis +Select Test Statistic +Specify Level of Significance +State Decision Rule Regarding Hypothesis +Calculate Sample Statistics +Make a Decision about Hypothesis +Make a Decision Based on Test

Accrual Accounts

+State the objective and context +Gather data +Process data +Analyze and interpret data +Report conclusions and recommendations +Update analysis

Steps of Financial Statement Analysis Framework

+State the objective and context +Gather data +Process data +Analyze and interpret data +Report conclusions and recommendations +Update analysis

Market Anomalies

+The January effect is that in the first five days of January, stock returns are significantly higher than the rest of the year +The overreaction effect is the finding that firms with poor stock returns over the last 5 years subsequently have higher turns in the next period than firms that performed well +The momentum effect is that firms with high short-term returns are followed by continued high returns +The size effect is that small cap stocks outperform large caps +The value effect is that value stocks outperform growth stocks +Closed end investment funds typically deviate from NAV at a discount +Positive earnings surprises are generally followed by above average returns that last past the announcement day and can be exploited by buying positive surprises and selling negative surprises +IPOs typically rise after issuance and then fall in the long term

Contents of Footnotes

+The basis of presentation such as the accounting period +Information about the accounting methods used +Additional information about extraordinary events

Contents of Management Discussion and Analysis

+The basis of presentation such as the accounting period +Information about the accounting methods used +Additional information about extraordinary events

In verification, a third-party attests that:

+The firm has complied with all GIPS requirements for using composites firm wide +The firm's processes and procedures are established to present performance in accordance with the calculation methodology, data requirements and in the format required by GIPS

Reasons for Differences Between an Accounting Item for Tax Reporting and Financial Reporting

+Timing of revenue and expense recognition may differ on the income statement and tax return +Some revenues are only recognized on the income statement or tax return +Assets and/or liabilities have different carrying amounts and tax bases +Gain or loss recognition in the income statement differs from the tax return +Tax losses from periods prior may offset future taxable income +Financial statement adjustments may not affect the tax return or may be recognized in different periods

Criticisms of Derivatives

+Too risky for investors with limited knowledge +High leverage and high payoffs liken them to gambling

Disadvantages of Callable Bonds

+Uncertainty about cash flow stream +Principal tends to be returned at times when the possibilities for reinvestment are less attractive +Capital appreciation potential is less than an option-free bond

Auditor's Opinions

+Unqualified opinion +A qualified opinion +An adverse opinion +A disclaimer opinion

Responsibilities as CFA Member/Candidate

+Uphold reputation of CFA +Don't misrepresent CFA

Barriers to Creating a Coherent Financial Framework

+Valuation +Standard setting +Measuring value at a point in time versus it's movement over a period of time

Decisions of an Index Maker

+What is the target market an asset is supposed to measure +What securities should be included +How should securities be weighted +How often should index be rebalanced +When should selection and weighting be reevaluated

Convertible Preference Shares advantages

- Preferred dividend is higher than common dividend - firm is profitable, the investor can share in profits by converting their shares into common stock - Conversion option becomes more valuable when the common stock price increases - Preferred shares have less risk than common shares because the dividend is stable, and they have priority over common stock in receiving dividends and in the event of liquidation of the firm.

Ke and Gc relationship

- difference between widens, stock value falls - difference narrows, stock rises - small changes in difference can cause large changes in stock value

Gordon Assumptions

- dividends are the appropriate measure of shareholders wealth - Constant dividend growth rate, Gc, and RR on stock, Ke, are never expected to change -Ke must be greater than Gc look for words like "forever, indefinitely, infinitely, foreseeable future"

Comparable Valuation of Price Multiples advantages

- evidence that some price multiples are useful for predicting stock returns -price multiples widely used -price multiples readily available -Can be used in time series and cross-sectional comparisons -EV/EBITDA useful when comparing firm values independent of cap structures or when earnings are negative and PE can't be used

Direct Investing Obstacles

- investment and return are in foreign currency - foreign stock illiquid -reporting requirement of foreign stock less strict -investors must be familiar with the regulations and procedures of each market in which the invest.

After splits or dividends - trend

- stock prices tend to rise after - price increases appear because splits are taken as a positive signal from mgmnt about future earnings -If no good earning report, stock prices revert to original levels -tend to reduce liquidity due to higher percentage brokerage fees on lower-priced stocks Create more shares but do not increase shareholder value

Industry Concentration

-Absolute market share may not matter as much as firms market share relative to competitors -if industry products are undifferentiated and commodity-like, then consumers will switch to lowest-priced producer -industry is capital intensive, therefore costly to enter or exit, overcapacity can result in intense price competition

Capital account components

-Capital transfers -Sale and purchase of non-financial assets

Technology Firms

-Computers -Software -Semiconductor

Regimes of countries with their own currency

-Currency board -Conventional fixed peg agreement -Target zone -Passive crawling peg -Active crawling peg -Crawling bands -Managed floating exchange rate -Indecent entry floating exchange rate

Regimes of countries without their own currency

-Formal dollarization -Monetary union

Sections of GIPS:

-Fundamentals of Compliance -Input Data -Calculation Methodology -Composite Construction -Disclosures -Presentation and Reporting -Real Estate -Private Equity -Wrap Fee/SMA Portfolios

Financial account components

-Government owned assets abroad -Foreign owned assets in the country

Important properties of central limit theorem

-If sample size n is sufficiently large (n>30), sampling distribution will be approx. normal -mean of population, and mean of distribution of all possible sample means are equal -variance of distribution of sample mean is STD^2 / n the population variance divided by the sample size.

Fraud Triangle

-Incentive/Pressure -Opportunity -Attitude/Rationalization

Oligopoly models

-Kinked demand curve -Cournot duopoly -Nash equilibrium -Dominant firm model

Selection Methods

-NPV -IRR -Payback Period -Discounted Payback Period Profitability Index

Schools of economic thought

-Neoclassical -Keynesian -New Keynesian -Austrian -New Classical

Steps multistage model:

-determine discount rate Ke -project size & duration of high initial dividend growth rate -Estimate dividends during high growth period -Estimate Gc rate at end of high growth period -Estimate first dividend that will grow at constant rate -Use Gc to calc stock value at end of high growth period -add all PV of all dividends to PV od terminal value of stock

Beta

-estimated using historical returns data -estimate is affected by which index is chosen to represent market return -revert toward 1 over time, and estimate may need to be adjusted for this tendency -estimates for small-cap firms may need to be adjusted upward to reflect risk inherent in small firms

Cluster limitations

-high correlations may not be same as future -groupings may differ over time -grouping is sometimes non-intuitive -method is susceptible to a central issue in statistics

Comparable Valuation of Price Multiples Disadvantage

-lagging price multiple reflect past -Price multiples may not be comparable across firms -for cyclical firms may be greatly affected by economic conditions -overvalued by comparable, under by fundamental -Different accounting methods -negative denominator results in meaningless ratio

Disadvantages of asset-based models

-mkt values are often difficult to obtain -mkt values are usually different than book values -inaccurate when a firm has high proportion of intangible assets or future cash flows not reflected in asset values. -assets can be difficult to value during periods of hyperinflation

Disadvantages of price multiple valuation based on fundamentals

-price multiples based on fundamentals will be very sensitive to the inputs

Advantages of asset-based models

-provide floor values -most reliable when firm has primarily tangible short-term assets, assets with ready market values, or when firm is liquidated -increasingly useful for valuing public firms that report fair values

Hypothesis Testing Procedure

-state hypothesis -select approp. test statistic -specific level of significance -state decision rule regarding hypothesis -collect the sample and calculate sample stat -make decision regarding hypothesis -make decision based on results of test

Probability function

0 ≤ p(x) ≤ 1 Σp(x) = 1 the sum of the probabilities for all possible outcomes, x, for a random variable, X, equals 1

Constructing Sales Driven Pro Forma Financial

1 - estimate relation tween changes in sales and changes in sales-driven income statement and bal sheet items 2 - Estimate future tax rate, i rate on debt, lease payments 3 - Forecast sales for period of interest 4 - Estimate fixed operating costs and fixed financial costs 5 - Integrate these estimates into pro forma financial statements for period of interest

CAPM Approach

1 Estimate risk free rate of government bond with maturity closest to the life of the project 2. Estimate beta 3. Estimate the expected return of the market 4. CAPM = Risk Free Rate + (Beta) * (Estimated Market Return - Risk Free Rate)

T-Notes

1) 2,3,5 & 10 years Maturity 2) Carry Coupon & Non-Callable

IFRS: Presentation Requirements

1) Aggregation where appropriate; 2) No offsetting assets against liabilities or income against exp.; 3) Classifed B/S; 4) Minimum Info on face; 5) Minimum disclosure; 6) Comparative info.

IFRS (IAS No. 1): Required F/S

1) Balance Sheet; 2) Comprehensive Income; 3) Change in Equity; 4) Cash Flow Statement; 5) Accounting policies and notes.

Measurement of A & L disclosure in footnotes

1) Basis for measurement; 2) carrying value of inventory by category; 3) Amount of inventory carried at FV less cost to sell 4) Write-downs & reversals (discussion of circumstance that led to reversal); 5) Inventories pledged as collateral for liabilities; 6) Inventories recognized as an expense.

Stock options: Use treasury stock method

1) Calculate cash raised on exercise 2) Repurchase shares at avg. price 3) New Shares = exercised - repurchased = (average mkt price - strike price) × (# of options / strike price)

Capitalization of Interest

1) Capitalize interst during construction period when building its own operating facility; 2) Interest must actually be paid by the firm; 3) Specific and general debt interest is capitalized

Types of accounting changes:

1) Change in accounting principle; 2) Change in accounting estimate; 3) Prior period adjustments

Reasons to Lease

1) Cheaper Financing; 2) Reduce risk of obsolescence; 3) Less restrictive provisions; 4) Off-B/S reporting; 5) Tax Reporting Advantages (treated as ownership for tax ( deduct depreciation and interest expense)

Implication for Analysts: Be aware of differences in tax reconcilation between periods

1) Consider the growth rate and capital spending levels when determining whether temp diff due to accelerated depre will reverse 2) Look for cumulative differences due to asset impairments and post-retirement benefits 3) Restructuring charges can create a DTA

Convexity Effect

1) Convexity is a measure of the curvature of the price-yield curve. The more curved the price-yield relation is, the greater the convexity. 2) A straight line has a convexity of zero. If the price-yield curve were, in fact, a straight line, the convexity would be zero. 3) The reason we care about convexity is that the more curved the price-yield relation is the worse our duration-based estimates of bond price changes in response to changes in yield are. The greater the convexity the greater the error in price estimates based solely on duration.

Credit Enhancement For ABS(CLB)

1) Corporate Guarantees 2) Letter of Credit 3) Bond Insurance

Explicit Paying Debt Security Returns

1) Coupon Interest Payment 2) Recovery of principal along with capital gain/loss 3) Reinvestment income (from investing coupon payments).

Forecasting Financial Performance: Application

1) Credit Scoring (CF Forecast) 2) Equity Investment screening (cutoff values)

IASB - Goals

1) Development of high quality, transparent and enforceable global standards; 2) Promote application of standards; 3) Take into account special needs (small & med entities & emerging markets); 4) Convergence of nat'l and int'l standards

Analyzing Effective Tax Rate Reconciliation

1) Diff tax rate in diff. tax jurisdictions (countries) (continuous)2) Permanent tax differences: tax credit, tax-exempt income, nondeductible expenses, & tax diff between capital gains and operating income. (continuous) 3)Δ in tax rates and legislation 4) Deferred tax provided on the reinvested earnings of foreign and unconsolidated domestic affiliates 5) Tax holidays in some countries (sporadic) notice conditions such as termination dates for holidays or a requirement to pay the accum' taxes at some point in the future.

Types of Event Risk

1) Disaster 2) Corporate Restructuring 3) Regulatory Issues.

Capital Asset Pricing Model

1) Estimate RFR. yield on default risk-free debt such as U.S Treasure notes are usually used. 2) Estimate stocks beta, B. Risk measure 3) Estimate the expected rate of return on market 4) CAPM to estimate the required rate of return Kcs = RFR +B [E(Rm) - RFR]

IFRS Revenue Recognition

1) Risk & Reward transferred; 2) No continued control; 3) Reliable measurement; 4) Probable flow of benefits; 5) Cost verifiable

Roles of financial reporting & analysis include:

1) Evaluating equity investments for a portfolio; 2) Evaluating potential M&A; 3) Evaluating a subsidiary of a parent company; 4) Deciding on private equity/ venture cap investment 5) Determine creditworthiness - borrowing; 6) Extending credit to customers; 7) Examining compliance with covenants/contracts; 8) Assigning a debt rating; 9) Valuing a security - Equity research/reports; 10) Forecasting future earnings/cash flows;

SEC guidance for Revenue Recognition

1) Evidence of an arrangement; 2) Completion of earnings process; 3) Price is determined or determinable; 4) Assurance of payment

Types of Federal Agencies

1) Federally Related Institution (GNMA, TVA) 2) Govt Sponsored Enterprise (Federal Farm Credit System, Fed Home Loan Bank System, FNMA, Freddie Mae, Sallie Mae). GSEs commonly issue debentures.

Financial Lease Reporting

1) Firms adds a lease asset and a lease liability to b/s = amounts 2) Recognize int. expense on liability and depreciation exp on asset *Since Int. exp + depre > lease pymt in the early years. This decreases NI, and Profitability ratios.

Forecasting Financial Performance: Top Down Approach:

1) Forecast GDP 2) Regress industry sales against GDP 3) Forecast industry sales 4) Cosider changes to firm's mkt share 5) Forecast firms sales 6) Use hisoric margins for stable firms or forecast individual expense items 7) Remove non-recurring items when calculating historic margins

Difference between forwards and futures?

1) Futures are not private transactions 2) Futures are traded on a futures exchange 3) Futures are standardized 4) Futures have a secondary market 5) Futures are guaranteed against credit losses resulting from a counter-party's ability to pay. 6) Futures contracts are regulated at the federal level

Fraud Triangle

1) Incentive/Pressure (the motive to commit fraud) 2) Opportunity (exists with weak internal controls) 3) Attitude/rationalization (mindset that fraud is justified)

FASB - Harmonization

1) Increase comparability; 2) Reduce expense of overseas capital; 3) Reduce the expense of producing consolidated accounts

B/S - investments

1) Intention to hold >1 year (e.g. debt or equity) valued @ cost or mkt value 2) Equity accounted investments

Type of Risks

1) Interest rate risk 2) Yield curve risk 3) Call risk 4) Prepayment risk 5) Reinvestment risk 6) Credit risk 7) Liquidity risk 8) Exchange-rate risk 9) Inflation risk 10)Volatility risk 11) Event risk 12) Sovereign risk

General Flow in Accounting System

1) Journal entries 2) general ledger 3) trial balance 4) FS

Intangible Assets

1) Lack physical form (patent, copyrights etc; 2) Good will is an ex. of an unidentifiable intangible asset, not amortized but subject to annual impairment reviews; 3) Identifiable intangibles are amortized. (eliminate goodwill from ratio analysis)

B/S - Long-lived assets PP&E

1) Land @ cost; 2) Plant & building @ historic cost less accu'm depr; 3) Equipment @ historic cost less accu'm depr 4) Intangible assets @ historic cost less accu'm amort

Types of GO Muni Debt

1) Limited Tax GO 2) Unlimited Tax GO 3) Double Barreled Bond 4) Appropriation Backed Obligation/Moral Obligation Bonds.

The Compensation Committee should ...

1) Link compensation with LT objectives

Fraud Triangle - 2) Opportunity

1) Nature of industry/entity operations: 3rd party transactions; Power of customer/supplier; Acct est subjective; Unusual transactions; International operations; International operations; Operations in tax havens. 2) Opportunity complex/unstable org. structures: Difficult to determine structure; Difficult to determine controlling interest; Overly complex structure; High key employee turnover 3) Insufficient internal Control: Inadequate monitoring; High stock turnover internal aduit, IT; Ineffective accounting and IT system. 4) Ineffective Monitoring: Dominant person/group; Ineffective audit committee; Ineffective board of directors.

Option Adjusted Spread(OAS)

1) OAS is the Z-Spread w/ the option value removed 2) Option Removed Spread 3) OAS is used when bonds have embedded options. 3) The OAS is the spread to the Treasury spot rate curve that the bond would have if it were option-free. 4) The OAS is the spread for non-option characteristics like credit risk, liquidity risk, and interest rate risk.

IFRS Revenue Recognition For Service

1) Outcome reliable: rev recognized by stage of completion. 2) Outcome unreliable: revenue recognized but no profit

Factors that affect individual's willingness to take risk

1) Personality type

Cost included in Inventory on b/s:

1) Purchase cost; 2) conversion costs; 3) Allocation of fixed production OH based on normal capacity levels; 4) Other costs necessary to bring the inventory to its present location and condition (freight costs & installation) Exclude: Admin OH, Storage costs, Abnormal material waste

Steps of F/S Analysis

1) Purpose and context 2) Data Collection 3) Data Processing 4) Analysis/Interpretation of data 5) Develop conclusions and recommendations 6) Follow-up

Medium Term Notes

1) Register with SEC Rule 415(Shelf Registration) 2) Maturity - 9 months to 100 years 3) Combined with Derivatives are called structured securities 4) Agents do on best effort basis.

MD&A contains:

1) Results of operations and discussions of trend; 2) Capital resources, liquidity, and cash flow trends; 3) General business overview based on known trends; 4) Effects of trends, events, and uncertainties; 5) Discontinued operations, extraordinary items, unusual items; 6) Disclosure in interim f/s; 7) Segment cash flow 8) Sig accounting methods and estimates

Disclosure for each segment:

1) Revenue (external & internal) 2) Segment results (operating profit) 3) Carrying amount of segment asset4 4) Segment liabilities (IFRS) 5) Cost of PPE and intangibles acquired 6) Depreciation and Amort expenses 7) Other non-cash expense 8) Share of profit/loss from equity accounted investments 9) Reconciliation bw segment data and consolidated data

Auditor/Audit Opinion

1) Unqualified opinion (good); 2) Qualified opinion (followed GAAP except for...); 3) Adverse opinion (bad) Must express an opinion about the effectiveness of the company's internal control system. Are internal controls in accordance with PCAOB (public company accounting oversight board). This is either final paragraph or as a separate opinion. Least likely to prepare and accept responsibility for them.

Barriers to a single framework:

1) Valuation; 2) Standard setting; 3) Measurement

Z-Spread

1) Z-Spread is the credit spread that adjusts for the curvature of the spot rate yld curve. 2) Z-Spread is the constant spread which must be added to each rate on the Treasury spot yield curve in order to make the present value of the risky bond's cash flows equal to its market price. 3) The steeper the benchmark spot rate curve, the greater the difference between the two spread measures. 4) The earlier bond principal is paid, the greater the difference between the two spread measures.

Proxy Statements are

1) available on EDGAR 2) A good source of info abt the qualifications of board members and management.

Cap Budgeting Principals

1) decisions based on cash flows, not accounting income 2) Cash flows based on opportunity costs & taxes 3) timing of cash flows is important 4) Cash flows are analyzed on a after-tax basis 5) financing costs are reflected in the projects required rate of return

Fundamental principles for PREPARING f/s under IFRS: (IAS No 10)

1) fair presentation; 2) going concern; 3) accrual basis; 4) consistency; 5) materiality

B/S - short-term investments

1) held-to-maturity: @ amortized cost (i.e Bonds) 2) trading: @ fair value through P&L @ fair mkt value, unrealized g/(l) are recognized on the I/S. 3) available-for-sale: @ fair mkt value, unrealized g/(l) are NOT recognized on the I/S, instead recognized on comprehensive income as part of SOE.

Estimate growth rate on div, three methods

1) historical growth in dividend for the firm 2) median industry in dividend growth rate 3) estimate the sustainable growth rate

Capital Budgeting Steps

1) idea generation 2) analyzing project proposals 3) create the firm-wide capital budget 4) monitoring decisions and conducing a post-audti

Sales Basis Revenue Recognitions

1) installment sales (If collection is certain, rev is recognized at time of sale) 2) installment method: (if collection cannot be estimated) 3) cost recovery (if collectability is highly uncertain)

Valuation allowance

1) is a contra asset account used to reduce the value of a DTA. 2) it is used to reduce the asset when future taxable income is deemed to be insefficient to fully use the DTA.

Invest based on differences between market prices and intrinsic

1) larger % diff tween mkt prices and estimated values, the more likely the investor is to take a position based on the estimate of intrinsic value. 2) more confident investor is about the appropriateness of the valuation model used, the more likely the investor is to take an investment position in a stock that is identified as overvalued or undervalued

Disadvantages of using price multiple based on comparable

1) stock may appear overvalued by comparable but undervalued by fundamental 2) different accting methods can result in price multiples that are not comparable across firms 3) price multiples for cyclical firms may be greatly affected by economic conditions

The 4 Qualitative Characteristics of IFRS

1) understandability; 2) relevance; 3) reliability; and 4) comparability No hierarchy <- shocking for Europeans

Analyst Treaments of DTL

1) when differences are expected to REVERSE and results in future tax payment, treate DTL as a LIABILITY in calculating leverage ratios 2) when differences are NOT expected to REVERSE and result in future tax payment, treat DTL as EQUITY in calculating leverage ratios 3) when the amount and timing of future tax payments from reversal is uncertain, exclude from both liability and equity.

Taxation Disclosure Requirements

1)DTL, DTA, valuation allowance, Net Δ in valutaion allowance over the period 2) unrecognized DTL or undistributed earning from subsidiaries & JVs 3) Current yr tax effect of each type of temp diff. 4)Components of Inc Tax Expense 5)Tax loss carryforwards and credits 6) Reconciliation of reported income tax expense and tax expense based on statutory rate (explain why there is a permanent difference. Why effective tax rate ≠ statutory rate)

Accounting Information Flow

1. Journal record every transaction by order of date in the general journal 2. The general ledger sorts the entries in the general journal by account 3. An initial trade balance is prepared at the end of the period to show the balance of each account and adjustments are then made 4. Financial statements are made from the adjusted trial balances

Free operating CF to Total Debt

= CFO - Capex / total debt

Operating Break Even Cost of Sales

= Fixed Operating Costs/(Price - Variable Cost per Unit)

Net Profit Margin

= NI / Sales = EBT x (1 - t) / Sales

Funds from Operations to debt

= NI adj for non cash items/ total debt

What are the four general steps in the portfolio management process?

1. Write a policy statement that specifies the investor's goals and constraints. Then itemize the risks the investor is willing to take to meet these goals. 2. Develop an investment strategy designed to satisfy the investor's policy statement based on an analysis of the current financial and economic conditions. 3. Implement the plan by constructing the portfolio, allocating the investor's assets across countries, asset classes, and securities based on the current and future forecast of economic conditions. 4. Monitor and update the investor's needs and market conditions. Rebalance the investor's portfolio as needed.

Non-parametric Test situations

1. hypothesis test of mean value for a variable that comes from a distribution 2. when data are ranks rather than values 3. Hypo not involve parameters of distribution, such as testing whether a variable is normally distributed. Use run tests

calculate and interpret the payoff of an FRA, and explain each of the component terms. FRA expiring in 90 days on the 180 day LIBOR, quoted at 5.5%. Face value = $10M. Real rate ends up being 6%. What does 1 X 3 and 12 X 18 mean for an FRA?

10,000,000(((.06-.055)(180/360))/(1.06(180/360))) = $24,272 Long makes money in this case. Notional principal ((Underlying rate at Exp. - Forward Contract Rate)(Days in underlying rate/360))/(1+Underlying rate at exp.(Days in underlying rate/360)) FRA notation: 1 X 3 : Contract expires in 1 Month, underlying rate is 60 day LIBOR (3 b/c it is total time, including contract time included) 12 X 18 : Contract expires in 12 months, underlying rate 180 day LIBOR

DuPont ROE Equations

= Net Profit Margin * Asset Turnover * Leverage Ratio = (Net Income/EBIT) * (EBT/EBIT) * (EBIT/Revenue) * (Revenue/Total Assets) * (Total Assets) * (Total Assets/Total Equity) = (Tax Burden) * (Interest Burden) * (EBIT Margin) * (Asset Turnover) *(Financial Leverage)

income inelastic normal good

1>ie>0

Calculate dividends declared:

1st: Net Income - dividends declared = chg in R/E Then: Dividends declared +/- chg dividends payable = cash dividends paid.

Impairments recognition (GAAP)

2 step-process 1) Recoverability: carrying value > undiscounted CF from asset's use and disposal 2) Loss measurement: Loss is the excess of carrying value over the asset's fair market value or PV of cash flows *Loss reversal for held-for-use assets is PROHIBITED *Loss reverse for held-for-sale assets is allowed

Kurtosis of a normal distribution

3

Payables TO

= Purchases / Avg Trade Payables

Fixed Asset TO

= Rev / Avg Fixed Assets

Total Asset TO

= Rev / Avg Total Assets

Total Debt Ratio

= Total Debt / Total Asset

D-to-E

= Total Debt / Total Equity

Invest based on differences between market prices and intrinsic

3) More confident the investor is about the estimated inputs used in valuation model, more likely the investor is to take an investment position in a stock that is identified as overvalued/undervalued. 4) even if assume mkt prices sometimes deviate from intrinsic values, market prices must be treated as fairly reliable indications of intrinsic value. 5) position in stock identified as mispriced in mkt, an investor must believe that the mkt price will actually move toward its estimated intrinsic value and that it will do so to a significant extent within the investment time horizon

30/360 Day Count Convention

30/360 is the easiest convention to use because it assumes that there are 30 days in every month, even though some months actually have 31 days. For example, the period from May 1, 2006 to August 1, 2006 would be considered to be 90 days apart. Given the simplicity of this day-count convention, it is often used in calculations of accrued interest for corporate, agency and municipal bonds. It is also commonly used by investors of mortgage backed securities.

TIPS

5 & 10 Yr Notes & 20 Yr bonds offered by US Treasury with Inflation Protection. Provides Real ROR w/ Semiannual Inflation Adj. Principal adjust, but cpn is fixed. Adjusted Par Bd Value * Cpn = Int Pmt

Confidence Intervals: 90% CI 95% CI 99% CI

90% -X -1.65 to X +1.65 95% - X - 1.96 to X +1.96 99% - X - 2.58 to X +2.58

nominal gdp equation

= # units produces * avg mkt price

Operating Leverage

= %chg in EBIT/ %chg in Sales

Degree of Financial Leverage

= (% Change in EPS)/(% Change in EBIT) = (EBIT)/(EBIT - Interest)

Bank Discount Yield

= ((face value - market value)/(face value)) * (360/days until maturity)

Effective Annual Rate

= (1 + (periodic rate/compounding periods)) ^ (compounding periods) - 1

Effective Annual Yield

= (1 + HPR) ^ (365/days until maturity) - 1

Cash ratio

= (Cash + mkt sec) / CL

Bond Equivalent Yield

= 2 * (semiannual discount rate) OR = HPR * (365/days until maturity)

Days of inventory on hand (DOH)

= 365 / Inv TO = 365 / ( COGS / Avg. Inv.)

Days of sales outstanding (DSO)

= 365 / Rec TO = 365 / (Rev / Avg. AR)

Days of payables

= 365 / payables TO = 365 / (purchases / Avg. AP)

DOH

= 365/(Inv. T/O) = 365/( COGS/ Avg. Inv.) LIFO = lower days, FIFO = higher days

Receivables Turnover

= Annual Sales / Avg Rec

Project Beta

= Asset Beta * [1 + (Debt/Equity) * (1 - Tax Rate)]

Cost of Goods Sold

= Beginning Inventory + Purchases - Ending Inventory

Current ratio

= CA/CL

Survivorship bias

most common form of sample selection bias. Does not include things that cease to exist

T-Distribution

A bell shaped distribution symmetrical about its median used to make confidence intervals with small samples (<30) and unknown population variance; Degrees of freedom = # of Observations - 1

Forward Contract

A bilateral contract that obligates one party to buy and the other to sell a specific quantity of an asset, at a set price, on a specific date in the future; No premium is paid to get into the contract ; Used to hedge risk and speculate on prices; Buyer has long position; Seller has short position; Can terminate a forward contract by entering into the opposite position in another trade

Reinvestment Risk

A bond has more Reinvestment Risk when: 1) The coupon is higher so that interest cash flows are higher 2) It has a call feature 3) It is an amortizing security 4) It contains a prepayment option.

Repo Agreement

A borrower sells a high quality asset and has both the right and obligation to buy it back at a higher price in the futures

Limit Order "Far From the Market"

A buy considerably lower than the best bid or a sell considerably higher than the best ask

Limit Order "Making the Market"

A buy order at the best bid or sell at the best ask

Limit Order "Behind the Market"

A buy order below the best bid or a sell order above the best ask

Share Repurchase

A company buys back shares of its own common stock; Increases earnings per share; EPS RISES IF EARNINGS YIELD > COST OF BORROWED FUNDS; EPS FALLS IF EARNINGS YIELD < COST OF BORROWED FUNDS; Purchasing with company funds reduces interest income and earnings; Purchasing with borrowed funds incurs interest costs; BOOK VALUE PER SHARE WILL INCREASE/DECREASE IF THE PURCHASE PRICE IS LESS THAN/GREATER THAN THE BOOK VALUE PER SHARE; Alternative to a cash dividend

Form 144:

A company can issue securities to certain qualified buyers without registering the securities with the SEC, but must notify the SEC that it intends to do so.

Differentiate between a dealer and an end user of a forward contract

A dealer will take the other side of a forward contract but will attempt to off-set the risk with another contract. An end user is using the forward either to speculate or hedge their exposure to an asset.

Eurodollar Deposit

A deposit in a large bank outside of the US but denominated in US dollars; LIBOR is the interest rate on Eurodollar deposits; Euribor is the equivalent Euro interest rate

Platykurtic distribution

A description of the kurtosis in a distribution in which the statistical value is negative. When compared to a normal distribution, a platykurtic data set has a flatter peak around its mean, which causes thin tails within the distribution. The flatness results from the data being less concentrated around its mean, due to large variations within observations.

Floating-Rate Security Sensitivity and Market Yields

A floating-rate security will be much less sensitive to changes in market yields than a fixed-coupon bond of equal maturity and thus lesser duration.

What is a swap?

A forward contract that is equivalent to a series of forwards. Usually, one cash flow is fixed, the other is variable and tied to another rate (exchange rate, stock price, commodity price). They are private transactions.

Futures Contract

A forward contract that is standardized, traded in a secondary market, regulated, backed by a clearinghouse, requires daily settlement of gains and losses, and exchange-traded

Forward Rate Agreement

A forward contract to lend/borrow money at a certain rate in the future; Cash settled, no loan is made; Creditworthiness is not considered; If yield goes up, long gets paid; if yield goes down, short gets paid Payment = (Nominal Principal) * [(Floating Rate - Forward Rate) * (Days/360)]/[1 + (Floating Rate * Days)/360]

Exchange Traded Fund

A fund that invests in a portfolio of stocks and bonds in efforts to mimic an index; Traded like a stock

If Company Redeems Bonds

A gain or loss is recognized by subtracting the redeem price from the book value of the bond liability at the redeem date; GAAP requires any remaining unamortized bond issuance costs must be written off and included in the gain or loss calculation; IFRS requires no write down since the legal and issuance costs have already been deducted

Special Purpose Vehicle

A legal entity to which the assets used as collateral in an ABS issue are sold. This transaction separates the assets backing the ABS from the other assets of the company that creates the SPV.

Elasticity of demand

A measure of how consumers respond to price changes; Perfectly elastic is when the demand curve is horizontal; Perfectly inelastic is when the demand curve is perfectly vertical

Attitude/Rationalization

A mindset that fraudulent behavior is justified; Inappropriate ethical standards; Excessive participation by nonfinancial management in the selection of accounting standards; Violations of laws and regulations by management or board members; A management obsession with maintaining or increasing the firm's stock price or earnings trend; Making commitments to third parties to achieve aggressive results; Failing to correct known reportable conditions; Inappropriately minimizing earnings for tax purposes; Use of materiality as a basis to justify inappropriate or questionable accounting methods; Strained relationship between management and the current or previous auditor

Indifference Curve

A plot of the combinations of risk and return that an investor is indifferent to; Slope upward for risk adverse investors because they will only take more risk if they get paid for it

How does the return on an index provide for dividend reinvestment?

A portfolio with equal numbers of shares of each stock in the price-weighted index will match the performance of the index assuming there are no stock splits, stock dividends, or changes in the make-up of the index. The return on the index does not include cash dividend payments. Since the reinvested dividends will add to the number of shares of those stocks that pay dividends, the portfolio return that reinvests dividends will exceed that of the index.

Interest Rate Floor

A series of floating rate options that have expiration dates that correspond to the reset date on a floating-rate loan; Protect floating rate lenders; Pays when rate falls below floor

Swap

A series of forward contracts where one party agrees to pay the short-term (floating) rate of interest on some principal amount, and the counterparty agrees to pay a certain (fixed) rate of interest in return

Interest Rate Cap

A series of interest rate call options that have expiration dates that correspond to the reset date on a floating-rate loan; Protect a floating-rate borrower; Pays when rate rises above the cap

Commercial Paper

A short-term unsecured debt instrument used by corporations to borrow money at rates lower than bank rates. CP has maturities from 2 - 270 days; unregulated by the SEC.

Market-Neutral Fund

A type of long/short fund that attempts to make money despite what the general market is doing; Long and short positions net themselves out

Cash Flow Earnings Index

A way to measure the relationship between the operating cash flow and earnings; CFEI = Operating Cash Flow/Net Income

Term Structure Of Interest Rates

A yield curve displaying the relationship between spot rates of zero-coupon securities and their term to maturity.

Alternative Bond Issues

ABS CCRs - Credit Card Receivables CARS - Automobile (loans) backed Bonds Assets w/ amortizing cash flows bundled together, sliced up, and sold to investing public.

Relationship cost curves

AFC slopes downward Vertical distance between ATC and AVC equals AFC MC initially declines, then rises MC intersects AVC and ATC at their minimums ATC and AVC are u-shaped The MC above the AVC is the firm's short-rum supply curve

Relative Yield Spread

Absolute yield spread expressed as a percentage of the yield on the lower-yield bond. Relative Yield Spread = [Absolute Yield Shield/Yield on lower-yield bond] OR [(yield on the higher yield bond / yield on the lower yield bond) - 1]

# days of payables =

Accounts Payable / Average days purchases

Comprehensive Income

Accounts for all changes in equity except for owner contributions or distributions; Includes foreign currency gains/loses, pension liability adjustments, cash from hedging and unrealized gains/loses from available-for-sale securities

Actual/Actual Day Count Convention

Actual/Actual convention uses the actual number of days between two periods and divides the result by the actual number of days in the year, rather than assuming that each year is made up of 360 or 365 days. Of course, we know that in reality there are always 365 days in a year - with the exception of leap years - but these conventions are standards that have developed over time and help to ensure that everyone is on an even playing field when a bond is sold between coupon dates.

Multi-Year Dividend Discount Model

Add each year's dividends discounted by each years required return on equity to the present value of the terminal value; Most of the time they use an infinite holding period model where the terminal value is calculated at some point in time when growth rates remain constant

Types of accounting changes: prior period adjustments

Adjustments Involves erros or new accounting standards Resate prior period Disclose nature and effect on NI Errors may indicate weakness in internal controls

Hedonic index

Adjusts a price index for the quality of goods used in basket

Low Willingness to Bear Risk, High Ability to Bear Risk

Advisor can try to educate client, but it is not his responsibility to force client to take on more risk

Kd (1-t)

After-tax cost of debt. t is firms marginal tax rate. The after tax component cost of debt, Kd (1-t) is used to calc WACC

Warning Signs of Earnings Manipulation

Aggressive Revenue Recognition Diff. growth rates of operating cash flow and earnings Abnormal comparative sales growth Abnormal inventory growth as compared to sales Moving nonoperating income and nonrecurring gains up to I/S to boost revenue Delaying expense recognition Excessive use of off-b/s financing arrangements including leases. Classifying expenses as extraordinary or nonrecurring and moving them down the I/S to boost Inc. from cont. operations. LIFO liquidations (decrease in inv. levels that result in out-of-date, low cost being recognized in COGS) Abnormal comparative margin ratios Aggressive assumptions and estimates Equity method investments with little or no cash flow

Voluntary export restraint

Agreement by the government to limit the quantity of a good that can be exported; The loss to the domestic economy is equal to that of an equivalent quota with no charge for quota rents

Forward Contract

Agreement to buy or sell an asset in the future at a specified price in the contract at its inception

Describe the characteristics of forward contracts on zero-coupon and coupon bonds

Agreement to buy/sell a certain bond for a certain price at a certain date.

Free trade area

All barriers to import and export of goods and services among member countries are removed

Economic union

All benefits of a common market; Member countries establish common institutions and economic policy for the union

Common market

All benefits of a customs union; All barriers to the movement of labor and capital goods among member countries are removed

Customs unions

All benefits of a free trade area; Countries adopt a common set of trade restrictions with non-members

Monetary union

All benefits of an economic union; Member countries adopt a single currency

Issuing an Investment Recommendation Report

All clients of a firm must be given it at the same time

Single-Step Format

All expenses are grouped together

Two Fund Separation Theorem

All investors' optimum portfolios will be made up of some combination of an optimal portfolio of risky assets and a risk free asset

Financial Liability: US GAAP/Amortized at Cost

All other liabilities (e.g. bonds, notes payables, leases)

Complete Markets

Allow investors to save for the future at fair rates of return, creditworthy borrowers obtain funds, hedgers manage risk and traders get assets

Open-End Fund

Allows investors to buy newly issued shares at NAV; New cash is invested by mutual fund manager in new securities; Investors can redeem their shares at NAV; Management charges an ongoing fee as a percent of NAV

Accelerated Sinking Fund

Allows the issuer the choice of retiring more than the amount of bonds specified in the sinking fund requirement

Par Value

Amount borrower promises to pay on or before maturity date.

Tax base of an asset

Amount deductible in future tax return

Leverage

Amount of fixed costs a firm has

Indexed Commodity Strategy

An active investment because rolling risk and investing on the futures curve require active management; Weights of various commodities and blocks can change over time and must be managed; Collateral must be managed

Describe the characteristics of swap contracts and explain how swaps are terminated (reading 72)

An agreement between two parties to exchange a series of future cash flows -initially, no cash is exchanged -payment is made at the settlement date through netting unless the swap is initiated in two different currencies -The final payment is made on the termination date -The original time to maturity of the swap is called the tenor of a swap -Swaps are subject to default risk and can be tricky to untangle. If A misses a payment to B but A's swap (after being discounted to present) is worth more than B's, the value of the swap will be used to settle the existing liability. *swaps are completely OTC Swap Termination: 1) Can terminate the swap ahead of time, discount the cash flows and pay the net difference. This can only happen if both parties agree to do so in advance or if both parties agree to at the time. 2) Terminate by setting up an off-setting swap. Exposes you to dual default risk. Most likely, the off-setting swap won't be perfect but at least the floating rate risk is no longer present. 3) Exercise an off-setting swaption -- an option to enz ter into a sway at terms that are established in advance

Forward Commitment (or Forward Contract)

An agreement between two parties. Buyer agrees to buy an asset from a seller at a future date and price established at the start. It is a completely customized, OTC, product and includes forwards, futures and swaps.

What is a Currency Forward Contract? Describe the characteristics of currency forward contracts

An agreement to buy/sell a certain amount of a currency at a certain time for a certain rate. Cash or delivery settlement.

Revaluation Model

An alternative to the cost model and allows for long lived assets to be reported at fair value as long as there is an active market for the asset; Any revaluation above historical cost is not reported on the income statement but is an increase in the revaluation surplus in owner's equity

Repo Agreement

An arrangement by which an institution sells a security with a commitment to buy it back at a later date for a higher price

Giffen good

An inferior good for which the income effect outweighs the substitution effect so that the demand curve is positively sloped (higher the price, higher the demand)

What does an investment policy statement do?

An investment policy statement identifies a benchmark portfolio that will be used to judge the performance of the portfolio manager.

Uncommitted Line of Credit

An offer of credit for a certain amount a bank extends but may refuse to lend if conditions change

Arbitrage

An opportunity where the return that can be earned without risk is greater than the risk-free rate; Come from market mispricings; If uncertain returns can be combined into a portfolio that has certain returns, the portfolio should not exceed the risk free rate

Financial Ratio based on I/S:

Any I/S subtotal is expressed a margin ratio (to revenues). Gross profit margin = gross profit/ revenue Net profit margin = Net Inc/revenue Operating profit margin = EBIT/ revenue Pre-tax margin = EBT/ revenue

Call Risk

As interest rates fall, an issuer is more likely to call its bonds and refinance at a lower rate

Gordon Growth Model

Assumes annual growth rate of dividend is constant; Stock value equals the dividend divided by the difference of the required return and the dividend growth rate

Arithmetic Mean

Average of every period's return

Discounted Cash Flow Calculations

BDY = D / F * 360 / t where D is discount rate and F is face value EAY = (1 + HPY)^365/t - 1 MMY = [360 * BDY] / [360 - (t * BDY)]

Bond Equivalent Yield (BEY)

BEY of an annual-pay bond BEY = [(1 + annual YTM)^1/2 - 1] * 2

Gain/(loss) on bond early retirement: (derecognition of debt)

BV - cash paid = gain/(loss) + any unamortized issue costs (US only) = Gain/Loss on repurchase [I/S as continuing operations)

BVPS

BVPS will decrease if the purchase price is greater than the original BVPS and increase if the repo price is less than the original BVPS

Double-Barrel Bonds

Backed by both taxes but also special charges that are collected outside of the general fund; General obligation

Mortgage Backed Securities

Backed by pools of mortgage loans that provide both collateral and cash flow; Self-amortizing and can be paid early; Issued by Ginnie Mae, Fannie Mae and Freddie Mac; Cash flows are of periodic interest, scheduled principal repayments, and unscheduled principal payments; Mortgage pass through securities pass payments made on a pool of mortgages through proportionally to each security holder; Collateralized mortgage obligations are derivatives of mortgage passthroughs; Stripped mortgage-backed securities are either principal or interest portions of a mortgage backed security

Tax Backed (General Obligation) Bonds

Backed by the full faith, credit and taxing power of the issuer

GO Muni Bonds

Backed by the full faith, credit, and taxing power of the issuer.

Unlimited Tax General Obligation Bonds

Backed by unlimited taxing power of the issuer; General obligation

Kinked demand curve

Based on the assumption that an increase in a firm's product price will not be followed by its competitors, but a price decrease will; Firms assume that demand is more elastic above a certain price than below it; Firms produce the quantity at the kink, assuming if they increase production, their revenues will be eroded by decreased prices and if they decrease production the price won't go up much; Model doesn't account for cause of kinks

What is the definition for "beta?"

Beta (systematic risk) is the slope coefficient of the regression line (historical returns of the stock against the historical returns of the market) and is used to construct the SML.

Ex-Coupon Bond

Bond traded without right to next coupon.

Bond yield + risk premium Kce =

Bond yield + Risk Premium

Duration

Bond's interest rate sensitivity; The ratio of the percent change in price to the percent change in yield; = (- Percent Change in Bond Price)/Yield Change in Percent; Longer maturities have longer durations; Lower coupon rates have higher duration; Callable bonds have lower duration; Putable bonds have less duration risk

Prefunded Bonds

Bonds for which Treasury securities have been purchased and placed in escrow to make all of the remaining required bond payments; Income and principal from Treasuries must be enough to cover remaining payments until maturity or next call date; Have little credit risk

GAAP Asset Impairment

Book value is greater than the sum of the estimated undiscounted future cash flows from its use and disposal

Liquidity Preference Theory

Both short-term rate expectations and a liquidity premium determine yields; Consistent with longer maturities having higher yields; Size of liquidity premium will depend on how much additional compensation investors require to take on the greater risk of longer maturity bonds; Liquidity premium can distort information coming from the yield curve

IFRS/US GAAP Frameworks: objective of F/S

Both: General agreement on objectives; focus on wide range of users. IASB: One objective for all users FASB: Separate objectives for business entities and non-business entities.

IFRS/US GAAP Frameworks: purpose of framework

Both: purpose is to assist development & revision of accting stds. IASB: Firms must consider framework if no std exists FASB: No express requirement to consider framework

Austrian

Business cycles are caused by the government

Long/Short Fund

Buy securities that are expected to outperform the market and sell those that are expected to underperform

Impact on the Cash Flow of a Zero Coupon Bond:

CFO: no impact CFF: increased by amount rcvd at issuance and decreased by payment made at redemption CFO is lower (b/c no impact) and CFF is higher

FCFE =

CFO - FCInv + Net borrowing

calculating free cash flow to equity

CFO - CAPEX + net borrowing

CFO Analysis:

CFO = NI, means high quality of earnings but may be affected by the stage of business cycle and firm's life cycle CFO > NI, means premature recognition of revenue or delayed recognition of expenses.

Impact on the Cash Flow of a Par Bond:

CFO: cash interest expense CFF: increased by amount rcvd at issuance and decreased by payment made at redemption

Impact on the Cash Flow of a Discount Bond:

CFO: cash interest expense CFF: increased by amount rcvd at issuance and decreased by payment made at redemption CFO is higher and CFF is lower

Impact on the Cash Flow of a Premium Bond:

CFO: cash interest expense CFF: increased by amount rcvd at issuance and decreased by payment made at redemption CFO is lower CFF is higher

Cash flow yield (CFY)

CFY incorporates a projection as to how these prepayments are likely to occur. Once we have this in hand, we can calculate CFY via an internal rate of return measure, similar to the YTM. Cash Flow yield (CFY) is use for MBS & other amortizing securities.

Discounted Payback Period

Calculates the time it takes to get back invested capital in present value terms; Alleviates the problem of the regular payback period by incorporating The time value of money; Doesn't take into account payback after investment is recouped

Negative Convexity

Callable or pre-payable debt, the upside price appreciation in response to decreasing yields is limited as once the bond reaches the call price the price wont appreciate. If Bd is callable and likely to be called,as ylds fall, no one will pay a higher price than call price. Price will not rise significantly as ylds fall; as ylds fall, prices rises at a decreasing rate. This is the concept of negative convexity (illustrated by the "back bending" portion of callable bd graph). Similarly for bonds with put option the negative convexity phenomenon occurs at high yields.

Non-Refundable Bonds

Can be called but cannot use borrowed money to buy back bonds; Can be called but not refunded

Convertible Preferred Stock

Can be exchanged for common stock at a predetermined exchange ratio; Dividend is usually higher; Investor has upside potential; Conversion option holds value over regular preferred stock; Less risk than common stock

Liquidity Risk

Chance a bond will be sold at less than market price due to a lack of liquidity

Volatility Risk

Chance of increased interest rate volatility causing prepayments

Credit Risk

Chance the creditworthiness of an issuer will decrease

Deferred Tax Asset: (DTA)

Income Tax Expense < Taxes Payable F/S < Tax Return Pay more tax now but more on reversal

According to capital market theory, what represents the risky portfolio that should be held by all investors who desire to hold risky assets?

Capital market theory suggests that all investors should invest in the same portfolio of risky assets, and this portfolio is located at the point of tangency of the CML and the efficient frontier of risky assets. Any point below the CML is suboptimal, and points above the CML are not feasible. The optimal portfolio for an investor is determined as the point where the investor's highest utility curve is tangent to the efficient frontier.

What is a "preservation of capital" return objective?

Capital preservation is the objective of earning a return on an investment that is at least equal to the inflation rate. The concern is the maintenance of purchasing power, which means that the real rate of return must equal the inflation rate.

Venture Capital

Capital provided to firms early in their life cycles to fund development and growth; Can be seed, early stage, or mezzanine funding; Very illiquid; Require 3-10 year commitment; Profit comes from the firm's IPO

Insured Bonds

Carry a third-party guarantee that cannot be cancelled and is good for the life of the bond; Usually raises rating to AAA; More common for a revenue bond than general obligation

Tax base on a liability

Carrying amount of the liability minus the amount that will be deductible in the future.

Free Cash Flow to the Firm - FCFF

Cash Flow available for distribution to all investors (stockholders & debt holders) CFO + int(1-t) - fixed capital investment or [FCFF calculated from NI = NI + noncash charged + (Int exp(1-tax rate) - net cap investment - working capital invt.]

Free Cash Flow to Equity - FCFE

Cash Flow available for distribution to the c/s; after all obligations have been paid. CFO - fixed capital investment + net debt increase or CFO - net cap expenditure + net borrowings

Free Cash Flow

Cash available once the firm has covered it's capital expenditures; = Net Income + Noncash Charges + (Interest Expense * [1 - tax rate]) - Fixed Capital Investment - Working Capital Investment; = Cash Flow from Operations + (Interest Expense * [1 - tax rate]) - Fixed Capital Investment

CFO - Direct method

Cash collections less direct cash inputs less other cash outfllows

Free Cash Flow to Equity

Cash flow that would be available for distribution to common shareholders; = Cash Flow from Operations - Fixed Capital Investment + Debt Issued - Debt Repaid

Comprehensive income

Change in equity from transactions from nonownership sources. Include: NI, chg in foreign currency translation adj., chg in pension adj to funded status, chg unrealized gains/losses on derivatives contracts accounted for as hedges chng in unrealized gains/losses on available-for-sale securities

Non-Amortizing Bond (Bullet Bond or Bullet Maturity)

Characteristic of most T-Bonds and Corporate bonds. Pay only interest until maturity, at which time full face value is paid back.

Insurance Companies

Collect insurance premiums in return for providing risk reduction to the insured

A Priori Probability

Comes from a formal reasoning and inspection process; an objective probability

Empirical Probability

Comes from past data; an objective probability

Directly-Placed Paper

Commercial paper that is sold to large investors without going through an agent or broker-dealer.

Form 8-K:

Companies must file this form to disclose material events including significant asset acquisitions and disposals, changes in management or corporate governance, or matters related to its accountants, financial statements, or the markets on which its securities trade.

Buy a fixed number of shares at a fixed price

Company may repurchase stock by making a tendor offer to repurchase a specific number of shares at a price that is usually at a premium to the current market price.

Interest Rate Risk and Bond Features (Deep Discount Bonds 2)

Compared w/ Bds selling at par, deep disc bds have greater price vol. Investors expecting declining int rates prefer zeros w/ long term to mat. Decreasing Int Rates then Reinvestment Rate Decreases and will not earn initial YTM Int Rate Decrease then Bd Price Increases with Increased Cap Gain. Investors expecting increasing int rates will not prefer zeros w/ long term to mat.

Simple Random Sampling

Completely random, systemic sampling is picking every nth member of a population; Sampling error is the difference between the sample statistic and the population's statistic

Positive substitution, negative income greater than positive substitution

Consumption decreases

options which benefit investor

Conversion features, put provisions, and floors, non-callable. FLOORRECEIVED=bondholder

Discounted Cash Flow Applications

Convert btwn a HPY, EAY, and MMY EAY and MMY are annualized version of the HPY HPY = (P1 - P0 + Income) / P0

Indirect Cash Flow Method

Converts net income into operating cash by making adjustments for transactions that affect net income but are not cash transactions; Eliminate noncash expenses and nonoperating items; Only presents the net of cash receipts and payments; Focuses on the differences between net income and operating cash flow

Look back at formulas for DOL and DFL

Convince yourself if no fixed costs, DOL = 1 and if no interest cost DFL = 1. Values of 1 mean no leverage.

Kce

Cost of common equity. Required rate of return on common stock and is generally difficult to estimate

Kps

Cost of preferred stock

Monetary union

Countries use a shared currency; Can't make their own monetary policy but participate in making the policy of the union

When Bond at Discount...

Coupon Rate < Current Yield < Yield to Maturity

When Bond at Par....

Coupon Rate = Current Yield = Yield to Maturity

When Bond at Premium...

Coupon Rate > Current Yield > Yield to Maturity

Inflation-Indexed Bonds

Coupon formulas based on inflation; Coupon Formula Ex.: 3% + annual change in CPI. Par value changes with chgs in CPI

Floating-Rate Bonds

Coupon payments are based on another rate or index; Reference rate is the underlying rate; Payment is a specified spread applied to the reference rate; Indenture lists schedule of rate changes

Step-Up Notes

Coupon rates increase over time at a specified rate

Discount Bond

Cpn Rate < Current Yld < YTM Cpn Rate < mkt yld < par value Discount/Price increases to par as bd approaches mat.

Par Bond

Cpn Rate = Current Yld = YTM Cpn Rate = required mkt yld, then bd price = par value.

Premium Bond

Cpn Rate > Current Yld > YTM Cpn Rate > mkt yld > par value Premium/Price decreases to par as bd approaches mat.

Bond Pricing No Arbitrage Pricing Relationship

Cpn bd can be thought as of a portfolio of zero cpns priced according to no-arb relationship. Each individual int rate used to compute PV of single cash flow in future is a spot rate.

Inverse Floater

Cpn moves in direction opposite to reference rate New Coupon Rate = Constant Rate (K) - (L * Reference Rate) Where K is the constant and L is the multiplier

Deferred Tax Liability

Created when income tax expense is greater than taxes payable; MOST COMMON REASON IS USING DIFFERENT DEPRECIATION METHODS ON TAX RETURN AND INCOME STATEMENT

Deferred Tax Asset

Created when taxes payable are greater than income tax expense; POST-EMPLOYMENT BENEFITS, WARRANTY EXPENSES AND TAX LOSS CARRYFORWARDS ARE MOST COMMON CAUSES; Must be reduced if it is unlikely to be used under GAAP

Asset Backed Securities

Credit Card Balances, Auto Loans, Receivables, etc. Can be securitized like residential mortgages into what are known as asset backed securities (ABS).

Corporate Bonds Credit Ratings

Credit ratings on corp bds are a function of four factors: (1) Character (2) Capacity (3) Collateral (4) Covenants

Sovereign Risk

Credit risk of a sovereign bond outside of the investor's home market

Effects of Lease Classification on Ratios - Operating Lease

Current Ratio (CA/CL): Higher Work. Cap (CA -CL): Higher Asset TO: (Sales/TA): Higher ROA (EAT/TA): Higher ROE (EAT/E): Higher Debt/Equity: Lower Understates Leverage ratios (b/c not recognized as a liability) Overstates Coverage ratios (b/c lease pymt is NOT treated as int. expense) Understates Fixed Assets & No impact on CA

Effects of Lease Classification on Ratios - Finance Lease

Current Ratio (CA/CL): lower Work. Cap (CA -CL): Lower Asset TO: (Sales/TA): Lower ROA (EAT/TA): Lower ROE (EAT/E): Lower Debt/Equity: Higher *Since Int. exp + depre > lease pymt in the early years. This decreases NI, and Profitability ratios.

Current Yield

Current Yield = (annual cash coupon payment) / (market price of bond). This measure looks at the current price of a bond instead of its face value and represents the return an investor would expect if he or she purchased the bond and held it for a year. This measure is not an accurate reflection of the actual return that an investor will receive in all cases because bond and stock prices are constantly changing due to market factors.

Weak Form Market Efficiency

Current security prices fully reflect all currently available security market data

Current Yield

Current yield is concerned only with coupon cash flow, but does not consider capital gains/losses or reinvestment income. Current Yield = Annual Cash Coupon Payment / Bond Price.

Down move factor

D = 1/1.01

Daily Sales in Payables

DSIP = (Accounts Payable)/(COGS) * Number of Days in Period; A firm can temporarily increase operating cash flows by delaying payment to suppliers

Collateralized Debt Obligation

Debt instrument where the collateral for the promise to pay is an underlying pool of other debt obligations; Tranches are created for seniority of cash flows

Single Price, Regular Auction Cycle

Debt is auctioned periodically according to a cycle and the highest price (lowest yield) at which the entire issue to be auctioned can be sold and is awarded to all bidders

Collateralized Debt Obligations (CDO)

Debt securities for which the underlying collateral is itself other debt (loans, mortgages, bonds, other CDOs, etc...). 1) Arbitrage CDOs - creator hopes to profit from spread between cash flows to be received on underlying assets and payments made by CDO 2) balance sheet CDOs - used to reduce debt exposure on firms' balance sheets.

Structured Note

Debt security combined with a derivative

An Increase in the Valuation Allowance Account:

Decreases DTA -> Decreases Net Income [Decrease in Valuation Allowance; Increase DTA and Increases Net Income]

Interest Rate Risk and Bond Features (Deep Discount Bonds 1)

Deep Disc Bd w/ low cpn relative to mkt then bd has increased price vol. Deep Disc Bd w/ high cpn relative to mkt then bd has decreased price vol.

Liquidity Drag

Delay or reduce cash inflows or increase borrowing costs

What are the methods of settlement for a forward contract?

Delivery = Seller delivers the good to the buyer Cash Settlement.= Buyer and Seller exchange the net cash value at the settlement date. Cash is much more common

Keynesian

Demand fluctuations are due to swings in the level of optimism of business owners and that business owners overinvest when optimistic and underinvest when pessimistic; Argue that wages are "downward sticky" and it is difficult to reduce them in times of recession; Believe government should control expectations with monetary or fiscal policy; Policymakers can use the budget to diminish aggregate demand through restrictive fiscal policy

Financial Liability: US GAAP/Fair Market Value

Derivatives Non-derivative investments with fair value exposure hedged by derivatives

Exchange-Traded Derivatives

Derivatives that are standardized and backed by a clearinghouse

Style

Describes the basic characteristics of the underlying assets

Deferred Tax Liability: (DTL)

Income Tax Expense > Taxes Payable F/S > Tax Return Pay less tax now but more on reversal

Financial Adj to Facilitate Comparison:

Diff. in depreciation methods/assumptions; Diff. in inventory methods/assumptions; Diff. in treatment of the effect of exchg rate chgs; Diff. in classifications of investment securities Goodwill: Internally Generated DON'T capitalize, Purchased = Capitalize Capitalization decisions Off B/S finance: Operating vs. Capital Leases Equity accounted SPEs vs. non-qualifying SPEs Sale of A/R

Contribution Margin

Difference between price and variable cost per unit

Permanent Difference

Difference between taxable income and pretax income that will not reverse in the future; Do not create deferred tax assets or liabilities but change the effective tax rate from the statutory tax rate

Defined Benefit Fund Status

Difference between the defined benefit obligation and the plan assets; Reported on balance sheet under GAAP; IFRS removes unrecognized actuarial gains and losses and unrecognized prior service expenses from the funded status and the result does not reflect economic reality; Firms separately disclose the components of the benefit obligation, assets and expenses and the assumptions used to calculate the pension expense

Bond Equivalent Yield (BEY) and Annual Equivalent Yield (AEY)

Different cpn frequencies mean that ylds cannot be compared directly without conversion. For example, annual pay bd's yld compared to semiannual pay bd's yld. Must convert BEY to EAY, or vice versa. Note: BEY is synonymous w/ seminannual YTM

Form 8-K

Discloses material events

Stock Dividend

Dividends paid as newly issued stock

Two Assets' Correlation Coefficient

Dividing the covariance between returns of two assets by the individual standard deviations of returns of the two assets

Nonparametric Tests

Do not make any assumptions about the population and are used when parametric tests cannot be

Zero-Coupon Bonds

Do not pay periodic interest; Sold at a discount and pay par value at maturity

Limitation of Yield to Maturity

Doesn't tell the compounded rate of return that will be realized on a fixed income security; Assumes reinvestment at the yield to maturity

Dollar Duration

Dollar Duration = Dollar change in bond price for a 1% change in yield.

Dollar Duration Price ▲

Dollar Duration Price ▲ = D/100 * ▲BP/100 * MV

What is "semivariance?"

Downside dispersion is measured using semivariance (the dispersion of returns occurring below a specified target return such as zero).

Cyclical unemployment

Due to changes in the general level of economic activity

What measure approximates the interest rate risk on bonds?

Duration

Duration Slope Price Yield Function

Duration is a measure of the slope of the price yield function. This function is steeper at low int rates, and flatter at high int rates.

What measure approximates the interest rate risk on bonds?

Duration.

From creditor POV: Int. Coverage;

EBIT/ *Gross Interest EBITDA/ *Gross Interest *(inc'd capitalized interest) How many times is EBIT or EBITDA bigger than gross interest? Higher ratio is desired. Shows ability to cover int. payment

Return on total capital (ROTC):

EBIT/ Avg. total capital Total capital includes: debt capital, so int. is aded back to NI

Statutory Voting

Each share gets one vote in the election of each board nominee

Effective Duration

Eff Dur linearly approximates change in bd price for 100 bp change in yld. Measure of price sensitivity to changes in yld. First derivative price/yld function. Effective Duration = [V- - V+] / [2 * V0 * (▲y)^2 ] V- : Bd price if yld decreases V+ : Bd price if yld increases V0: Current Bd Price ▲y : Change in yld (in decimal form) Note: 1% = 0.01 Effective Duration is the preferred measure because it gives a good approximation of interest rate sensitivity for both option-free bonds and bonds with embedded option.

Event Risk

Effects from factors outside of financial markets

Inventory mangement: High T/O (low DOH) and sales growth above industry average

Efficient inventory managment

Income effect

Either increase or decrease a good that has fallen in price; Typical of normal good to have a positive income effect; Typical of inferior good to have negative substitution effect

Biased Fund

Either stays net long or net short always

Coincident economic indicators

Employees on nonfarm payroll Personal income Industrial production Manufacturing sales

Defined Contribution Plans

Employer contributes specific % No guarantee on future benefits Employee bears investment risk Pension expense = employer contribution

Defined Benefit Plans

Employer promises specific payment stream at retirement Payments are based on yrs of service, retirement age, and final salary Employers bears investment risk Funded by pool of assets Complicated accounting

One-Year Holding Period Dividend Discount Model

Equal to the current year's dividend in present value plus the present value of the stock's expected price at the end of the year

Cost of Preferred Stock

Equals the dividend yield of the preferred stock

Cost of Debt

Equals the market's yield to maturity

Describe the characteristics of equity forward contracts

Equity forward contract: The promise to deliver a certain stock, stock portfolio or stock index at a certain price+date.

Fama-French Model

Estimates a security's sensitivity to firm size, book to market value and excess market return; Carhart adds sensitivity to price momentum

What is a Eurodollar? Describe the characteristics of the Eurodollar time deposit market, and define Eurobor

Eurodollar: USD time-deposits outside of the US. Banks borrow dollars from other banks by issuing Eurodollar time deposits, which are essentially unsecured loans. The rate of the loans is LIBOR (London Interbank Offer Rate) - the rate at which London banks lend USDs to other London banks. Eurobor: Euro time-deposits. The cost of borrowing Euros from another bank. Quotes issued by the ECB (European Central Bank).

Portfolio Perspective

Evaluating individual investments by their contribution to the risk-return of a portfolio

Independence Test

Events are independent if P(A|B) = P(A)

Barter (IASB & FASB)

Exchange of goods or services between two parties (no cash) IASB: Revenue = FMV of similar non-barter transaction with unrelated parties FASB: Revenue = FMV only if the company has received cash payments for such services in the past.

American Option

Exercisable at any time; Will never have a smaller premium than a European option; More flexible

Rights Offering

Existing shareholders are given the right to buy new shares at a discount to the current market price; Dilutes ownership unless option is exercised; Sometimes the option can be sold

Opportunity

Exists when there is a weakness in internal controls; The nature of the firms operations; Ineffective management monitoring; A complex or unstable organizational structure; Deficient internal controls

Credit Spreads Expanding Economy

Expanding economy then credit spreads decline. Corps have stronger cash flows.

Phases of business cycle

Expansion Peak Contraction/Recession Trough

Software Development Treatment

Expensed until known to be feasible, then they are capitalized by both GAAP and IFRS

Currency board

Explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate; Cannot set its own monetary policy

What is the importance of risk and return in an investment policy objective?

Expressing investment goals in terms of risk is not more appropriate than expressing goals in terms of return. The investment objectives should be stated in terms of both risk and return. Risk tolerance will likely help determine what level of expected return is feasible.

Percentage of Completion

FASB & IASB -LT projects under contract, reliable estimates of revenue, cost and completion time. -Rev, exp and profit are recognized in proportion to total cost incurred to date, divided by total expected cost. (Total Cost Incurred / Total Cost) x Total Revenue

IFRS/US GAAP Frameworks: F/S elements:

FASB: Asset is a future economic benefit IASB: Asset is a RESOURCE from which future economic benefit is expected to flow.

IFRS/US GAAP Frameworks: Recognition of Elements:

FASB: No discussion of "probables" IASB: Asset, liabilities, are probable flows

Inventory Cost Flow Methods:

FIFO: EI = newest purchases LIFO: EI = oldest purchases Avg. Costs: EI = Available for sale/Units Specific ID: high value items (cars, diamonds etc)

What is a FRA? Describe the characteristics and calculate the gain/loss of forward rate agreements (FRAs)

FRA = interest rate forward contract. You calculate the gain/loss by determining the present value of the agreed upon rate and the present value of the market rate at expiration and determine the difference.

DBO Funded Status =

Fair Value of Plan Assets - Defined Benefit Obligation (DBO) Fair Value > DBO: overfunded (asset on B/S, GAAP) Fair Value < DBO: underfunded (liability on B/S, GAAP) (Funded Status = Economic Position of Plan)

Tax Burden

Falls on the party with less elastic curve

Operating vs. Non-operating Income

Financial Services Companies: Operating activities: Interest, Dividends, G/(L) on disposal Non-Financial Services Companies: Non-operating activities: Interest, Dividends, G/(L) on disposal

Average Revenue > AVC

Firm continue production

Average Revenue < AVC

Firm should shut down

Average Revenue > ATC

Firm should stay in business for long-run

GIPS Compliance with CVGs

Firms may include performance figures for periods prior to January 1, 2006, that were compliant with their applicable CVG, together with GIPS-compliant performance figures for periods after that date, and claim GIPS compliance

Range Notes

Floaters that equal the reference rate if it is within a specific range or zero if it is outside the range

Central Limit Theorem

For simple random samples of size n from a population with a mean u and a finite variance o, the sampling distribution of the sample mean x approaches a normal distribution with mean u and a variance equal to the population variance divided by the number of sample observations

Marginal cost pricing

Forces the monopoly to reduce price to the point where the firms marginal cost curve intersects the market demand curve

Combinational Ordering

Formula to find the number of possible ways of selecting r items from a set of n items; C = (n!) \ {(n - r)! * r!}

Coupon Formula (Floater)

Formula used to find new rate on a floating-rate security [New Coupon Rate = Reference Rate (+) or (-) Quoted Margin].

differentiate between margin in the securities markets and margin in the futures markets, and explain the role of initial margin, maintenance margin, variation margin, and settlement in futures trading.

Futures margins vs. Securities margin: For securities, federal regulators set the margin. For Futures, the clearinghouse sets the margin. Margin for futures is expressed in dollar terms instead of as a percent as in the securities market. Futures initial margin is usually much lower than securities market initial margin. Initial margin - a minimum amount deposited to demonstrate a commitment to pay the full value. Maintenance margin - an amount lower than the initial margin. If the balance of the margin account drops below the maintenance margin, the account holder is required to deposit enough money to return the account to the initial margin level or close the position and settle the loss. Settlement price - the avg. of the final few trades of the day. Variation margin: additional margin posted to meet initial margin after losing more than the maintenance margin.

Forward Rate

Fwd Rate is a borrowing/lending rate for a loan to be made at some future date. Forward rates are calculated from spot rates of the yield curve N-period Spot Rate (SˇN) = [1 + ˇ1fˇ0)(1+ˇ1fˇ1) ... (1+ˇ1fˇN)]^1/N - 1 ˇ1fˇN = [(1+ spotˇn+1)^n+1 / (1 + spotˇn)^n] - 1

Bond Legal and Issuance Costs

GAAP: Capitalized IFRS: Subtracted from book value

Presentation of deferred taxes on balance sheet

GAAP: Classified as current or noncurrent based on the classification of the underlying asset or liability IFRS: Netted and classified as noncurrent

Undistributed profit from an associate firm

GAAP: Deferred taxes are recognized from temporary differences IFRS: Recognized unless the parent is able to control the distribution of profit and it is probable that the difference will not reverse in the future

Tax rate used to measure deferred taxes

GAAP: Enacted tax rate only IFRS: Enacted or substantially enacted tax rate

Undistributed profit from a joint venture

GAAP: No deferred tax for a foreign joint venture that meets the indefinite reversal criterion IFRS: Recognized unless the parent is able to control the distribution of profit and it is probable that the difference will not reverse in the future

Undistributed profit from a subsidiary

GAAP: No deferred taxes for foreign subsidiaries that meet the indefinite reversal criterion or domestic subsidiaries if amounts are tax free IFRS: Recognized unless the parent is able to control the distribution of profit and it is probable that the difference will not reverse in the future

Revaluation of fixed and intangible assets

GAAP: Not allowed IFRS: Deferred tax recognized in equity

Recognition of DTA

GAAP: Recognized in full and reduced if it is more likely than not it won't be fully realized IFRS: Recognized if probable that tax profit will be able to cover the tax asset

CFO Disclosure requirement:

GAAP: direct method must disclose adj to reconcile NI to CFO. reconciliation is NOT required for IFRS. IFRS: pymts for Int & Taxes MUST be disclosed separately in the CF Stmnt under direct or indirect. Under GAAP, this can be reported in CF stmnt or disclosed in footnotes.

Quota Rents

Gains to those foreign exporters who receive import licenses under a quota if the domestic government does not charge for the import licenses.

Use of Activity Ratios

Give indications of how well a firm utilizes various assets

Use of Profitability Ratios

Give information about how well a company generates operating profits and net profits from its sales

Callable Common Shares

Give the firm the right to repurchase the stock at a pre-specified price; Benefits the firm because when the market price is great than the call price, the firm can call shares and reissue them at a higher price; Allows firm to reduce its dividend payments without changing its per-share dividend

Warrants

Give the holder the right to buy a firm's equity at a fixed price prior to the warrant's expiration; Similar to options

Effective Tax Rate

Income Tax Expense/Pretax Income (EBIT) Income Tax Exp. = Taxes payable + chg in DTA

Broker Dealers

Have an inherent conflict of interest because they should seek the best prices for their clients but their goal is to profit through the transaction; Traders typically place limits on how their orders are filled when working through a broker dealer

Interest Rate Option

Have an interest rate as the exercise price and reference are as the underlying asset; No deliverable asset and are only cash settled; Mostly European options; Long gets paid when reference rate exceeds strike price; short gets paid when reference rate is below strike price; LONG RATE CALL COMBINED WITH A SHORT RATE PUT IS THE SAME AS A LONG FORWARD RATE AGREEMENT

Sector Strategy

Have its investments concentrate in a specific industry

Core inflation

Headline inflation - food & energy

Investment Property

Held by a firm for the purpose of collecting rental income and gaining capital appreciation; ONLY DISTINGUISHED BY IFRS; Can be valued using fair value or cost model; Any upside revaluation is recognized as a gain on the income statement; Must disclose the the valuation model used

B/S - Long-lived assets

Held for continuing use within the business (not for resale) 1) investment property; 2) Assets held for sale; 3) Natural resources; 4) PP&E

How is the holding period return calculated?

Here, the holding period (or expected) return is calculated as: (ending price - beginning price + any cash flow or dividends) / beginning price. The required return uses the equation of the SML: risk free rate + Beta × (expected market rate - risk free rate).

Creative Cash Flows Accounting: Motivation

Higher share price Lower borrowing cost Higher incentive compensation

explain how option prices are affected by the exercise price and the time to expiration

Higher the exercise price, lower the price of a call, higher the price of a put and vice versa The greater the time till expiration, the higher the price of the bought option.

Cluster analysis

Historically group firms by highly correlated returns

Outright Ownership of Real Estate

Holder has full ownership rights for an indefinite time period

Holding Period Yield

Holding Period Return = (ending value/beginning value) - 1 OR = (ending value - beginning value + cash flow received)/(beginning value) - 1

Nth firm indicator

How much market share is held by the top N firms in the market; Isn't affected by two large companies merging

Price elasticity

How responsive the quantity demanded is to a change in price

Preferred Stock

Hybrid between debt and equity; Typically have fixed periodic payments to investors; Usually don't have voting rights; Have a stated par value and dividend is a percentage of that par

Horizontal Common Size Statements:

I/S and B/S Each line is relative to base year

LIFO results in: (assuming inflationary period)

I/S: COGS higher, EBT lower, Taxes: lower, NI: Lower B/S: INV: lower, W/C: Lower, R/E: lower CF: CFO: higher

FIFO results in: (assuming inflationary period)

I/S: COGS lower, EBT higher, Taxes: higher, NI: higher B/S: INV: higher, W/C: higher, R/E: higher CF: CFO: lower

Vertical Common Size Statements:

I/S: Income statement account / Sales B/S: Balance sheet account / Total Assets

Convergence IFRS/US GAAP:

IAS 39 Marketable securities IAS 2 Inventories (LIFO prohibited) IAS 16 PP&E JV (IFRS: proportional consolidation) IAS 38 Intangibles IAS 18 & 11 Contruction Contracts Extraordinary Items: Prohibited in IFRS Cash Flow Statement

Asset Revaluation: IFRS

IFRS Allows firm to report PP&E at FMV less Accm' Depr' Must disclose carrying vlaue using historic cost model.

Funded Status US GAAP & IFRS

IFRS: Funded status is NOT on B/S Asset/Liability Result in a b/s that does NOT represent econ reality GAAP: Funded status = B/S Asset/Liability -Both disclose components of DBO, plan assets, expenses, and assumptions used to calculate pension expense. -Both smooth the effect of changes in actuarial assumptions and prior services costs over time. (less volatile expense)

Lessor Accounting Capital Lease: Sales-Type Lease

If PV of min lease pymt < cost of asset 1) lessor is a dealer or seller of the leased equipment 2) at the time of lease inception, lessor recognized a gross profit on sale. (NI, R/E, and Assests are higher) 3) Interest rev recognized over period of lease 4) PV of min. lease pymt - cost of asset = gross profit CFO = Int. Income inflow CFI = Reduction in lease value

Lessor Accounting Capital Lease: Sales: Direct Financing Lease

If PV of min lease pymt = cost of asset 1) lessor is not a dealer of leased equipment (fin. co.) 2) no gross profit is recognized at time of lease inception 3) all profit is int. revenue recognized over period of lease. CFO = Int. Income inflow CFI = Reduction in lease value

Short term rates expected to rise and Yield Curve

If ST rates are expected to rise, then LT yield will be higher than ST yield, & yield curve will slope upward.

Taxable Income

Income subject to tax as per Tax Return

Fair Dealing

If a client places an order that goes against the firm's recommendation for that security, members and candidates should inform the client of the discrepancy between the order and the firm's recommendation before accepting the order.

Finance (capital) Lease criteria (under US GAAP)

If any ONE out of the FOUR are met must be classifed as Financial Lease: 1) Title transfered to lessee at the end of lease; 2) Bargain purchase option at the end of the lease; 3) Lease period is at least 75% of asset's useful life; 4) The PV of least pymts is at least 90% of fmv. (given borrowed rate and lease rate use lower of the two)

Investment Property Transfers

If from owner-occupied to investment property, treat as a revaluation and recognize gain only if it reverses a previous loss; If from inventory to investment property, recognize a gain or loss if fair value is different from carrying amount; If from investment property to owner-occupied or inventory, the cost basis is the property's fair value at that date;

When would it be beneficial for a bondholder to exercise a put option?

If interest rates have risen and/or the creditworthiness of the issuer has deteriorated so that the market price of the bond has fallen below par.

Interest Rates and Financial Capital Relationship

If the demand for financial capital rises, interest rates also rise

How can the lack of theoretical explanation allow mispricings to persist?

If the reasons underlying a persistent pricing anomaly are not well understood, it is difficult to exploit. Arbitrageurs will use their funds to exploit other mispricings which they believe they understand better and are, therefore, better able to exploit and profit from.

Realized Yield on Bond

If the reinvestment rate is < YTM, then the realized yield on the bond will be less than the YTM. The realized yield will always be between the YTM and the assumed reinvestment rate.

Revaluation below historic cost

Impairment is recorded on a Contra asset account. revalued below original cost means contra asset account is 0 1) B/S asset reduced to FMV 2) Loss take to I/S 3) Reversal of org. loss allowed I/S 4) Increase above org. cost to equity (comprehenive income)

Decreases to Consumer Surpluses

Import quotas, tariffs and volunteer export restraints

Increases to Producer Surpluses

Import quotas, tariffs and volunteer export restraints

Motivation to Understate Assets/Overstate Liabilities

Improve ROA and Asset TO Ratios Report higher aquisition goodwill

Custodians

Improve market integrity by holding client securities and preventing their loss due to fraud or other events

Unrealized Gains/Losses on Held For Trading Securities

Included in net income

Cash Flow From Operations (CFO) - FASB

Includes: cash flow from interst Rec'd and Paid, and Dividend received. Includes all income taxes paid.

Causes of demand changes

Income Increases as prices of substitute goods increase Decreases as the prices of complement goods increases

Income Tax Expense

Income tax expense is the expense recognized on the income statement that includes taxes payable and changes to the deferred tax assets and liabilities = Taxes Payable + Changes in Deferred Tax Liability - Changes in Deferred Tax Assets

Financial Implications of Capitalizing

Income variability lower Profitability early years (ROE, ROA & NI) is Higher Profitability later years: lower Total Cash Flows: Same CFO: higher CFI: Lower Leverage ratios: D/E & D/A: lower Opposite fore Expensing

CFO - Direct/Indirect method

Increase in an asset: deduct (use of cash) Increase in a liability: add (source of cash) Decrease in an asset: add (source of cash) Decrease in a liability: deduct (use of cash)

Shifts in long run aggregate supply

Increase in supply and quality of labor Increase in supply of natural resources Increase in stock of physical capital Technology

Export subsidies

Increase the good's price and decrease consumer surplus; In a small country, the price of the good will increase by the amount of the subsidy. In a large country, the world price decreases and some foreign participants also benefit

Fraud Triangle - 3) Attitude/rationalization

Ineffective corp. ethical values; non-financial managers invovled in selection of accounting principles/estimates; History of violation; Focus on stock price and earning trends; Commitment to unrealistic/aggressive forecasts; Failure to correct known breaches quickly; Focus on tax reduction; Materiality as justification for inappropriate accounting policy; Strained relationships with auditors (auditor TO, disputes, unreasonable demands, time pressures, Limitation of 411 access, influence over auditor's scope).

TIPS

Inflation protected 5 and 10 year notes and 20 year bonds; Make semi-annual coupon payments at a rate fixed at issuance; Par value starts at $1,000 and is adjusted semi-annually for changes to the CPI; COUPON IS PAID ON ADJUSTED PAR VALUE; Bond holder gets the greater of $1,000 or the final adjusted par value at maturity; The par value increase is taxed as income in that year

Depository Institutions

Institutions pay interest on customer deposits and provide transaction services

Market Order

Instructs broker to execute trade immediately at best possible price

Impact on the B/S of a Zero Coupon Bond:

Interest Expense = Amortization

Leveraged Equity Real Estate Ownership

Investor the same entitlements of outright ownership but must meet conditions of the loan

Funded Investor

Investor who borrows to finance an investment position

Global Fund

Invests in strategies all over the world

Certificates of deposit (CDs)

Issued by banks and sold to their customers.They represent a promise by the bank to repay a certain amount plus interest and, in that way, are similar to other bank deposits.

Certificates of Deposit

Issued by banks and sold to their customers; A promise by the bank to repay a certain amount plus interest; Issued in specific denominations and for specified periods of time that can be of any length; Penalty if funds are withdrawn earlier than the maturity date

Foreign Bonds

Issued in a local mkt by a foreign issuer.

Callable Bond Provisions

Issuer has right (not obligation) to retire all or part of bond prior to maturity. There may be several call dates, and customarily when a bond is called on the first permissible call date, the call price is above par value. The call price will normally decline over time according to the schedule.

Open End Fund

Issues and redeems new shares based on that day's closing value; May charge an upfront sales fee called a load Sometimes there are back-end loads; Annual fees are charged to cover management fees, administrative expenses, distribution fees

Revised Capm with country risk premium

Kce = Rf + B [E (Rmkt) - Rf + CRP]

CAPM

Ki = Rf + Bi[E(Rmkt) - Rf]

Excess Kurtosis

Kurtosis - 3; Significant if result is greater than 1

FIFO after-tax profit =

LIFO after-tax profit + (change in LIFO reserve)(1 − t)

Preferred Stock Risk ___ Common Stock Risk

Less than

Putable Shares Risk ___ Callable Shares Risk

Less than

Float Adjusted Market Weighting Index

Like a market cap index but are based on the proportion of each firm's share value available to investors to the total market value of the index available to investors; Stock with large controlling shareholders will have less weighting in index; Advantage is weights represent total market value; Disadvantage is the relative impact of a stock's return on the index; S&P 500 is an example

describe price limits and the process of marking to market, and calculate and interpret the margin balance, given the previous day's balance and the change in the futures price.

Limits: Absolute price change over the previous day allowed for a specific futures contract. If price hits a limit, the futures contract has made a limit move. Limit up, limit down. If a transaction cannot take place because of a limit, it is called locked limit. Marking to market: The clearinghouse can mark to market, intraday and collect losses, distribute gains through daily settlement to keep loses from getting out of hand.

Trading Securities

Listed at fair value, with unrealized gains and losses are recognized in the income statement

Positive Skew

Long tail to the right and Mean > Median > Mode

Structural unemployment

Long-run changes in the economy that eliminate some jobs while generating others for which unemployed workers are not qualified

Normal Yield Curve

Long-term rates are greater than short-term rates, so the curve has a positive slope.

Inverted Yield Curve

Long-term rates are less than short-term rates, thus yield curve a negative slope.

Tax Loss Carryforward

Loss that could not be deducted on the tax return in current period but may be used to reduce taxable income and taxes payable in future (i.e. warranty)

Screening for Potential Equity Investment: Criteria

Low: P/E, P/CF, or P/S High: ROE, ROA, growth rates of sales and earnings Low: leverage

M2

M1 plus deposits with maturity up to two years and deposits redeemable at notice up to three months

M3

M2 plus repo agreements, money market funds and debt with maturity up to two years

Monopolistic competition

Many firms that compete with differentiated products; Demand curve is downward sloping and is highly elastic; Quality, Price and Marketing are key differentiators ; Low barriers to entry; Firms must advertise and innovate; In short run maximize economic profits by producing where marginal revenue equals marginal cost ; In long run, price equals average total cost and economic profits are 0

Money Markets

Markets for debt securities with maturities of one year or less and capital markets are for longer term debt securities and equities

What does Markowitz portfolio theory rely on?

Markowitz Portfolio Theory relies on your understanding of basic statistics. You need to understand and be able to calculate the mean, the standard deviation and the correlation coefficient. The measure of risk used is the standard deviation of the returns for an individual investment. Downside dispersion is measured using semivariance (the dispersion of returns occurring below a specified target return such as zero). Beta (systematic risk) is the slope coefficient of the regression line (historical returns of the stock against the historical returns of the market) and is used to construct the SML.

Treasury Bills

Maturities of less than a year and do not make explicit interest payments; Sold at a discount to par and pay out par value at maturity; The implied interest rate is called the implicit interest rate; Either 28 day (4 week), 91 day (3 month) or 182 day (6 month) maturities; Sometimes offer cash management bills with very short maturities

Maturity Relationship to Duration

Maturity is directly related to Dur. Dur of zero cpn bd is equal to its mat. Cpn bds have shorter dur than zero cpn w/ same term to mat.

Coupon Rate Cap

Maximum rate paid by borrower/issuer.

Mean, Median, Mode

Mean = arthimetic average Median = middle number (if even # of values take average of middle two) Mode = number which occurs most often

ROE interpretation: if ROE is low:

Means that at least ONE of the following is true: Company has poor profit margin; Company has poor asset TO; Company is underleveraged

Effective Convexity

Measures how much bd's price yld curve deviates from linear approximation of duration curve. Second derivative price/yld function Effective Duration = [V- + V+ - 2V0] / [2 * V0 * (▲y)^2 ] V- : Bd price if int decreases V+ : Bd price if int increases V0: Current Bd Price ▲y : Change in yld (in decimal form) Note: 1% = 0.01

Retail Inventory Method

Measures inventory at retail price and subtracts a predetermined profit from each unit

Volatility Index (VIX)

Measures the volatility of options on the S&P 500 index; The higher the level, the more scared the market; Sentiment indicator

Enterprise Value

Measures total company value and represents what it would cost to acquire the firm; Appropriate when comparing firms with different capital structures; EBITDA is most used denominator

Scenario Analysis

Measuring interest rate risk by plugging in different rates to the valuation model and looking at the outputs

Motivation to Over-report Earnings

Meet Analyst Expectations Meet debt covenants Incentive compensation

Referral Fees

Members and candidates must disclose to employers and to affected clients, before entering into any formal agreement for services, any benefits received for the recommendation of services provided by the member.

Bootstrapping

Method of constructing a Treasury yield curve using the yield to maturities of different maturities

Coupon Rate Floor

Minimum periodic coupon interest payment received by lender/security owner.

Why does the mispricing of small company stocks persist at times?

Mispricings of small company stocks can persist because the small size of the positions that can be established limits the ability to execute sufficiently profitable arbitrage trades. The total profit to be gained by exploiting a mispricing may be small enough that it does not represent a significant profit opportunity to large funds.

Modified Duration

Modified Duration is derived from Macaulay Duration and offers slight improvement over Macaulay duration in that it takes the current YTM into account. Measure of price vol given small changes in required yld. It is always neg for option free bds because of inverse relationship btwn bd price and bd yld. Mod Dur = Mac Dur / (1 + y/m); where m is number of cpn pmts %▲P = - Mod Dur * ▲y Not useful for bonds with embedded options.

Difference Between Modified and Effective Convexity

Modified convexity does not take options into account and effective convexity does

New Keynesian

Modify Keynesian by saying all inputs of productivity are downward sticky, not just labor

Speculative demand

Money available to take advantage of investment opportunities that arise in the future; Rises as economic future becomes uncertain

Precautionary demand

Money held for unforeseen future needs; Increases with GDP

Transaction demand

Money held to meet the need for undertaking transactions; Increases with GDP

Callable Shares Risk ___ Common Shares Risk

More than

Which of the following characteristics should be of least concern about management's opportunities to commit fraud?

More than a third of Maxwell's total sales go to its own consolidated subsidiaries High levels of related-party transactions are worrisome, particularly when those parties are not audited. But transactions within the company between subsidiaries consolidated in a company's audited financial statements are neither unusual nor a particularly fertile ground for fraud. Both remaining characteristics are legitimate risk factors. 1) market penetration gives ability to dictate terms to vendors 2) More than half of the revenues is generated in emerging markets.

On The Run Issues

Most recently auctioned treasury issues; More actively traded than other issuances; Provide best information

Incentive/Pressure

Motive for fraud; Threats to financial stability or profitability; Excessive third-party pressures on management; Personal net worth of management or the board of directors is threatened; Excessive pressure on management or operating personnel to meet internal financial goals

MBS

Mtge Pass thru amortizing sec created by pooling large number of mtges. Shrs sold as participation certificates. Scheduled prin pmts, prin prepmts, & int pmts passed thru to investors after deducting admin & svce fees.

Inventory Cost Changes

Must be changed retrospectively on all past financial statements; IFRS requires an explanation as to why a change provides better information; GAAP requires an explanation as to why the cost flow method is preferable; IF CHANGING TO LIFO, NO CHANGES ARE MADE RETROSPECTIVELY AND THE OLD METHOD JUST BECOMES THE FIRST LAYER OF THE LIFO COST BASIS

Short-Term Treasury Forwards

Must settle before maturity date; Price is typically the yield to maturity as of the settlement date; Default provisions must be worked in if there is a chance of default by issuer; Option provisions must be made if bond has embedded options

calculating CFO=

NI + depr +/- chg working cap

ROE =

NI / Average BV

Return on Assets ROA:

NI/Avg. Total Assets NI + Int (1-t) / Avg. Total Assets Operating ROA: Operating INc/ Avg. Total Assets

national income =

NI=NDP + net foreign income or NI=GNP - depreciation

Does IFRS accept LIFO?

NO!!!

Crossover rate

NPV's are equal

Advantages of NPV and IRR

NPV: A direct measure of the expected increase in the value of a firm IRR: A percentage and shows return on each dollar invested

Drawbacks of NPV and IRR

NPV: It is an absolute measure and doesn't take into account the size of the project. IRR: It is not too useful for mutually exclusive projects and a project could have multiple or no IRR

Net Realizable Value (NRV) (IFRS)

NRV = Est. selling cost - Est. cost of complition - selling costs

Personal Income

National income + transfer payments to households - indirect business taxes - corporate income taxes - undistributed corporate profits

Footnote Finance Liability Disclosure

Nature of liability; Maturity dates; Stated and effective int. rates; Call and conversion features; covenants; security pledged as collateral; Amount of Debt maturity in each of the next 5 years; Fair value of o/s instrutments

Decline Stage

Negative Growth Declining prices Consolidation

FCFE =

Net Income + depreciation - increase working capital - fixed capital investment (FCInv) - debt principal repayments + new debt Issues

Value Weighted Indices Adjust for Stock Splits?

No, market cap does not change

Do non-callable zero-coupon bond have reinvestment risk before maturity?

No, since there are no cash flows to reinvest until maturity.

Do non-callable zero-coupon bonds have reinvestment risk before maturity?

No, since there are no cash flows to reinvest until maturity.

Reinvestment Risk

Not being able to reinvest money at the same rate of return if interest rates fall and issuers call bonds or prepay loans

Type II Error

Not rejecting a false null

Private Securities

Not traded on public markets, illiquid, and not subject to regulation

Form 144

Notice to the SEC of a sale of non-registered securities

Forms 3, 4, 5

Notices of insider ownership

What produces a kinked capital market line?

One of the key assumptions of the CAPM is the ability of investors to lend and borrow at the risk-free rate. This assumption is necessary to produce a straight line CML. Investors can lend all they want by buying investments at the risk-free rate, but investors must pay a premium over the risk-free rate to borrow. Unequal borrowing and lending rates put a kink in the CML.

Forward Contract

One party agrees to buy, and the counterparty to sell, a physical asset or security at a specific price on a specific date in the future

Currency Forward

One party agrees to exchange a certain amount of one currency for a certain amount of another at a future date; Specifies an exchange rate where one party can buy a fixed amount of currency; Either delivered or cash settled

Currency Swap

One party makes payments denominated in one currency while the payments from the other party are made in a second currency

Mutual Termination

One party pays the other to end the swap

Oligopoly

Only a few firms compete and each must consider the actions of others when setting price and strategy; High barriers to entry; Demand is less elastic than monopolistic competition

Simple Capital Structure

Only contains common stock and nonconvertible stock

Amortization

Only done on assets with finite lives and is done the same as depreciation

Monopoly

Only one seller in the market and there are no good substitutes; High barriers to entry; Maximize profit, not price; Profit maximized when marginal revenue equals marginal cost when demand curve is above ATC

Amortization of Bond Premium = (in/out flow) in the indirect method CFO

Outflow (bringing bond DOWN to par)

Separately Managed Account

Owned by a single investor and managed to meet their needs

Total Probability

P(A and B) = P(A) * P(B) if independent events

Addition of Probability

P(A or B) = P(A) + P(B) - P(AB)

Joint Probability

P(AB) = P(A|B) * P(B) P(A|B) = P(AB)/P(B)

PI Decision Rule

PI > 1, accept project PI < 1, reject project

Profitability Index (PI)

PV of a projects future cash flows divided by the initial cash outlay

PI =

PV of future cash flows / CFo also 1+ (NPV / CFo)

Defined Benefit Obligations (DBO)

PV of future obligation or the PV of the amount owed to employees for future pension benefits earned to date. Payments are determined based on expected final salary.

Price Value of a Basis Point

PVBP shows what happens to bd price given 1 bp change in yld. Another way of measuring bd's potential price vol. It is an absolute value. Price Value of a Basis Point = (duration) * (.001) * (bond value)

Non-Amortizing (Bullet) Bonds

Pays interest until maturity, then principal is repaid

Percentage Change in Price

Percentage Change in Price = duration + convexity effect Percentage Change in Price = ( [-duration × ▲y)] + [convexity × (▲y)^2 ] ) × 100 Note: 1% = 0.01

Inventory Systems:

Periodic: Inventory and COGS determined at p/e Perpetual: Inv. & COGS updated for each sale (no purchase account need) Cost flow method impact: FIFO = same for both LIFO = different Avg. cost = different FIFO & LIFO relationship remain

Personal disposable income

Personal income - personal taxes

Limit Order

Places a minimum execution price for a sale or maximum execution price for a buy; Not guaranteed to be filled; Marketable or aggressively priced if buy/sell order is above the best ask/below the best bid; A limit between bid and ask is said to be making a new market or inside the market; Standing orders are limits waiting to be executed

Security Market Line

Plot of the relationship between an asset's risk and return; = Risk Free Rate + (Beta *Excess Return); Shows CAPM

Gordon Growth Value

Po = D1 / K-G

Dividend Discount Model Kce =

Po = D1 / Kce - g Kce = (D1 / Po) + g (D1 / Po) +g

Hedge Funds

Pools of investor funds that are not regulated to the same extent as mutual funds

Jensen's Alpha =

Portfolio Return - Portfolio's CAPM; Most appropriate when a fund has multiple managers and only has systematic risk

What is the relationship between interest rate volatility and Call or Prepayment Risk?

Positive, higher volatility in rates increases probability of yields falling to level where bonds will be called.

Yield Curve Risk

Possibility of a change in the shape of the yield curve

Asset Returns and Correlation

Prefer correlations of asset returns within an asset class are significantly greater than correlations of asset class returns

Participating Preferred Stock

Preferred stock that gets an increased dividend if profits exceed a predetermined level and may get more than par value if firm is liquidated; Used by smaller, riskier firms to attract capital by giving investors chance for upside potential

How should investor's feel about loads and transaction fees?

Premiums, loads, and redemption fees are compensation for sales and marketing efforts, but they are not performance incentives for the portfolio managers. Different classes of shares can be structured with different schedules of front-end, back-end, and distribution fees. The optimal choice depends on the investor's expected holding period and is not necessarily the one with the lowest total annual fees.

Bond Pricing

Prices quoted in percent and 32nds of a percent; 102-5 is equal to $102.16 per bond

Informational Efficiency

Prices reflect all information associated with fundamental value in a timely fashion; Allocationally efficient is capital is allocated to its most efficient use; Brought by traders who bid prices up and down in response to new information; Helped by accounting standards and financial reporting requirements

Multivariate Distribution

Probabilities associated with a group of random variables and its meaningful only when the behavior of each random variable in the group is in some way dependent upon the behavior of the others. Can be discrete - joint prob tables Continu - normal distribution

Responsibilities of standard-setting bodies

Professional organizations to establish financial reporting standards

Closed-End Fund

Professionally managed pools of investor money that do not take in new money or redeem shares; Trade like equity shares on an exchange or over the counter Charges an ongoing management fee

Non-Refundable Bond

Prohibit call of an issue using proceeds from a lower coupon bond issue.

Front-Running

Prohibited for employees at financial firms

Negative Covenants

Prohibitions on the borrower.

What does the implementation process of portfolio management focus on

Putting the plan that has been devised to work. The portfolio is constructed and assets are allocated based on the investment strategy and market forecasts.

Domestic Government Collects Full Value of Import License

Quota has same economic result as a tariff

Coupon Rate

Rate when multiplied by Par Value gives amount of annual interest payment.

Humped Yield Curve

Rates in the middle spectrum are higher or lower than those for both short and long maturity bonds.

Depository Receipts

Represent ownership in a foreign firm and are traded in other countries' markets at the local currency; A bank deposits shares of the foreign firm and then sells receipts representing ownership of a specific number of foreign shares; Depository bank acts as a custodian and manages stock events such as splits and dividends; Although conversion is not necessary, changes in exchange rates affect price; Sponsored DR is if the firm is involved with the issue

Free Cash Flow

Represents the total amount that could be paid to investors; The cash remaining after a firm meets all of its debt obligations and provides for capital expenditures necessary to maintain existing assets or purchase new ones; FCF = Net Income + Depreciation - Increase in Working Capital - Fixed Capital Investment - Debt Principal Repayments + New Debt Issues; FCF = Cash Flow from Operations + Net Borrowing - Fixed Capital Investment

Collateralized Commodities Futures Positions

Require buying a specific futures contract and buying government securities, with a market value equal to the contract value of the futures contract; Any gains from the futures contract would be used to buy more government securities and cover margin calls by selling them; Total return is the change in commodities' prices plus the interest from the government securities

Outside Compensation and Benefits

Require written consent from employer

Component depreciation

Required by IFRS Permited by US GAAP

GAAP Inventory Requirements

Requires inventory be reported at the smaller of cost or market value; Market price is usually replacement cost but cannot be greater than net realizable value or net realizable value minus a normal profit margin; Even if inventory has to be written down, it is not allowed to be written back up

Record Retention

Requires members to maintain records of the data and analysis they use to develop their research recommendations.

A change in accounting principles...

Requires restatement of prior financial statements

Intangibles under IFRS:

Research = Expensed Development may be capitalized when the following critera is met: (ie if in the Development stage and NOT research stage) 1) process is clearly identified 2) Cost can be clearly idenfified 3) Technical feasibility established 4) Market is clearly identified 5) Frim has resources to complete

Selecting an External Auditor

Responsibility of the Board's audit committee

Short Position

Result from borrowing an asset and selling it, with the obligation to replace the asset at a later date; Must borrow the securities through a broker, return the securities at the request of the lender when the short sale is closed out, and keep a portion of the proceeds on deposit with the broker; Borrower must pay lender all dividends or interest the lender would have received; *Collateral earns interest, some of which is returned to the borrower at a short rebate rate

Deductible Temporary Difference

Result in expected future tax deductions

Taxable Temporary Difference

Result in expected future taxable income

Real Return

Return adjusted for inflation

Return on Equity (ROE):

Return on Total Equity = NI/ Avg. Total Equity Return on C/E = NI - Pref. Div/ Avg. Common Equity

Pretax Nominal Return

Return prior to paying taxes

What does the real total return objective consider

Returns from both capital gains and the reinvestment of current income net of inflation

What does a total return objective consider

Returns from both capital gains and the reinvestment of current income, but is not net of inflation

Net Revenue =

Revenues - ordinary expenses + other income - other expenses + gains - losses

Causes of supply changes

Rises if technology increases; Rises if input prices decrease

CAPM =

Risk Free Rate + (Beta * Excess Market Return)

Volatility Risk

Risk associated with fixed-income securities that have embedded options, such as call options, prepayment options, or put options. Changes in interest rate volatility affect the value of these options.

What shape will the indifference curve have for risk-averse versus less risk averse investors?

Risk averse = steep. Less risk averse = flatter

Sovereign Risk

Risk of changes in governmental attitudes and policies toward the repayment and servicing of debt.

Financial Risk

Risk that the firm's common stockholders must bear when a firm uses fixed cost financing

Business Risks

Risks associated with a firms' operating income and is the result of uncertainty about a firm's revenues and expenditures

Order Driven Market

Rules are used to match buyers and sellers; Traders are usually anonymous; Order matching rules establish an order precedence hierarchy; *After orders are matched, trade pricing rules are used to determine the price; *In electronic markets, orders are batched together and matched at fixed points in time during the day at the average of the bid-ask quotes from the exchange

Money Weighted Return

Same as IRR

Earnings Multiplier

Same as a PE ratio

Time Weighted Return

Same as annualized return

Discount Basis

Same as bank discount yield; = (Face Value Discount) * (360/ Days)

Future Contract

Same as forward but are standardized in amount, asset characteristics and delivery time; Greater liquidity than forwards since they are traded on a secondary market

Quota

Same effect as a tariff except the government only gains if it charges for tariff licenses (quota rents); If the government doesn't charge quota rents, the loss to the domestic economy is equal to the quota rents (the difference between the gain in producer surplus and the loss in consumer surplus)

Commercial classifications

Sector, industry, sub-industry GICG by S&P MSCI Barra Russell Global Sectors Industry classification benchmark by Dow Jones and FTSE

Agency Bonds

Securities issued by various agencies and organizations of the Federal government; Most aren't guaranteed by US Government explicitly, but it is implicit; Federally related institutions are owned by the US Government and are exempt from SEC rules and are guaranteed by US Gov't; Government sponsored enterprises are privately owned but publicly chartered organizations and were created by Congress but not guaranteed by US Gov't

Semi-Strong Form Market Efficiency

Securities rapidly adjust without bias and reflect all current publicly available data; Best for passive investing; Suggested if fundamental analysis allows for profits

Short-Term Fixed Income

Securities that have maturities less than 2 years; Usually called paper or notes

Derivative Contracts

Securities with values that depend on values of other assets

Risk Budgeting

Sets an overall risk limit for a portfolio and allocates the risk to different asset classes

Cumulative Voting

Shareholders can allocate their votes to one or more candidates and lets minority shareholders have proportional representation on the board

Parallel Shift

Shift in the curve is when the entire curve shifts by the same amount

Neoclassical

Shifts in aggregate supply and demand are driven by technology over time and that the economy has a strong tendency towards full employment; Business cycle is a temporary deviation from the long-run equilibrium

Shifts in short term aggregate supply

Shifts to long run aggregate supply Labor productivity Input prices Expectations of future output prices Taxes and government subsidies Exchange rates

Common Size Income Statement

Shows each category of the income statement as a percentage of revenue; +Controls for a company's size, allowing for easier comparison +The effective tax rate is the amount of tax paid divided by pretax income +Gross profit margin is the gross profit divided by the total revenue +Net profit margin is the net income divided by total revenue

Net Reporting of Revenue

Shows only the difference between sales and cost of goods sold Users are usually: 1) internet-based merchandising companies; 2) Sell prodict but never hold inventory; 3) Arrangement for supplier to ship directly to end customer. Discolsure policies in footnotes

Point and Figure Chart

Shows price movement by having price on the vertical axis and the number of changes in direction on the horizontal axis; X = increase one box size O = decrease one box size

LM curve

Shows the combination of GDP and real interest rates; Demand for money is inversely related to the real interest rate; Demand for money is positively related to real income; At equilibrium, there is a positive relationship between real income and real interest rates

IS curve

Shows the inverse relationship between the real interest rate and income; Decrease in real interest rates -> decrease in financing costs -> increase in capex by businesses -> same increase in savings as capex

Income Statement

Shows the performance of the company over a reporting period.

Prepayment Risk

Similar to Call Risk, risk of prepayment when interest rates fall, requiring investor to reinvest at a lower rate.

Exchange Traded Funds

Similar to closed end funds but we often passively managed and do not always trade to their NAVs Often traded to match a particular index Can be bought, sold short, and bought on margin intra-day Pay brokerage commissions on trade and bid-ask spreads Dividend is typically only offered as cash Produce less capital gains liabilities since it doesn't have to sell securities to match redemptions

Coupon Rate Collar

Simultaneous combination of both cap and floor.

Market Model

Single factor model where the only factor is excess return on the market portfolio

Point Estimates

Single values used to estimate population parameters

Mature Stage

Slow growth Consolidation High barriers Stable Pricing Superior Firms Gain Market Share

Embryonic Stage

Slow growth high prices large investment required high risk failure

Platykuric

Smaller peak and fatter tails than a normal distribution (k<3)

Forward End-User

Someone looking to lock in a future price

Country Risk Premium

Sometimes added to Beta to capture specific country risk; Spread between Treasury yield and country's yield; = Sovereign Yield Spread * (Annualized St. Dev. Of Developing Country Equity Index)/(Annualized St. Dev. Of Developed Country Bond Market) CAPM = Risk Free Rate + (Beta) * (Estimated Market Return - Risk Free Rate + Country Risk Premium)

Describe the sources of return and risk for a commodity investment

Sources of return: 1) Collateral yield - the return on the cash used as margin 2) Roll Yield - the return from rolling forward the maturity 3) Spot price - changes to the price

Country Risk Premium =

Sovereign Yield Spread x (annualized std of equity index of developing country / annualized std of sovereign bond mkt in terms of developed mkt currency)

Formative Stage Financing

Spanning seed stage to first stage financing

Clearing Instructions

Specify how to settle a trade

Pure Expectation Theory

States that the yield for a particular maturity is an average(not a simple average) of the short term rates that are expected in the future. Yld curve shape reflects investor expectations about fut behavior of int rates. Fwd rates that can be compounded using today's spot rates are best guess of fut int rates.

What types of options exist?

Stock options, index options, bond options (primarily OTC), interest rate options, currency options, options on futures, commodity options, weather options, real options

Dilutive/Anti-Dilutive Securities

Stock options, warrants, convertible bonds or convertible preferred stock that would decrease/increase earnings per share if converted to common stock; Stock options and warrants are only dilutive when their exercise prices are less than market value of the stock; the treasury stock method must be used to calculate average number of shares outstanding

Deleveraged Floater

Structured note that has coupon rates that equal a fraction of the reference rate plus a constant margin

Step-Up Note

Structured note with coupon rates that raise on a set schedule

Neutral Interest Rate

Sum of the real growth rate and the target inflation

Sum of value added method GDP

Summing the additions to value created at each stage of production and distribution

Value of final output GDP

Summing the value of all final goods and services produced

Currency Swap

Swapping loans in different currencies

Equity Swap

Swapping the return on an equity index for the interest payments on a debt instrument

What type of risk is positively related to expected excess returns according to CAPM?

Systematic. The CAPM concludes that expected returns are a positive (linear) function of systematic risk.The risk that cannot be diversified away is systematic risk (nondiversifiable risk or market risk). Since the market portfolio contains all risky assets, it must represent the ultimate in diversification. All the risk that can be diversified away must be gone. Unsystematic risk (diversifiable risk or unique risk) is the risk that can be diversified away by adding more securities to a portfolio.

Fixed Income Arbitrage

Take long and short positions in bonds to benefit from mispricing while minimizing interest rate effects

Long/Short Fund

Take long and short stock positions; Largest category; Not market neutral since they try to profit more from their long positions than their short positions

Foreign Currency Translation Loss

Taken directly to owners' equity

Heckschler-Ohlin model

Takes into account a country's labor and capital; Assumes capital receives more income than labor

Convertible Bond Arbitrage

Takes long and short positions in convertible bonds and equity shares to benefit from relative mispricing

DTA/DTL: Effect on Net Income when Tax Rate decreases:

Tax Rate down: DTL down -> Inc. Tax Exp down -> NI up DTA down -> Inc. Tax Exp up -> NI down

Taxation: Tax Payable

Tax liability based on taxable income as per TAX Report/RETURN

Taxation: Income Tax Expense

Taxes payable + chg deferred tax as per Financial Report. Income tax expense - change in DTA + change DTL

Yield to Maturity

The IRR of a bond's price and promised cash flows; Stated as two times the semiannual coupon payments implied by the bond's price

How is the CML related with the SML?

The SML and CML both intersect the vertical axis at the risk-free rate. The SML describes the risk/return tradeoff for individual securities or portfolios, whereas the CML describes the risk/return tradeoff of various combinations of the market portfolio and a riskless asset.

Use of Liquidity Ratios

The ability to pay short-term obligations as they come due

Relative Yield Spread

The absolute yield spread as a percentage of the benchmark bond's yield; = Absolute Yield Spread/Yield on Benchmark Bond

Maintenance Margin

The amount of margin that must be maintained in a futures account; Additional funds must be added to the margin account if the balance falls below the maintenance margin

Repo Rate

The annualized percentage difference between lender's purchase and sell back price.

Price Weighting Index

The arithmetic average of the prices of securities included in the index; Divisor is adjusted for stock splits and changes in composition when securities are added or subtracted; Advantage is it is simple to compute; Disadvantage is that a percentage change in a higher priced stock has a greater impact than an equal percentage increase in a lesser valued stock; Stock splits, repurchases or dividends can change the relative weight of a stock in the index; Having an equal weighting of stocks to the index will return an identical return; Major examples are the Nikkei and Dow Jones Industrial

Equal Weighting Index

The arithmetic average return of the index stocks; Matched by the returns of a portfolio that had equal dollar amounts invested in each stock; Simple to calculate; Replication portfolio would have to be periodically rebalanced, creating transaction costs; Percentage increases by smaller companies equal a proportionally larger weight in the index return; Value Line Composition Average and Financial Times Ordinary Share Index are major examples

Operating Cash Cycle

The average number of days that it takes to turn raw materials into cash proceeds; = Days of Inventory + Days of Receivables

Money neutrality

The belief that real variables (real GDP and velocity) are not affected by monetary variables (money supply and prices)

Going Concern Assumption

The company will remain in operation for the foreseeable future

Explain default risk for both long and short positions in a forward contract

The contract is not settled unless both parties deliver on their side of the contract. Default risk is counter-party risk in this case.

Bond Indenture

The contract that specifies all the rights and obligations of the issuer and the owners of a fixed income security

Convexity

The curvature of the price-yield curve; The more convexity, the worse the duration estimate will differ from actual change

Payment Date

The date dividend checks are sent out

Holder-Of-Record Date

The date that share holders on record are owed the dividend

Declaration Date

The date the board of directors approves the dividend

Tax Rate Decrease Causes...

The decrease in the DTL would result in lower income tax expense and the decrease in DTA would result in higher income tax expense

Marshall-Lerner condition

The demand for exports plus the demand for imports is greater than 1; Under this condition, depreciation of a currency will decrease a trade deficit; For export elasticity, the worst case is completely inelastic demand because the decrease in foreign currency has no effect on the quantity demanded; For import elasticity, the worst case is perfectly inelastic demand because the quantity demanded remains the same as price changes; Overall, currency depreciation will improve the trade deficit when either import or export demand is elastic; Only considers trade flows and not capital flows

DDM in terms of FCFE =

Vo = SUM FCFEt / (1+Ke) ^t

Nominal Spread

The difference between a bond's YTM and a similar Treasury's YTM; Uses a single discount rate; Ignores the shape of the yield curve and is technically only correct if yield curve is flat

Bid-Ask Spread

The difference between the bid price and ask price; Bid price is the price that a dealer will sell a security; The ask or offer price is the price a dealer will pay for a security; How the dealer makes money

Absolute Yield Spread

The difference between yields on two bonds. Absolute Yield Spread = [yield on the higher-yield bond - yield on the lower-yield bond] Absolute yield spreads are usually expressed in basis points (100ths of 1%).

Absolute Yield Spread

The difference between yields on two bonds; = Higher Bond Yield - Lower Bond Yield; Most commonly used; Shortcoming is it may always remain constant even as yield rise or fall

Nominal Spread

The difference in yield basis points between a non-treasury security and similar treasury security; i.e., difference between YTM Corporate Bond and the YTM of a similar Treasury Bond.

Credit Spread

The difference in yields between two issues that are similar in all respects except credit rating; Decline in an expanding economy; Increase during economic contractions

Weighted Average Cost of Capital

The discount rate used in capital budgeting; = (Weight of Debt) * (After Tax Cost of Debt) + (Weight of Preferred Stock) * (Cost of Preferred Stock) + (Weight of Common Equity) * (Cost of Common Equity)

Portfolio Duration

The duration of a portfolio is simply the weighted average of the durations of the individual securities in the portfolio Portfolio Duration = wˇ1*Dˇ1 + wˇ2*Dˇ2 + ... +wˇN*DˇN Where: w is equal to the individual security's weight and D is equal to the individual security's duration. Limitations of Portfolio duration: 1) limitations of portfolio duration as a measure of interest rate sensitivity stem from the fact that yields may not change equally on all the bonds in the portfolio 2) Useful only for parallel changes of yield curve.

The Duration/Convexity approach

The duration/convexity approach utilizes the measure of duration combined with convexity to estimate the percentage price change of a bond for a given change in interest rates.

Interest Rate Risk

The effect of changes in bond rates on bond values

Interest Rate Risk

The effect of changes in the prevailing market rate of interest on bond values. Inverse relationship btwn interest rates and bd prices. i.e., When rate goes up, bond prices fall.

What does the efficient frontier outline?

The efficient frontier outlines the set of portfolios that gives investors the highest return for a given level of risk or the lowest risk for a given level of return. It is also the point at which there are no more benefits to diversification.

On a graph of risk, measured by standard deviation and expected return, what does the efficient frontier represent?

The efficient set is the set of portfolios that dominate all other portfolios as to risk and return. That is, they have highest expected return at each level of risk.

Positive Convexity

The increase in bond price when yield decreases is more than decrease in bond price when yield increases. Low ylds, then prices rise at an increasing rate as ylds fall. High ylds, then prices fall at a decreasing rate as ylds rise.

Zero Volatility Spread

The equal amount that must be added to each rate on the Treasury spot yield curve in order to make the present value of the risky bond's cash flow equal to its market price; Measures spread to Treasury spot rates necessary to produce a spot rate curve that correctly prices a risky bond; For a risky bond, the value obtained from discounting expected cash flows at Treasury spot rates will be too high since Treasury spot rates are lower than they would be for a risky bond

Cross rate

The exchange rate between two currencies implied by both their exchange rates to a third currency

Leadership Strategy

The firm seeks to have the lowest costs of production in the industry; Either to protect or grow market share; Pricing can be aggressive or predatory; Managerial incentives are to improve efficiency

Ex-Dividend Date

The first day the stock trades without the dividend; If stock bought on or after, it does not receive the dividend; Always two business days before the holder of record date; Stock falls by dividend amount on the ex-dividend date

Full Valuation Approach

The full valuation approach requires the re-valuation of a bond for a range of interest rate changes.

Lognormal Distribution

The function e^x where x is normally distributed; Positively skewed; Bound to the left by 0 ;Price relative is the ending price divided by the starting price

First Stage Financing

The funding used during the transition to commercial production and sales of products

Variation Margin

The funds that must be deposited into an account to bring it back up to the initial margin amount

Tax Rate Increase Causes...

The increase in DTL is added to taxes payable and the increase in DTA is subtracted from taxes payable

What does a bond's duration tell us?

The interest rate risk of a bond, or parallel changes in the yield curve (rate changes at every maturity).

What does a bond's duration tell us?

The interest rate risk of a bond, or parallel shift changes in the yield curve (rate changes at every maturity).

Why is an investment policy statement important?

The investment policy statement provides a clear articulation of the risk a client will accept, and addresses risk in the context of the client's return requirement or expectations. Write a policy statement that specifies the investor's goals and constraints. Then itemize the risks the investor is willing to take to meet these goals.

Floating-Rate Security Sensitivity and Reset Dates

The longer the time period between the two reset dates for a floating rate security (coupon reset period), the greater the amount of potential bond price fluctuation and therefore greater duration, IE interest rate risk.

High Willingness to Bear Risk, Low Ability to Bear Risk

The low ability will win out in an advisor's assessment

The market portfolio in the Capital Market Theory contains which types of investments?

The market portfolio contains all risky assets in existence. It does not contain any risk-free assets.

Lower Bound of European Put

The maximum of 0 and the present value of the strike price

Lower Bound of American Put

The maximum of 0 and the present value of the strike price minus the stock price

Harmonic Mean

The mean of n numbers expressed as the reciprocal of the arithmetic mean of the reciprocals of the numbers

Initial Margin

The money deposited in a futures account before trading begins; Typically around one day's maximum price movement

Day Count Convention Notation

The notation used for day-count conventions shows the number of days in any given month divided by the number of days in a year. The result represents the fraction of the year remaining that will be used to calculate the amount of future interest owed.

Margin Percentage

The percentage of security value that is owed

Affirmative Covenants

When the borrower promises to do certain things

Power of a test

The power of a statistical test is the probability that the test will reject the null hypothesis when the null hypothesis is actually false (i.e. the probability of not committing a Type II error, or making a false negative decision). The power is in general a function of the possible distributions, often determined by a parameter, under the alternative hypothesis. As the power increases, the chances of a Type II error occurring decrease.

Capital Budgeting

The process of identifying and evaluating projects where the cash flow to the firm will be received over a period longer than a year

What is LIBOR?

The rate of eurodollars, LIBOR (London Interbank Offer Rate) is the rate at which London banks lend USDs to other London banks.

LIBOR

The rate paid on negotiable CDs by banks and bank branches located in London; Most important reference rate for floating-rate debt

Ex-Coupon

When the buyer does not get the next coupon

Diversification Ratio

The ratio of the risk of an equally weighted portfolio of n securities to the risk of a single random security from the list of n securities

Yield Ratio

The ratio of the yield on the subject bond to the yield on the benchmark bond; = Subject Bond Yield/Benchmark Bond Yield; = 1 + Relative Yield Spread

Capital Market Line

The same thing as a capital allocation line but the risky portfolio is now a portfolio of all the investable assets available in the market

Corporate Governance

The set of internal controls, processes and procedures by which firms are managed and defines the rights, roles and responsibilities of management

Short Interest Ratio

The short interest divided by the average daily trading volume; Can indicate a bearish sentiment but also an upcoming spike from shorts closing positions; Sentiment indicator

Option Adjusted Spread

The spread to the Treasury spot curve that the bond would have if it were option-free

Taxes Payable

The tax liability on the balance sheet caused by taxable income

Portfolio Duration

The weighted average of each bond's duration; Best with a parallel curve shift since not all bonds will have the same yield change

Yield to Worst

The worst yield outcome of any of the possible call provisions

Pure Expectations Theory

The yield for a particular maturity is an average of the short term rates that are expected in the future; If rates are expected to rise, yields on longer maturities will be higher than on shorter maturities

Current Yield

The yield from the bond's annual coupon payments; Offers little information; Current Yield = (Annual Cash Coupon Payment)/(Bond Price)

After-Tax Yield

The yield on a taxable bond, after adjustment for federal income taxes, is called the after-tax yield After-Tax Yield = (Taxable Pre-Tax Yield) × (1 - Marginal Tax Rate) Taxable-Equivalent Yield|Taxable-Equivalent Yield = Tax-Free Yield / (1 - Marginal Tax Rate)

Yield to Call

The yield on callable bonds that are selling at a premium to par; Can be less than the yield to maturity if the bond is trading at a premium; Calculate the same way as yield to maturity but the call price is used instead of par and the time period only runs to the next call

Why are Repo issuances preferred among lenders?

They are not regulated by the Federal Reserve and provide better collateral positions for the lenders if the sellers goes bankrupt. Lenders have only an obligation to sell back the repos rather than stake a claim against sellers' assets.

Impact lag

Time it takes for fiscal policy to produce change once out into law

Action lag

Time it takes governments to vote on and enact policy

Use of Accounts Receivable Aging Schedule

To identify trends in how well the firm is doing at collecting receivables and converting them to cash

Plain Vanilla Interest Rate Swap

Trade fixed interest payments for floating rate payments; LIBOR is typically the floating rate used; Zero-sum game; Net Fixed-Rate Payment = (Swap Fixed Rate - Swap Floating Rate) * (Number of Days/360) * (Notional Principal)

Block Brokers

Trade large lots

Motivation to Under-report Earnings

Trade relief Contingent consideration Union concessions

Primary Dealers

Trade with central banks when they buy and sell securities

Treasury Bond Future

Traded on bonds with maturities greater than 15 years; Deliverable contract; Can choose a number of bonds to deliver, will choose the cheapest; Face value of $100,000; Quotation in 1/32nds of percent of face value; Conversion factor is used to adjust the long's payment at delivery so more valuable bonds receive a higher payment

Publicly Traded Securities

Traded on exchanges or through securities dealers and are subject to regulatory oversight

Closed End Fund

Traded through secondary markets; Initially sell for a small premium to the value of the underlying assets

Continuous Markets

Trades occur any time a market is open

All or Nothing Orders

Trades that execute only if the entire lot can be bought

Basis Swap

Trading one floating rate payment for another

describe the characteristics of the following types of futures contracts: Treasury bill, Eurodollar, Treasury Bond, stock index and currency

Treasury bill futures: Not very popular. Calculated as $1,000,000[1-rate(90/360)] Eurodollar futures: Much more popular. Same calculation as Tbill. Treasury Bond: Many choices on what bond can be delivered so the exchange declares a hypothetical or standard bond. Thus, if the short delivers a bond with lower interest than the hypothetical bond, they will have to pay additional money and vice versa. Thus, at settlement, the futures price is multiplied by a conversion factor which attempts to balance out the value. Since different bonds cost different amounts to buy in the open market and get multiplied by different conversion factors, the seller is still able to deliver the "cheapest to deliver" bond which fulfills their obligation. Thus, it is assume that the cheapest to deliver bond underlies the future. Stock Index futures: Quoted in the same magnitude as the index (1187 for the S&P which is trading at 1185 etc.) but then is multiplied by a standard amount ($250 for S&P) to determine the actual price. S&P futures expire March, June, Sept, and Dec. on the Thursday before the third Friday of the month. Cash settled. Currency Futures: A much smaller market than currency forwards. Euro face value * conversion rate = price

Treasury Strips

Treasury securities that are sold in bulk to large dealers, who then strip out the coupons from principal, repackage the cash flows, and sell them separately as zero-coupon bonds; Coupon strips are strips created from coupon payments stripped from the original security; Principal strips refer to principal payments with the coupons stripped off; Taxed on their implicit interest rate

Treatment of Float Costs

Treat as a cash outflow at project initiation rather than as a component of the cost of equity

Research Cost Treatment

Typically expensed

Cum Coupon

When the buyer is entitled to the next couponn

Basic Bond Pricing

Use Constant Rate (YTM) to discount all cash flows. [Maturity Value]/[(1+i/m)^n*m]

Cash Flow Yield

Used for mortgage-backed securities and other amortized asset-backed securities; Includes assumptions on how prepayments are likely to occur; Once monthly cash flow projections are made, can calculate a CFY as a monthly IRR based on the market price of the security; Bond Equivalent Yield = [(1 + Monthly CFY) ^ 6 - 1] * 2

Yield to Put

Used if a bond has a put option and is selling at a discount; Calculated the same way as yield to maturity but with the put price as the price and put date as the date

T-Test

Used to compare two means when population is known to be normally distributed

F-Test

Used to compare two variances

Security Market Index

Used to represent the performance of a certain asset; Constituent securities are those that make up an index; Have a numerical value calculated from constituent securities

Chi-Squared Test

Used to test hypothesis about one variance

Bayes' Formula

Used to update a given set of prior probabilities for a given event in response to new information; (Updated Probability) = {(Probability of new information of a given event) \ (Unconditional probability of new information)} * (Probability of event)

Yield to Refunding

Used when a bond is callable and rates make sense for it to be called, but the bond covenants contain provisions giving protection from refunding until a future date; Same calculation as yield to call but date used is the first date refunding is allowed

Under Completed Contract Method:

Used when estimates of revenue or cost are unreliable or short-term contracts. (US GAAP only) Revenue, expense, and profit is recognized at completion (IFRS) Revenue is recognized to the extent of contract cost, cost are expensed when incureed, and profit is recognized at completion.

Special Dividend

Used when favorable circumstances allow a firm to make a one-time cash payment to shareholders,in addition to any other dividends it pays

Laspeyres index

Uses a constant basket of goods; Can be biased to upward movement when old products are replaced by newer and more expensive products, higher quality products replacing lower quality and by consumers using substitute goods when those in the basket get expensive

Ricardian model

Uses the factor of differences in labor productivity due to differences in technology

Discriminatory Pricing

Uses the limit price of the order that arrived first as the trading price

One year holding period DDM =

Value = (dividend to be rec'd / (1+Ke) ) + (year end price / (1+Ke))

One-year holding period DDM

Value of stock today is PV of any dividends during the year plus the PV of the expected price of the stock at the end of the year (terminal value).

Variable Rate Bond Interest Rate Risk

Variable Rate Bond Interest Rate Risk is highest 1 day after reset date.

Binomial Random Variable

Variable may be defined as the number of successes in a given number of trials where the outcome can be either a success or failure; Expected value = (probability of success) * (number of trials); Variance = (expected value) * (1 - probability of success)

Discrete Random Variable

Variable where the number of outcomes can be counted and each outcome has a measurable and positive probability

describe how a futures contract can be terminated at or prior to expiration

Via off-setting. If a buyer has purchased a certain future, it offers for sale the same security.

Gordon Model simplified

Vo = D1 / Ke - Gc Valuation model for preferred stock is the same as the constant growth model with no growth (g = 0)

Market Weighting Index

Weightings based on the market cap of each stock as a proportion of the index's market cap; Replicated by a portfolio in which the value of each security position is the same proportion of the security's market cap to the index's market cap; Not adjusted for dividends or stock splits; An alternative is to incorporate a security's number of shares available to the investing public, or a security's float

Fundamental Weighting Index

Weights are based in firms' fundamentals, like earning, dividends or cash flow; Avoids bias of market cap indices to overvalued firms; Has a value tilt, overweighting firms with higher value-based metrics

Sources of Differences: Permanent

When Statutory tax rate does NOT equal Effective tax rate Tax expense does note equal pretax income x statutory rate

Committed Line of Credit

When a bank commits to lending a certain amount over a certain period of time

Underwritten Issues

When a banker purchases the entire issue and resells it; Arrangement is called a firm commitment; Deal is called a bought deal; Typically a syndicate of other banks is put together to help sell issue; Goal is to presell as much of the debt as possible

Accrued Interest Bond Price

When a bd is sold btwn cpn pmt dates, part of next cpn belongs to seller. This portion of cpn is called accrued int. AI Period = # of days from LAST cpn pmt date to settle date / # of days in cpn period AI = AI Period * Cpn

Arbitrage Free Valuation

When a bond has each of its cash flows discounted using a discount rate that is specific to the maturity of each cash flow; Spot rates used are required rate of returns on zero coupon bonds maturing at a given time; The value of a bond based on spot rates must be equal to the value of its parts or there is an arbitrage opportunity

Liquidating Dividend

When a company goes out of business and distributes its proceeds to shareholders; Treated as a return of capital for tax reasons and not taxed unless it is over the investor's cost basis

Regular Dividend

When a company pays out a portion of its profits on a regular basis; Sign of company stability

Form DEF-14A:

When a company prepares a proxy statement for its shareholders prior to the annual meeting or other shareholder vote, it also files the statement with the SEC as Form DEF-14A.

Conventional fixed peg agreement

When a country pegs its currency to within a certain margin of another currency or to a basket of currencies of is trading partners

Installment Sales

When a firm finances a sale and payments are expected to be received over an extended period of time; If collection is certain, revenue is recorded at the time of sale; If not certain, either the installment method or cost recovery method can be used; In the installment method, profit is recognized as cash is collected and equals the cash collected multiplied by the total expected profit as a percentage of sales; The cost recovery method only recognizes profit when cash collected exceeds costs incurred

Shelf Registration

When a firm makes its public disclosures as a regular offering but it then the issues the registered securities as it needs capital or the markets are favorable

Dominant firm model

When a firm with the vast majority prices smaller firms out of the market over time by lowering prices to the point where it falls below the average total cost of smaller competitors

Deliverable Forward Contract

When a forward is settled with physical delivery

Limit Move

When a future exceeds its limit and trading does not take place

Contango

When a future price is above the spot price; Caused by companies wanting to lock in future rates to match future liabilities

Backwardation

When a futures price is below the spot price; Caused by hedgers to insure against price declines in the future; Some markets are described as having normal backwardation

Tactical Asset Allocation

When a manager varies from the strategic allocation weights when attractive opportunities are present

Stratified Random Sampling

When a population is divided up into smaller groups based on distinguishing characteristics; Proportions of groups in sample same as in population

Private Investment in Public Equity

When a public firm needs capital quick and sells private equity to investors; Usually at a sizable discount to the market price

Unstable equilibrium

When a supply curve intersects a demand curve more than once, the unstable equilibrium is an equilibrium where supply can increase towards another equilibrium that results in a lower price; Caused by a nonlinear supply function

Reversal Pattern

When a trend approaches a range of prices but fails to continue beyond that range

Uniform Pricing Rules

When all trades trade at the same price, which results from where the highest volume is

Straight Line Depreciation

When an asset's value is decreased by the same amount each year

Total Return

When an index includes both price changes and income from constituent securities

Price Return

When an index uses only the prices of an index's constituency securities

Operational independence

When the central bank can independently set the policy rate

Leveraged Buyout

When an investor buys an entire firm with debt financing; Called a managed buyout if it is the firm's management that is taking it private; Firms usually have cash flow to service the debt or undervalued assets hat can be sold to pay down debt over time

Private Placement

When an issue is sold to a small group of investors and is not required to be registered with the SEC; Issue can be better tailored for the investors' needs; Buyers will require a slightly higher interest rate since issue can not be resold to the public

In-Kind Creation and Redemption

When authorized participants ensure an efficient and orderly market; Can create new shares by depositing with a trustee a portfolio of stocks that track the index; Can redeem shares with the trustee for underlying portfolio; Keeps market price close to NAV; No capital gains to fund, resulting in no tax liability

Regular Redemption

When bonds are redeemed under the call provisions specified in the bond indenture.

Leveraged Position

When borrowed funds are used to purchase assets; Funds are considered margin loans; Interest paid is called the call money rate; The initial margin requirement is the minimum amount of equity an investor is required to provide at time of new margin purpose; Additional risk in portfolio is considered risk from financial leverage

Prior Service Cost

When changes in the terms of a defined benefit pension plan increase the future benefits due employees based on their prior employment with the company

Distressed Securities

When companies are about to or have filed for bankruptcy; Company sometimes tries to negotiate a restructuring outside of court; Debt holders try to get equity stakes; Illiquid with long investment horizons

Stock Split

When each existing share is divided into multiple shares; No change in owners wealth; Share price drops accordingly; Historically, stocks rise after a split because it is seen as a positive sign

Interest Rate Swap

When floating rate interest payments are exchanged for fixed rate payments

Round Trip Transaction

When goods are sold to one party with the simultaneous purchase of identical goods from the same party

Shakeout Stage

When growth and profitability are slowing due to strong competition; Growth has slowed; Intense competition; Increasing industry overcapacity; Decreased profitability; Increased cost cutting; Increased failures

Growth Stage

When industry is growing rapidly; Rapid growth; Limited competitive pressures; Falling prices; Increasing profitability

Declining Stage

When industry starts to shrink; Negative growth; Declining price; Consolidation

Perpetual Inventory System

When inventory purchased or sold is recorded directly in the inventory account

IFRS Inventory Requirements

When inventory purchased or sold is recorded directly in the inventory account; Inventory is written down if net realizable value is less than cost and written back up if necessary

Periodic Inventory System

When inventory values and COGS are determined at the end of the period; Inventory bought is put into a Purchase account, which is added to beginning inventory to find the cost of goods available for sale. COGS is found by subtracting the ending inventory from goods available for sale

Book Building

When investment banks solicit indications of interest from market participants and adjust the offering price accordingly

Disposition Effect

When investors are willing to realize gains but not losses

Representativeness

When investors assume good companies are good investments

Conservatism

When investors react slowly to change

Interest Rate Risk and Bond Features (Market Interest Rates)

When mkt int rates are high, price vol will be lower When mkt rates are low price vol will be higher Increase int rate then decrease vol. Decrease int rate then increase vol.

Non-Parallel Shift

When not all maturities change by the same amount

Conditional Probability

When one event's probability affects the other events *P(A|B) = The probability of A given B

Operating Profit

When operating expenses are subtracted from gross profit; Profit before financing costs, income tax and nonoperating items

Backfilling Bias

When past performance of an index is inflated because funds with poor performance in the past is not included

Bringing About Disinflation

When policy rate is above the neutral interest rate

Guarding Against Inflation

When policy rate is less than the neutral interest rate

Gambler's Fallacy

When recent events affect investors' perceptions of future probabilities

Private Placement

When securities are sold directly to qualified investors with the help of an investment bank; Do not require the issuer to disclose as much information about the securities; Issuance costs are less; Offer price is lower since securities cannot be resold in the public markets

Natural monopoly

When the average cost of production is falling over the relevant range of demand and having two or more producers would lead to hire production costs and hurt the consumer

Best Efforts Sale

When the banker agrees to sell as much of the issue as possible; Not liable for the debt left over

Par Bond

When the bond's coupon rate equals the market yield; Bonds are typically issued near par value

Negative Covenants

When the borrower promised to refrain from certain activities than can adversely affect the lenders position

Sales-Type Lease

When the present value of the lease payments exceeds carrying value of the asset; Treated as if the lessor sold the asset to the buyer and also provided them a loan for the same amount; Typical of dealers or manufacturers; Lessor recognizes a sale equal to the present sale of the lease payments, cost of goo sold equal to the carrying value, and a lease receivables account is created equal to the present value of the lease payments; Interest portion of each payment is the lease receivable balance at the beginning of the period times the lease interest rate

Negotiated Offering

When the price is determined between the lead investment bank and the issuer

Acquisition Method of Accounting for Business Combinations

When the purchase price is allocated to the identifiable assets and liabilities of the acquired firm based on fair value and the rest is recorded as goodwill

Equity Swap

When the return on a stock, portfolio or index is paid each period by one party in return for a fixed or floating rate payment

Appropriations Backed Obligations

When the state isn't the issuer but can act as a back up if the issuer defaults; General obligation

Covered Call

When the writer of a call also owns the stock he is obligated to sell; Used to increase income in a time when you do not expect the stock price to increase; Can be written out of the money to add insurance that the stock won't get called away; Trading away chance of stock appreciating in future for income now

Mature Stage

When there is little industry growth and firms consolidate; Slow growth; Consolidation; High barriers to entry; Stable pricing; Superior firms gain market share

Swap Contract

When two parties make payments equivalent to one asset being traded for another one

Brokered Markets

Where investors use brokers to locate a counterparty to a trade; Useful with unique or illiquid securities; Dealers do not carry inventory; Too few trades to trade in an order-driven market

Break Point

Where the cost of one of the WACC components changes; = Amount of Capital at which the Component's Cost Changes/Weight of the Component in Capital Structure

Incidence of tax

Who ends up bearing the cost of a tax

Statutory incidence

Who is legally responsible for paying a tax

Multiple Price, Regular Auction Cycle

Winning bidders receive bonds at the price each bidder bid

Downside Price response to Increasing Yields Putable Debt

With Putable debt the downside price in response to increasing yields is limited.

Upside price appreciation Callable or pre-payable debt

With a callable or pre-payable debt the upside price appreciation in response to decreasing yields is limited.

What happens when the underlying assumption of zero transaction costs is relaxed (CAPM)?

With positive transactions costs, there will be rates of return on both sides of the SML for which the cost of trading will be greater than the expected gains from trading. This means there is a band of expected returns for each level of systematic risk that is consistent with efficient pricing, once transactions costs are considered.

Working Capital

Working Capital = Current Assets - Current Liabilities

Yield to call (YTC)

YTC - Investors are typically interested in knowing what the yield will be if the bond is called by the issuer at the first possible date. This is called yield to first call or yield to call (YTC).

Yield to Call Quoted Callable Bd's Price > Bd's Call Price

YTC is the more conservative yld measure whenever the quoted Callable Bd's Price is greater than the Bd's Call Price.

Yield to First Par Call (YTFPC)

YTFPC is calculated in exactly the same way as YTC, except that the number of years is to first par call, and FPC becomes par value.

YTM Reinvestment Assumption

YTM assumes all cpns will be automatically reinvested at YTM rate to mat. Failure to reinvest cpns at YTM will result in a different actual yield.

Yield to Maturity (YTM)

YTM uses a single discount rate to value the cash flows, so it ignores the shape of the spot yield curve. It is the annualized IRR of a bond based on its price and cash flow. It is the most popular of all yield measures used in the marketplace.

Yield to put (YTP)

YTP - Some bonds may be put (sold back to the issuer prior to maturity) at the option of the holder. Investors are typically interested in knowing what the yield will be if the bond is put to the issuer at the first possible date. This is called yield to put (YTP).

Yield to worst (YTW)

YTW involves the calculation of YTC and YTP for every possible call or put date, and determining which of these results in the lowest expected return. Least attractive yield option when bond has a call or put option.

Flotation costs

are a cash outflow that occurs at the initiation of a project and affect the project NPV by increasing the initial cash flow. Correct way to account for flotation costs is to adjust the initial project cost.

Law of one price

asserts two identical assets should sell at the same price, or have same multiple

Statement of Cash Flow - relevance:

assess liquidity, solvency and financial flexibiliy

What is the most important decision to be made in the investment process?

asset allocation

The report format of B/S

assets, liabilities, and equity are presented in a single column.

Binomial distribution

assumes a variable can take one of two values (success/failure) or, in the case of a stock, movements (up/down). A binomial model can describe changes in the value of an asset or portfolio, it can be used to compute its expected value over several periods

Gordon growth model

assumes annual growth rate of dividends, ge, is constant Vo = Do (1+Gc)^1 / (1+Ke)..... uses single constant growth rate of dividends and is most appropriate for valuing stable and mature, non-cyclical, dividend-paying firms

Justified P/E

assuming we have correct inputs for D1, E1, Kc and g, the equation above will provide a P/E ratio that is based on the PV of future cash flows. (leading PE ratio) - serves a benchmark for the price at which the stock should trade

Uncommitted line of credit

bank extends an offer of credit for certain amount but may refuse to lend if circumstances change

Committed (regular) line of credit

bank offers credit that it "commits to" for some period of time.

Financial Services

banking insurance real estate

Asset-based models

based on idea that equity value is the market or fair value of assets minus the market or fair value of liabilities.

Dividend Discount Model

based on rationale that intrinsic value of stock is the PV of future dividends Vo = SUM (Dt / (1+ke)^t) Vo - current stock value Dt - dividend at time t Ke- required rate of return on common equity

Monte Carlo Simulation

based on repeated generation of one or more risk factors that affect security values, in order to generate a distribution of security values.

T-distribution

based on small samples N<30 from populations unknown variance. -symmetrical -defined by single parameters, degrees of freedom (df), where df are equal to the number of sample observations minus 1. n-1 for sample means. -more probability in tails (fatter tails) than normal distribution -as df (sample size) gets larger, the shape of the T distribution more closely approaches a standard normal distribution

Specific Identification Method

best matches the actual historical cost of inventory to their physical flow.

How is beta calculated?

beta of stock A = covariance between stock and the market / variance of the market

Bernoulli random variable

binomial random variable for which the number of trials is 1. Final outcome is the number of successes in a series of n trials. Final outcome is number of successes in a series of n trials. p(x) = P(X = x) = (number of ways to choose x from n) pⁿ (1-p)ⁿ-ⁿ

Basic materials

building materials chemicals paper and forest products containers and packaging

Accounting return on equity (ROE)

calculated as net income available to common (NI - PF div) divided by the average book value of common equity over period

Convertible preference shares

can be exchanged for common stock at a conversion ratio determined when the shares are originally issued.

Multiplier model

can be used to estimate intrinsic values. 1) ratio of stock price to such fundamentals as earnings, sales, bk value, cash flow per share 2) enterprise value

Venture Capital

capital provided to firms early in their life cycles to fund their development and growth. Illiquid and investors often have to commit funds to three to ten years before they can cash out.

Simple capital structure

capital structure that contains NO potentially dillutive securities (contains only c/s, nonconvertible debt, and nonconvertible pref. stock)

cfo

change in most current assets and most current liabilities

marginal cost equation

change in total cost/change in total produc

marginal product formula

change in total product/change total labor

marginal revenue product (MRP)

change in total rev/change of last unit of labor employed

Non-participating shares

claim equal to par value in the event of liquidation and do not share in firms profits.

cash paid to vendors

cogs per IS outflow inc inventory outflow decr inv inflow incr A/P inflow decr A/P outflow __________________________ = net outflow

given constant or increasing inventory levels, if prices are rising over a give period

cogs(lifo)>cogs(avco)>cogs(fifo) ei(fifo)>ei(avco)>ei(lifo) *opposite if prices are falling

DTL =

combines the degree of operating leverage and financial leverage. DTL measures the sensitivity of EPS to change in sales = DOL x DFL = (%ΔEBIT/%Δsales) x (%ΔEPS / %ΔEBIT) = (%ΔEPS / %Δsales)

aggregate demand curve measures

combos of agg income and price level for which planned expenditures equal (or realized) income or output there is equilibrum in the money markets

Repurchase by direct negotiation

companies may negotiate directly with large shareholder to buy back a block of shares, usually at a premium to the market price. Will reduce number of shares out, and increase EPS

The best indicator of overstating its profits is

companies should not recognize revenue from barter transactions. The additional revenue is likely to improperly boost profits. While an unusually high sales-growth rate may indicate fraud, it could also indicate good management. It's a yellow flag, but not the best indicator of accounting shenanigans. Rising inventory is also a dual signal. It could be meant to overstate profits, or it could simply reflect an actual buildup of inventory in response to market forces or corporate operations.

Normal Distribution

completely described by its can and variance 68% fall w/in ±δ 90% fall w/in ± 1.65δ 95% fall w/in ±1.96δ 99% fall w/in ±2.58δ

Marginal Cost of Capital

cost of the last new dollar of capital a firm raises. As firm raises more and more capital, the costs of difference sources of financing will increase. Raising additional capital increases WACC. Shows WACC for differenc amounts of financing

Present Value (PV)

current value of some future cash flow PV = FV(1+I/Y)ⁿ

Consumer discretionary

cyclical - selling goods and services in industries -automotive -apparel

Macroeconomic factors

cyclical or structural (Longer-term) trends, most notably economic outputs as measured by GDP or some other measure. Technology Demographic Governments Social Influence

Holder-of-record date

date on which the shareholders of record are designated to receive the dividend.

defintion of held to maturity

debt - bonds - etc...

Continuous uniform distribution

defined over a range that spans between some lower limit, a, and some upper limit b, which serves as the parameters of the distribution.

Growth Industries

demand so strong they are largely unaffected by the stage of the business cycle

Contribution margin

difference between price and variable cost per unit, is available to help cover fixed costs.

Surplus

difference between projected growth in assets and projected growth in liabilities and stockholders equity

Tracking error

difference between total return on a portfolio and the total return of the benchmark against which its performance is measured.

Key advantage of NPV

direct measure of the expected increase in the value of the firm. main weakness doesn't take consideration of project size

Univariate distributions

distribution of a single random variable

payout formula

div per common share / earnings per common share

Stock Splits

divide each existing share into multiple shares, thus creating more shares. No change in wealth

Non-cumulative preferred

do not accumulate over time when they are not paid but dividends for any period must be paid before common shareholders can recieve.

imperfect competition

downward sloping demand curve in order to increase qty sold, individ producer must reduce price marg rev curve downward sloping and steeper than demand curve total revenue - increases at increasing rate above unitary elastic curve and increases as decreasing rate below it total rev max at unit elastic....and marg rev at unit elastic is negative

Statutory Voting

each share held is assigned one vote in the election of each member of the board of directors.

cross elasticity of compliments

ec<0

cross elasticity of substitutes

ec>0

Externalities

effects the acceptance of a project may have on other firm cash flows.

Energy

energy refining production

The objective of f/s is to

ensure that information in f/s is useful to a wide range of users. to provide econ decision mkrs w/useful info abt 1) fin performance 2) fin position

Pure-play

equity beta of a publicly traded firm that is engaged in a business similar to, and with risk similar to, project under consideration.

CAPM

estimate of required rate of return (ki) for security i as function of its systematic risk (bi) and risk-free rate (Rf) and the expected return on the market [E(Rmkt)]

Changes in asset lives and salvage values are changes in accounting ...

estimates and no specific disclosure are required.

Basket of listed depository receipts (BLDR)

exchange-traded fund (ETF) that is a collection of DRs. ETF shares trade in markets just like common stock.

cost of equity

expected equilibrium total return (including dividends) on it's shares in the market. Using dividend discount model or capM. Decrease in share price will increase the expected return on the shares and increase in share price will decrease expected returns. Increase in required return used to discount future cash flows will decrease intrinsic value. Vice versa

coefficient of variation

expresses how much dispersion exists relative to the mean of a distribution; allows for direct comparison of dispersion across different sets

Skewness

extent to which a distribution is not symmetrical

Special Dividends

favorable circumstances allow the firm to make a one-time cash payment to shareholders, in addition to any regular dividends the firm pays.

Predatory Pricing

firm hopes to drive out competitors and later increase prices. laws prohibiting , hard to prove if prices not easily traced

Sponsored DR

firm is involved with the issue. Provides investor voting rights and usually subject to greater disclosure requirements. Unsponsored, depository bank retains voting rights

Differentiation strategy

firms products and services should be distinctive in terms of type, quality, or delivery. For success, firms cost of differentiation must be less than the price premium buyers place on product differentiation. Should be sustainable over time.

P/E Ratio

firms stock price / earnings per share

Price-sales ratio

firms stock price / sales per share

Ex-dividend date

first day a share of stock trades without a dividend. Occurs two business days before the holder-of-record date. If buy a share on or after the ex-dividend date, you will not receive the dividend

The account format of B/S

follows the traditional ledger account, assets on the left hand side and liabilities and equity on the right hand side.

LIFO is appropriate

for inventory that does not deteriorate with age.

FIFO is appropriate

for inventory that has a limited shelf life ex) Because the movies have a very limited shelf life and will greatly deteriorate in value with age, especially after the first year, FIFO is the most appropriate method of accounting for the movies for sale.

Pro-forma balance sheets / IS

forward-looking financial statements that are constructed based on specific assumptions about future business conditions and firm performance. (don't confuse with proforma financial statements)

Payback period =

full years until recover + (unrecovered cost at beginning of last year / cash flow during last year)

Commodity Index Returns reflect the changes in ...

future prices and the roll yield

Sovereign yield spread

general risk of developing country. Difference in yields between the developing countrys government bonds and T bonds of similar maturity.

Proxy

having someone else vote as they direct them on their behalf

Dividend displacement of earnings

higher dividends will increase firm value, a lower growth rate will decrease firm value

How to determine if shr repurchase will cause EPS to increase/decrease

if after-tax cost of debt < earnings yield = EPS increases if after-tax cost of debt > earnings yield = EPS decreases

Direct Investing

in securities of foreign companies simply refers to buying a foreign firms securities in foreign markets.

Secondary sources of liquidity

include liquidating short-term or long-lived assets, negotiating debt agreements or filing for bankruptcy and reorganizing the company.

After-tax cost of debt (Kd)

interest rate at which firms can issue new debt net of the tax savings from the tax deductibility of interest. kd (1-t)

What is the economic substance of financial (capital) lease?

it is the purchase of an asset using debt finance.

North American Industry Classification System (NAICS)

jointly developed by the US, Canada and mexico

Autralian and New Zealand Standard Industrial Classification

jointly developed by those countries

Discretely compounded returns

just the compound returns we are familiar with given some discrete compounding period

Holding period yield, calculation from price relative

ln (S1/So) = ln (1 + HPR) = Rcc

P-value =

lowest level of significance for which the null hypothesis may be rejected.

To investigate the stability of that structure, Kilgore would be best served by looking at

management turnover.

Weighted Average Cost of Capital

marginal cost of capital (MCC) - discount rate cost of financing firms assets. View as opportunity cost.

least cost optimization formula

marginal product of input/price of input

EV =

market value of CS + Mkt Value of debt -cash and short-term investments want to compare values of firms that have significant difference in capital structure.

Price-to-book ratio

market value of a firms equity divided by the book value of it's equity

Enterprise Value

market value of all a firms outstanding securities minus cash and short-term liabilities. common stock value estimated by subtracting the value of liabilities and preferred stock from an estimate of enterprise value.

total product

max output that a given qty of labor can produce when working with a fixed qty of capital units

Left/negative skewed distribution

mean < median < mode. Distribution appears as if the left tail has been pulled away from the mean.

Right/positive skewed distribution

mean > median > mode. Distribution appears as if the right tail has been pulled away from the mean.

gdp deflator definition

measures aggregate change in prices across entire economy

sharpe ratio

measures excess return per unit of risk -the larger the better

Key advantage of IRR

measures profitability as a %, showing the return on each dollar invested. Provides info on margin of safety that NPV does not. Disadvantages - 1) possibility of producing rankings of mutuall exclusive projects different from NPV analysis 2) possibility are multiple IRRs or no IRR for project

Simple random sampling

method of selecting a sample in such a way that each item or person in the population being studied has the same likelihood of being included in the sample.

Revolving line of credit

more reliable source of short-term financing than a committed line. Typically for longer terms than committed, sometimes as long as years.

calculations of cash received from customers

net sales in I/S inflow increase in AR outflow decrease in AR inflow increase unearned rev inflow decrease unearned rev outflow _____________________________________ net inflow total

Preference Shares

no voting rights usually, fixed periodic payments.

gdp deflator formula

nominal gdp/real gdp * 100%

Variance of binomial random =

np (1-p)

if irr < required rate of return

npv<0

if irr is > required rate of return

npv>0

Discrete random variable

number of possible outcomes can be counted and for each possible outcome there is a measurable and positive probability.

Z-value

number of std a given observation is from the population mean

Break Points

occur at any time the cost of one of the components of the company's WACC changes

Look-ahead bias

occurs when a study tests a relationship using sample data that was not available on the test date.

cost-push inflation

occurs when rising costs compel biz to raise prices

sentiment indicators

opinion polls, put/call ratio, VIX, margin debt, short interest ratio

Reverse Stock Splits

opposite of stock splits. Fewer shares outstanding but higher priced stock.

Industry Rotation

overweighting or underweighting industries based on current phase of business cycle

Common Shares

ownership interest. Residual claim (what's left after debt holders and preferred stockholders)

bayes formula

p(event|info)= {p(info|event) / p(info)} x p(event or p(event|info) x p(info) = p(info|event) x p(event)

Continuous distribution

p(x) = 0 even though x can occur. Only consider P(X1 ≤ X ≤ X2)

Discrete distribution

p(x) = 0 when x cannot occur, or p(x) > 0

Debt covenants

part of indenture that place restrictions on the firm that protect bondholderns and increase value of the firm's bond. Breach is technical default

Preferred Stock

pays dividend that is usually fixed and indefinite maturity. When fixed the stream of dividends is infinte: Dp/(1+Kp)^1.....

B/S - Long-term Liabilities

pd after more than 1 year notes & bonds: at PV of future CF pymets Capital leases Provisions Deferred tax

DOL =

percentage change in EBIT / percentage change in sales Q (P-V) / Q (P-V) - F ------------------------------------------- S - TVC / S - TVC - F S - sales

Complex Capital Structure

potentially dilutive securitites [options, warrants, convertible securities]

Discrete uniform random variable

probabilities for all possible outcomes for a discrete random variable are equal.

sampling distribution

probability distribution of all possible sample statistics computed from a set of equal-size samples randomly drawn from the same population. The sampling distribution of the mean is the distribution of estimates of the mean

Standardization

process of converting an observed value for a random variable to its z-value

Non-cyclical

produces goods and services for which demand is relatively stable over the business ex) health care, utilities, and food and bev

Private Investment in Public Equity (PIPE)

public firm that needs capital quickly sells private equity to investors.

definition of marketable security

publically traded and no significant influence or you own less than 20% of equity in a company

real gdp formula

qty produced in current year * avg mkt price base year prices

Breakeven quantity of Sales

quantity of sales for which revenues equal total costs, so net income is zero.

Confidence interval

range of values around the expected outcome within which we expect the actual outcome to be some specified percentage of time.

Growth Stage

rapid growth limited competitive pressures falling prices increasing profiability

Kd

rate at which the firm can issue new debt

DFL =

ratio of the percentage change in net income (or EPS) to the percentage change in EBIT % change in EPS / % Sales or EBIT / EBIT - interest

TRIN (Arm Index)

ratio of two ratios: (Number of advancing issues / number of declining issues) / (volume of advancing issues / volume of declining issues)

Intrinsic Value

rational value investors would place on asset if they had full knowledge of assets characteristics

Participating preference shares

receive an extra dividend if firm profits exceed a predetermined level and may receive a value greater than par of preferred stock if firm is liquidated.

Unusual OR Infrequent items:

reported ABOVE the line. 1) G/(L) from disposal of a business segment 2) G/(L) from sale of investment in subsidiary 3) Provisions for environmental remediation, impairments, write-offs, write-downs, restructuring. 4) Integration expense for recently acquired business Analyst must determine effects on future income

Discontinued Operations:

reported BELOW the line. Operations mgmt has decided to dispose of but: 1) has not yet done so or 2) did so in CY after it generated profit/(loss) Must be physicallly and operationally distinct from firm. Analyst must determine effects on future income amd cash flows.

Extraordinary Items: Unusual AND Infrequent items:

reported BELOW the line. Prohibited under IAS1 1) Losses from expropriation of assets. 2) Uninsured losses from natural disasters Analyst must determine if it is really THAT extraordinary and if should be included in forecasting

Depository Receipts

represent ownership in a foreign firm and are traded in the markets of other countries and local market currencies. Bank deposits shares of the foreign firm and then issues receipts representing ownership of a specific number of the foreign shares.

Cost of equity capital

required rate of return on the firms common stock.

Time period basis

result if the time period over the data is gathered is too short or too long.

Sampling error of mean =

sample mean - population mean

cross-sectional data

sample of observations taken at a single point in time.

Dilutive Securities

securities that would DECREASE EPS if exercised If X< Avg. stock price then could be exercised If X> Avg. stock price then will not be exercised

Anti-dilutive Securities

securities that would INCREASE EPS if exercised

Annuities

series of equal cash flows that occur at evenly spaced intervals over time

Corporate governance

set of internal controls, processes, and procedures by which firms are managed.

Share repurchase if after-tax cost of borrowing is less than earnings yield (vice versa)

share repo will increase company's EPS (vice versa)

Industry Life Cycle

should be a component of an analysts strategic analysis. -embryonic -growth -shakeout -mature -decline

Gross Reporting of Revenue

shows sales and cost of goods sold. Under GAAP: 1) must be primary obligor under the contract; 2) bear inventory and credit risk; 3) have the ability to choose its supplier; 4) have reasonable latitude to set the price.

Experience curve

shows the cost per unit relative to output

Balance Sheet

shows the financial position of a firm AT A SINGLE POINT in time A = L + E.

Conventional Cash Flow Patter

sign on the cash flows changes only once, with one or more cash outflows followed by one or more cash inflows

Statistical Classification of Economic Activities

similar to the ISIC, but is designed for Europe

Point estimates

single values used to estimate population parameters. x = ∑x / n Point estimate +/- (reliability factor x standard error) Not as reliable as confidence interval estimates.

Inventory mangement: Low T/O (High DOH):

slow moving or obsolete inventory

Nonbank finance companies

smaller firms or firms with poor credit use for short-term funding

Primary source of Liquidity

sources of cash it uses in its normal day-to-day operations.

two-tailed test

tests whether value is equal to a given number Ho: µ = 0 versus Ha: µ≠0

one tailed test

tests whether value is greater than (greater than equal to) or less than (less than equal to) a given number Ho: µ≤0 verses Ha: µ>0

arithmetic mean

the average; the sum of a set of numbers divided by the number of numbers in the set

Continuous random variable

the number of possible outcomes is infinite, even if lower and upper bounds exist.

Probability distribution

the probabilities of all the possible outcomes for a random variable. Probability of all possible outcomes must sum to 1.

marginal cost curve intersects avc and atc at?

their min values

Marginal cost of capital slopes ____, investment opportunity schedule slopes ____

upward, downward

Bankers acceptances

used by firms that export goods. Guarantee from bank of firm that has ordered goods stating that a payment will be made upon receipt of goods

geometric mean

used when calculating investment returns over multiple periods or to measure compound growth rates

Discounted payback period

uses present values of the projects estimated cash flows. Number of years takes a project to recover its initial investment in a PV term and must be greater than the payback period without discounting.

Private equity

usually issued to institutional investors via private placements. -less liquidity, no public market -share price negotiated between firm and investors -More limited firm financial disclosure, no gov't exchange -Lower reporting costs -potentially weaker corporate governance -greater ability to focus on long-term prospects, no public short term pressure -potentially greater return once goes public

book value of equity

value of the firms assets and the balance sheet minus it's liabilities

Cannibalization

when a new project takes sales from an existing product

Problems with Pure Play

~Beta uses historical data and sensitive to the length of time and frequency of data ~Affected by which index is chosen to represent the market return ~Betas are believed to revert to 1 after time and the estimate may need to be adjusted accordingly ~Betas of smaller firms may need to be adjusted upward to reflect risk inherent in small firms not captured by Beta calculation

Risks of Insurance Companies

~Moral hazard when policy holders take more risk because they are insured ~Adverse selection that people who buy insurance are the ones who are most risky ~Fraud when the insured purely causes damage to collect a claim

Defined Benefit Pension Expense Components

~Service cost is the present value of benefits earned by employees during the current period ~Interest costs is the increase to the benefit obligation due to the passage of time ~Expected return on plan assets reduces the pension expense ~Actuarial gains or losses come from changes to assumptions the actuary uses about future obligations ~Prior service costs are retroactive benefits awarded to employees when the plan is initiated or amended

Pure Expectations Theory Yield Curve Ramifications

~Short term rates expected to rise in future = normal curve ~Short term rates expected to fall in future = inverted curve ~Short term rate expected to rise then fall = humped curve ~Short term rate expected to remain constant = flat curve

Factors Influencing Difference Between Nominal and Zero-Vol Spreads

~The steeper the benchmark spot rate curve, the greater the difference between the two and an upward/downward sloping curve produces a Z spread greater/smaller than nominal spread ~The shorter the maturity, the greater the difference

probabilistic variance

δ²(X) = ∑P(x)x = P(x₁)[x₁ - E(X)]² + P(x₂)[x₂ - E(X)]² +... Probabilistic Standard Deviation would be the square root of the above.