CFA - Level I
Occur any time the cost of one of the components of the company's WACC changes
Break points
Investment policy statement
Details the investor's objectives and constraints, results from the planning step
If random variable Y follows a lognormal distribution then the natural log of Y must be:
Normally distributed
The period of time within which a hedge fund must fulfill a redemption request is the:
Notice period
Recoverability test
an asset is impaired if the carrying value > the asset's future undiscounted cash flow stream
An unexpected increase in businesses' inventory-to-sales ratios is most likely to occur as an economy...
...approaches the peak of an expansion
When average product is at a maximum...
...average variable cost is at a minimum
Option adjusted spread > zero-volatility spread
Embedded option has a positive value to the bondholder (i.e. bond is likely putable)
Ending accounts payable
Ending accounts payable = beginning accounts payable + purchases - cash paid to suppliers
Ending accounts receivable
Ending accounts receivable = beginning accounts receivables + sales - cash collections
Ending cash balance
Ending cash balance = change in cash balance + beginning cash balance
Free cash flow to equity
Net income + depreciation - increase in working capital - fixed investment - debt principal repayments + new debt issues
Income elasticity
%∆ quantity demanded / %∆ in income Income elast < 0 good is an inferior good Income elast > 0 good is a normal good
Own price elasticity
%∆ quantity demanded / %∆ price Abs val price > 1 = demand is elastic Abs val price < 1 = demand is inelastic
Cross price elasticity
%∆ quantity demanded / %∆ price of related good Cross price > 0 related good is a substitute Cross price < 0 related good is a complement
Sustainable growth rate
(1 - dividend payout ratio) x ROE
Degree of operating leverage
(1) (S - TVC) / (S - TVC - FC) (2) (∆EBIT / EBIT) / (∆Sales / Sales)
DuPont Equations
(1) (net profit margin) x (asset turnover) x (financial leverage ratio) (2) (tax burden) x (interest burden) x (EBIT margin) x (asset turnover) x (financial leverage)
Forward rate: (1) 1 period from now (2) 2 periods from now
(1) 1y1y = (1 + S2)^2 / (1 + S1) (2) 2y1y = (1 + S3)^3 / (1 + S2)^2
Examples of: (1) Leading indicator (2) Coincident indicator (3) Lagging indicator
(1) Consumer expectations; initial claims for unemployment insurance (2) Industrial production; manufacturing and trade sales (3) Average duration of unemployment; inventory-to-sales
PP&E reporting (1) GAAP (2) IFRS
(1) Cost model (2) Cost model or revaluation model (fair value - accumulated depreciation)
Dividend payout ratio formula
(1) DPS / EPS (2) Dividends / net income
(1) Dividend yield (2) Earnings yield
(1) DPS / stock price (2) EPS / stock price
Examples of: (1) Price-weighted indices (2) Equal-weighted indices
(1) Dow Jones and Nikkei 225 (2) Value Line Composite Average and the Financial Time Ordinary Share Index
Degree of financial leverage
(1) EBIT / (EBIT - interest) (2) % ∆ in EPS / % ∆ in EBIT
(1) Patterns that typically indicate a reversal of price trend (2) Patterns that typically indicate the price trend will continue in the same direction
(1) Head and shoulders and inverse head and shoulders (2) Triangle and rectangle patterns
Essential qualities of effective central banks
(1) Independence (2) Credibility (3) Transparency
Components of a client's Investment Policy Statement
(1) Introduction-Describes the client. (2) Statement of Purpose-The intentions of the IPS. (3) Statement of Duties and Responsibilities-Of the client, the asset custodian, and the investment managers. (4) Procedures-Related to keeping the IPS updated and responding to unforeseen events. (5) Investment Objectives-The client's investment needs, specified in terms of required return and risk tolerance. (6) Investment Constraints-Factors that may hinder the ability to meet investment objectives; typically categorized as time horizon, taxes, liquidity, legal and regulatory, and unique needs. (7) Investment Guidelines-For example, whether leverage, derivatives, or specific kinds of assets are allowed. (8) Evaluation and Review-Related to feedback on investment results. (9) Appendices-May specify the portfolio's strategic asset allocation (policy portfolio) or the portfolio's rebalancing policy.
Inventory methods under rising prices: (1) COGS (2) Inventory (3) Gross profit
(1) LIFO - higher; FIFO - lower (2) LIFO - lower; FIFO - higher (3) LIFO - lower; FIFO - higher
Inventory reporting (1) GAAP (2) IFRS
(1) Lower of cost or market (2) Lower of cost or net realizable value
A worker is most likely to earn economic rent when the marginal revenue product (MRP) from her labor and the supply curve for her type of labor exhibit which of the following characteristics?
(1) Marginal revenue product: high (2) Supply curve: less elastic
Impact of a stock dividend on: (1) Equity (2) Net income (3) EPS
(1) No effect (2) No effect (3) Decrease
GAAP v. IFRS Reversals of inventory writedowns
(1) Not permitted under GAAP (2) Permitted under IFRS; the firm is required to discuss the circumstances of the reversal
GAAP v. IFRS (1) Interest and dividends received (2) Interest and dividends paid
(1) Operating or investing under IFRS (2) Operating or financing under IFRS
What factors are fixed in the short run?
(1) Plant size (2) technology (3) equipment
(1) Payables turnover (2) Receivables turnover (3) Inventory turnover
(1) Purchases / average trade payables (2) Credit sales / average receivables (3) COGS / average inventory
Delays in realizing the effects of fiscal policy changes limit their usefulness. Delays can be caused by:
(1) Recognition lag: Policymakers may not immediately recognize when fiscal policy changes are needed (2) Action lag: Governments take time to enact needed fiscal policy changes (3) Impact lag: Fiscal policy changes take time to affect economic activity
Characteristics that make financial information useful
(1) Relevance (either predictive value and/or confirmatory value, and materiality) (2) Faithful representation (complete, neutral, and free from error)
Breakeven formula: (1) call option (2) put option
(1) X + option cost (2) X - option cost
Anti-dilutive test: (1) convertible debt (2) preferred dividends
(1) [convertible debt interest (1 - t) / convertible debt shares] > basic EPS (2) preferred dividend / number of shares created if the preferred stock is converted > basic EPS
Financial statements that are required by IAS No. 1 include:
(1) a balance sheet (2) a statement of comprehensive income (3) a cash flow statement (4) a statement of changes in owners' equity (5) and explanatory notes that include a summary of the company's accounting policies
Characteristics that increase convexity
(1) a longer maturity; (2) a lower coupon rate; (3) a lower yield to maturity (4) a putable bond (5) cash flows that are more dispersed over time
GDP deflator
Nominal GDP / Real GDP
Main functions of the financial system
(1) allow individuals and organizations to save, borrow, raise capital, and manage risks; (2) to determine equilibrium rates of return that equate the amounts of lending and borrowing; (30 to allocate capital to its most productive uses
Real estate performance is measured by
(1) an appraisal index = based on periodic estimates of property values; (2) a repeat sales index = based on price changes for properties that have sold multiple times; (3) REIT indices = based on the actual trading prices of REIT shares
Four C's of credit analysis
(1) capacity; (2) collateral; (3) covenants; (4) character
Characteristics that enhance relevance and faithful representation
(1) comparability; (2) verifiability; (3) timeliness; (4) understandability
Bond settlement: (1) government bonds (2) corporate bonds
(1) day of trade (cash settlement) or T+1 (2) either T+2 or T+3
Trading securities
(1) debt and equity securities acquired with the intent to profit over the near term (2) reported at fair value (3) realized and unrealized gains and losses are recognized in the income statement
Available-for-sale securities
(1) debt and equity securities that are not expected to be held to maturity of traded in the near term (2) reported at fair value (3) unrealized gains and losses are recognized as other comprehensive income in owner's equity
Held-to-maturity securities
(1) debt securities acquired with the intent to be held to maturity
How does a write-down of inventory impact: (1) assets (2) equity (3) asset turnover (4) debt / equity (5) debt / assets (6) net income (7) profit margin (8) ROA / ROE
(1) decrease (2) decrease (3) increase (4) increase (5) increase (6) decrease (7) decrease (8) decrease
(1) Other things equal, an increase in the coupon rate of a bond will... (2) Other things equal, an increase (decrease) in a bond's YTM will...
(1) decrease its interest rate risk (2) decrease (increase) its interest rate risk
Degree of total leverage
(1) degree of operating leverage x degree of financial leverage (2) % ∆ in EPS / % ∆ in sales
Main factors affecting business risk
(1) demand variability (2) sales price variability (3) input price variability (4) ability to adjust output prices (5) and operating leverage
Nominal risk-free rate
Nominal risk-free rate = real risk-free rate + expected inflation rate
Major sections of GIPS
(1) fundamentals of compliance; (2) input data; (3) calculation methodology; (4) composite construction; (5) disclosure; (6) presentation and reporting; (7) real estate; (8 private equity; (9) wrap fee/separately managed account portfolios
(1) shorter-term average above a longer-term average is a buy signal
(1) golden cross
The sustainable growth rate in GDP is positively affected by...
(1) increases in the supply of natural resources (2) increases in the supply of physical capital (3) increases in the supply or productivity of labor (4) human capital
Characteristics of frequency distributions
(1) mutually exclusive (2) non-overlapping (3) work with all types of measurement scales
The three sources of bias associated with CPI data are:
(1) new goods (2) quality changes (3) substitution
The conditions that often lead to low-quality financial reporting are:
(1) opportunity (2) motivation (3) rationalization
Steps in the portfolio planning process
(1) planning = analysis of the investor's risk tolerance, return objectives, time horizon, tax exposure, liquidity needs, income needs (2) execution = analysis of the risk and return characteristics of various asset classes to determine how funds will be allocated to various asset types, top down analysis to select assets, bottom-up analysis to select individual securities (3) feedback = monitor risk/return characteristics, portfolio weights, investor circumstances and rebalance when necessary
CAPM assumptions
(1)investors are risk averse, utility maximizing, and rational; (2) markets are free of frictions like costs and taxes; (3) all investors plan using the same time period; (4) all investors have the same expectations of security returns; (5) investments are infinitely divisible; (6) prices are unaffected by an investor's trades
Solvency is classified as what type of risk?
Non-financial risk
Sources of commodity futures returns
(1) roll yield; (2) collateral yield; (3) change in spot prices
The four general categories considered in the formulas used by credit rating agencies to determine the capacity of a borrower to repay a debt
(1) scale and diversification, (2) operational efficiency, (3) margin stability, and (4) leverage
Two components of the benchmark yield curve's interest rate
(1) the real rate of return and (2) expected inflation
The characteristics of a coherent financial reporting framework are:
(1) transparency (2) comprehensiveness (3) consistency
An investor invested $10,000 into an account five years ago. Today, the account value is $18,682. What is the investor's annual rate of return on a continuously compounded basis?
(18,682/10,000)^1/5 = 1.133143 ln(1.133143) = 12.4995%
The fundamental relationship among savings, investment, the fiscal balance, and the trade balance is
(G - T) = (S - I) - (X - M)
Profitability Index formula
(PV of future cash flows / CF0)
Treynor measure
(Rp - Rf) / βp ; excess returns per unit of systemic risk
Approximate convexity
(V- + V+ - 2V0) / (∆YTM)^2 V0
Approximate modified duration
(V- - V+) / (2 x V0 x ∆YTM)
Price value of a basis point
(V- - V+) / 2
Bank discount yield
(dollar discount / face value) × (360 / t)
Breakeven quantity of sales
(fixed operating costs + fixed financing costs) / (price - variable cost per unit)
Holding period yield (from MMY)
(money market yield) ÷ (360 ÷ t)
Convert balance sheet to FIFO with LIFO reserve = 150 and t = 40%
+ inventory $150, -change in LIFO reserve from COGS, -cash $60 (150 x 40%). + retained earnings $90 [150 x (1-40%)]
Examples include: (1) negotiating debt contracts (2) liquidating assets (3) filing for bankruptcy protection and reorganization
Secondary sources of liquidity
Change in full bond price
-modified duration (∆YTM) + ½ convexity (∆YTM)^2
Under IFRS, when inventory recovers in value after being written down...
... may be "written up" and a gain recognized in the income statement. The amount of such gain, however, is limited to the amount previously recognized as a loss.
Impairment writedowns are reported losses...
..."above the line" and are included in income from continuing operations
Work-in-process inventory increasing faster than finished goods inventory is a likely indicator that...
...a firm expects demand to increase, which should increase future revenues and earnings
If a good has elastic demand...
...a small price increase will cause a larger decrease in the quantity demanded
The settlement price for a futures contract is...
...an average of the trade prices during the 'closing period'
An RSI above 70 is thought to indicate...
...an overbought condition, which can be a warning sign that the current uptrend is not sustainable
Revenue recognition for long-term contracts under the converged accounting standards issued in May 2014...
...based on progress toward satisfying the performance obligations in the contracts, which is comparable to the percentage-of-completion method under the prior accounting standards
The global minimum variance portfolio lies...
...below the CML and is not an efficient portfolio under the assumptions of the CAPM
Zero coupon bonds always sell...
...below their par value, or at a discount prior to maturity. The amount of the discount may change as interest rates change, but a zero coupon bond will always be priced less than par.
Frequent changes in advertised prices are one of the costs of...
...both expected and unexpected inflation
Bonds that are issued by a corporation, but paid from a pool of the corporation's assets that is legally bankruptcy-remote, are best described as...
...covered bonds (they are different from securitized bonds, which are issued by a special purpose vehicle)
In the context of an LBO, mezzanine financing refers to..
...debt that carries warrants or equity conversion features
Other things equal, an increase in an option-free bond's yield to maturity will...
...decrease its interest rate risk; because the price-yield relationship for an option-free bond is convex, interest rate risk as measured by duration changes when a bond's YTM changes. An increase in YTM reaches a flatter part of the price-yield curve, from which changes in yield will have relatively smaller effects on the bond's value
Declaring a stock dividend...
...decreases retained earnings and increases contributed capital by the same amount, leaving total shareholders' equity unchanged
The price of a pay-fixed receive-floating interest rate swap is...
...determined by expected future short-term rates; price of an interest rate swap refers to the fixed rate specified in the swap
Under U.S. GAAP, income from continuing operations is reported net of...
...discontinued operations and extraordinary items
Whether a lease is an operating or a finance (capital) lease, both U.S. GAAP and IFRS require disclosure of the minimum lease payments for...
...each of the next five years and the sum of minimum lease payments more than five years in the future
Some forward contracts are termed cash settlement contracts. This means:
...either the long or the short in the forward contract will make a cash payment at contract expiration and the asset is not delivered
Transactions costs incurred from portfolio rebalancing are most likely to be highest for funds that track...
...equal-weighted indexes; equal-weighted index portfolios require rebalancing after each return period because differences in returns among securities will drive the security weightings away from equal weighting
Elliott wave theory describes the typical pattern of price movements as...
...five waves with the direction of the trend, followed by three waves against the direction of the trend
If rates rise (fall) before the first coupon date, an investor who holds a bond to maturity will earn a rate of return...
...greater (less) than the YTM at purchase
Under U.S. GAAP, an asset is considered impaired if its book value is...
...greater than the sum of its undiscounted expected cash flows
Under U.S. GAAP, land owned by the firm is most likely to be reported on the balance sheet at...
...historical cost; unless impairment has been recognized, land is reported at historical cost and is not subject to depreciation. Increases in value are not reflected in balance sheet values under U.S. GAAP
To be compliant with GIPS, firms must make compliant presentations available to prospects, on request, for any composite the firm has offered...
...in the last five years, even for composites that have been terminated
Greene Company discloses that its net income for the most recent period was reduced by a writedown of inventory to net realizable value. What effect is the inventory writedown most likely to have on Greene's net income in future periods?
...increase; in future periods, lower-valued inventory will result in lower cost of sales and higher net income
Forward and futures prices may differ for otherwise identical contracts if...
...interest rates are positively or negatively correlated with futures prices
In the short run, the average product of labor...
...is at a maximum where it intersects the marginal product of labor curve
The long-run aggregate supply curve...
...is perfectly inelastic because all input prices change in proportion of the price level; it represents the level of potential GDP
The short-run supply curve for a firm is...
...its marginal cost curve above the average variable cost curve
An agency RMBS pool with a prepayment speed of 50 PSA will have a weighted average life that is...
...less than its weighted average maturity; weighted average life of a mortgage pool is less than its weighted average maturity if there are any prepayments. "50 PSA" means the prepayment speed is assumed to be 50% of the Public Securities Association prepayment benchmark
If the coupon payments are reinvested at the coupon rate during the life of a bond, then the yield to maturity...
...may be greater or less than the realized yield; for the realized yield to equal the YTM, coupon reinvestments must occur at that YTM. Whether reinvesting the coupons at the coupon rate will result in a realized yield higher or lower than the YTM depends on whether the bond is at a discount (coupon < YTM) or a premium (coupon>YTM).
Compared to an otherwise identical European put option, one that has a longer time to expiration...
...may be worth less than the put that is nearer to expiration
Akor is a country that has chosen to use a conventional fixed peg arrangement as the country's exchange rate regime. Under this arrangement, Akor's exchange rate against the currency to which it pegs...
...may fluctuate around the peg rate
Smith has more steeply sloped risk-return indifference curves than Jones. Assuming these investors have the same expectations, which of the following best describes their risk preferences and the characteristics of their optimal portfolios? Smith is...
...more risk averse than Jones and will choose an optimal portfolio with a lower expected return; steeply sloped risk-return indifference curves indicate that a greater increase in expected return is required as compensation for assuming an additional unit of risk, compared to less-steep indifference curves
How should an analyst interpret a downward-sloping term structure of yield volatility? Short-term interest rates are...
...more variable than long-term interest rates; the term structure of yield volatility refers to the volatility of interest rates at different maturities
If the firm does not use fair value reporting of debt obligations and market interest rates have changed materially since a firm issued a bond...
...net income and shareholders' equity are not affected by changes in the market value of the firm's debt, and disclosing its gain or loss in market value is not required; material changes in the firm's cost of debt capital should be included in the Management Discussion and Analysis section of the financial statements.
To ensure the continuity of a value-weighted index when one of the stocks in the index is split...
...no adjustment is necessary; value-weighted indexes do not need to be adjusted for stock splits because the market capitalization of the company remains the same.
Assume that the supply of ethanol is relatively more elastic than the demand for ethanol. Compared to an initial competitive equilibrium in the market for ethanol, the imposition of a per-gallon tax on producers of ethanol will most likely decrease...
...producer surplus by less than it reduces consumer surplus; Regardless of whether a tax is imposed on suppliers or consumers, the relative burden of the tax to each depends on the relative elasticities of supply and demand. Since demand is relatively less elastic than supply, the burden of the tax will be greater on consumers than on producers. These burdens are equivalent to decreases in producer and consumer surpluses. Total consumer and producer surpluses will be reduced by the amount of the resulting deadweight loss in addition to the total amount of tax collected.
Beta measures the sensitivity of an asset's rate of return to the market's...
...rate of return
The investment needs of property and casualty insurers are characterized by a...
...short-term time horizon and low risk tolerance
A bond with nine years to maturity is quoted at an interpolated spread of +150 basis points. The benchmark yield for this bond is a...
...swap rate (I-spreds are spreads to swap rates)
The price to book value ratio (P/BV) is a helpful valuation technique when examining firms...
...that hold primarily liquid assets
If the margin account balance falls below the maintenance margin level...
...the account must be brought back up to the initial margin amount
Under negative convexity, when interest rates fall...
...the borrower/issuer is more likely to repay/call the bond, which causes the bond's price to approach a maximum. As such, the bond's price increases at a decreasing rate as interest rates decrease
When selling an asset, the gain or loss is...
...the difference between the carrying value and the cash received
When exchanging one long-lived asset for another, a gain or loss is recorded as...
...the difference between the old asset's carrying value and its fair value (or the fair value of the asset received in exchange, if that value is more evident)
Value of the liability is calculated using the bond's yield at issuance under...
...the effective interest rate method
If investors' expected future incomes increase and the demand for financial capital increases, other things equal...
...the equilibrium interest rate will rise; increases in expected future incomes will decrease savings, which will decrease the supply of financial capital and increase the equilibrium interest rate. If the demand for financial capital rises, interest rates also rise; so both changes tend to increase the equilibrium interest rate
The less the degrees of freedom...
...the fatter the tails; a t-distribution with sufficiently high degrees of freedom is approximately normal and a normal distribution has thinner tails compared to a t-distribution
When a property is transferred from owner-occupied to investment property, a firm using the fair value model must treat any increase in the property's value as a revaluation...
...the firm may only recognize a gain on the income statement to the extent that it reverses a previously recognized loss
IFRS rules require inventory to be valued at...
...the lower of cost or net realizable value (NRV) NRV = estimated sales price less estimated selling and completion costs
In a descending price or Dutch auction, the government will sell bonds to the bidders who bid...
...the lowest yields (highest prices) until all the bonds are sold
The convenience yield associated with holding the underlying asset of a derivative is most accurately described as...
...the nonmonetary benefits of holding the asset
In a competitive market, the equilibrium quantity is...
...the one for which the sum of the consumer and producer surpluses is maximized
An analyst finds a stock that has had a low beta given its historical return, but its total risk has been commensurate with its return. When writing a research report about the stock for clients with well-diversified portfolios, according to Standard V(B), Communication with Clients and Prospective Clients, the analyst needs to mention:
...the relationship of the historical beta and return only. Using reasonable judgment, an analyst may exclude certain factors from research reports. Since the report will be delivered to clients with well-diversified portfolios, total risk is not as important as beta. Given that the total risk has been only commensurate with historical return, furthermore, then the analyst is not negligent by not mentioning it.
A firm uses the first-in first-out (FIFO) cost flow assumption. Compared to gross profit with a periodic inventory system, the firm's gross profit with a perpetual inventory system would be...
...the same; for a firm using LIFO or average cost, gross profit can be different depending on the choice of inventory system
Asset-backed securities (ABS) may have a higher credit rating than the seller's corporate bonds because...
...the special purpose vehicle is a separate entity
Floating-rate securities are subject to interest rate risk because...
...their coupon rates are not reset continuously
The primary goal of firm management is...
...to increase the book value of equity
A multivariate distribution describes the relationship between...
...two or more random variables, when the behavior of each random variable is dependent on the others in some way
Revenue recognition method when future cash collection cannot be reasonably estimated...
...use installment method
Accruals are best described as requiring an accounting entry...
...when the earliest event in a transaction occurs (paying or receiving cash, providing a good or service, or incurring an expense)
Power of a test
1 - Type II Error
Loss severity
1 - recovery rate; refers to the value a bond investor will lose if the issuer defaults; can be stated as a monetary amount or as a percentage of a bond's value (principal and unpaid interest)
If the possible outcomes are X:(0,1,2,3,4,5), then the probability of each of the six outcomes is
1 / 6 = 0.167
Money expansion multiplier
1 / required reserve ratio
Financial intermediaries that issue securities which represent interests in a pool of similar financial assets are best characterized as:
Securitizers
Annuity due
First cash flow is at the beginning of the period
Ordinary aunnuity
First cash flow is at the end of the period; the present value of the ordinary annuity is less than an annuity due since it is discounted one more period
A callable bond must offer a lower or higher yield than an otherwise identical non-callable bond?
Higher yield (so the bond sells at a lower price)
The full price of a bond equals
clean price + accrued interest (also called dirty prices)
Approximate percentage price change of the bond due to convexity
1/2 x convexity × (ΔYTM)^2
Fibonacci ratio
5/8
Critical values of two-tailed z-test
90% = 1.645 95% = 1.96 99% = 2.58
An analyst wants to determine whether the monthly returns on two stocks over the last year were the same or not. What test should she use if she is willing to assume that the returns are normally distributed?
A paired comparisons test because the samples are not independent. The difference in means test requires that the samples be independent. Portfolio theory teaches us that returns on two stocks over the same time period are unlikely to be independent since both have some systematic risk.
The central bank defines how inflation is computed, sets the target inflation level, and determines the horizon over which the target is to be achieved
Target independence
Kinked demand model of oligopoly
A firm's competitors will not match a price increase, but will match the price of a competitor that offers a lower price. The result is a demand curve that is more elastic above the current price, but less elastic below it.
A firm writes down inventory to net realizable value. In the period of the writedown, what is the most likely effect on cost of goods sold?
A write-down of inventory to net realizable value is typically recognized as an INCREASE in cost of goods sold in the period of the write-down.
National saving must increase relative to domestic investment for a currency devaluation to narrow a trade deficit, which in turn depends on whether the economy is producing at maximum capacity (full employment or potential GDP) when the devaluation occurs
Absorption approach
The extent to which buyers bear the cost of the tax through a higher price paid and sellers bear the cost through a lower price received
Actual tax incidence
Auditor believes the statements are not presented fairly or are materially nonconforming with accounting standards
Adverse opinion
Examples include: (1) make timely interest and principal payments to bondholders; (2) to insure and maintain assets; (3) to comply with applicable laws and regulations
Affirmative covenants
Fair value model
All gains and losses from changes in the value of investment property are recognized on the income statement
firm has deferred tax assets of $315,000 and deferred tax liabilities of $190,000. If the tax rate increases, adjusting the value of the firm's deferred tax items will:
An increase in the tax rate increases the values of both DTAs and DTLs. Because the firm's DTAs are greater than its DTLs, the net effect of adjusting their values for an increase in the tax rate will be to decrease income tax expense.
Project beta formula
Asset beta x [1 + (1 - tax) (D / E)]
Regulators attempt to force monopolies to reduce prices to where a firm's average total cost curve intersects the market demand curve
Average cost pricing
If the government regulates a natural monopoly and enforces an average cost pricing, what are the effects on output quantity and price compared to an unregulated natural monopoly?
Average cost pricing is meant to force a natural monopolist to reduce price to where the firm's average total cost intersects the market demand curve. This results in higher output and a lower price than would prevail for an unregulated natural monopoly.
When the convenience yield is high, futures prices will be less than spot prices
Backwardation
Bond in which periodic interest payments are made over the life of the bond and the principal value is paid with the final interest payment at maturity
Bullet bond
Call option - increase in: (1) Price of asset (2) Exercise price (3) Risk-free rate (4) volatility of asset (5) time to expiration (6) costs of holding underlying asset (7) benefits of holding underlying asset
Call Option (1) increase (2) decrease (3) increase (4) increase (5) increase (6) increase (7) decrease
Call Option: (1) max loss (2) max gain
Call Option: (1) buyer (long) = option cost; seller (short) = unlimited (2) buyer = unlimited; seller = option cost
Markets in which the stock is only traded at specific times
Call markets
How does an increase in the riskfree rate affect call and put option values?
Call option: increases value Put option: decreases value
The line representing the possible combinations of risk-free assets and the optimal risky asset portfolio
Capital allocation line
Cash paid for insurance formula
Cash = insurance expense + change in prepaid insurance
Cash conversion cycle
Cash conversion cycle = (days sales outstanding) + (days of inventory on hand) - (number of days of payables)
What test is used to determine whether the variance of a population equals a particular value?
Chi-squared test
Firms separately report current assets from non-current assets/liabilities
Classified balance sheet
Interest earned on collateral required to enter into a futures contract
Collateral yield
When the collateral securities of a CDO are corporate and emerging market debt
Collateralized bond obligation
A structured security issued by an SPE for which the collateral is a pool of debt obligations
Collateralized debt obligation
Used when the outcome of the project cannot be reliably estimated; revenue and expenses are recognized only when the contract is complete
Completed contract method
More consumption is preferred to less consumption of a good
Condition of non-satiation
Capital account
Consists of capital transfers and the acquisition and disposal of non- produced, non-financial assets
If demand is less elastic than supply, who will bear a higher proportion of a tax, consumers or suppliers?
Consumers
If there is little or no convenience yield, futures prices will be higher than spot prices
Contango
Markets where trades occur at any time the market is open (i.e. they do not need to be open 24 hours per day)
Continuous markets
The risk that prepayments will be more rapid (slower) than expected
Contraction (extension) risk
The value of having the physical commodity for use over the period of the futures contract; non-monetary benefits of holding an asset
Convenience yield
Cost of trade credit
Cost of trade credit = [1 + (% discount / 1 - % discount)]^365/days past discount - 1
An increase in the price of productive inputs
Cost-push inflation
A company issued a bond with a face value of $67,831, maturity of 4 years, and 7% annual-pay coupon, while the market interest rates are 8%. What is the unamortized discount when the bonds are issued?
Coupon payment = ($67,831)(0.07) = $4,748.17. Present value of bond: FV = $67,831, N = 4, I = 8, PMT = $4,748.17, CPT PV = $65,584.35. Discount = $67,831 - $65,584.35 = $2,246.65.
Buying a stock and writing a call option on that stock
Covered call
You feel the stock's price will not go up any time soon, and you want to increase your income by collecting the call option premium
Covered call
The decrease in production and trade as a result of a tax
Deadweight loss
Date the BOD approves payment of the dividend
Declaration date
Industry stage: negative growth; declining prices; consolidation
Decline stage
The slope of the efficient frontier increases or decreases as one moves up the curve?
Decreases steadily
Defensive interval ratio
Defensive interval ratio = (cash + marketable securities + receivables) / average daily expenditures
TI > PTI
Deferred tax asset; a deferred tax asset is created when warranty expenses are accrued on the financial statements but are not deductible on the tax returns until the warranty claims are paid
Tax expense > taxes payable
Deferred tax liability
DJIA is considered what type of variable
Discrete random variable
Option adjusted spread < zero-volatility spread
Embedded option has a negative value to the bondholder (i.e. bond is likely callable)
Supplying capital to companies that are just moving into operation, but do not as yet have a product or service available to sell, is a description that best relates to which of the following stages of venture capital investing?
Early stage
Changes in a fixed-coupon bond's cash flows associated with changes in yield would be reflected in the bond's...
Effective duration; effective duration and effective convexity capture the effects from changes in a bond's cash flows when the yield changes. For this reason, they are the appropriate measures of interest rate sensitivity for bonds with embedded options
Point of maximum total revenue (in terms of elasticity)
Elasticity = -1 (point of unit elastic demand)
Significance of a test
Equals probability of a Type I error
Asset beta formula
Equity beta / [1 + (1 - tax) (D / E)]
Bond that is issued outside the jurisdiction of any one country and denominated in a currency different from the currency of the countries in which they are sold
Eurobond
First day a share of stock trades without the dividend; occurs 2 days before the holder-of-record date
Ex-dividend date (if you buy the share on or after the ex-dividend date, you will not receive the dividend)
Includes limit orders and market orders, as well as instructions regarding trade size and visibility
Execution instructions
Unbiased estimator
Expected value of the sampling distribtion is equal to the true value of the population parameter
Common-size for cash flow statement items
Express each line item as a percentage of total revenue or each inflow of cash as a percentage of total cash inflows and each outflow as a percentage of total cash outflows
Examples include: (1) surety bonds; (2) bank guarantees; (3) letters of credit from financial institutions
External credit enhancements
A material transaction or event that is BOTH unusual and infrequent in occurrence (reported after tax and income from continuing operations; not used by IFRS)
Extraordinary items
What is the test statistic for the equality of two variances (from two normally distributed and independent populations)?
F-statistic
FIFO COGS
FIFO COGS = LIFO COGS - change in LIFO reserve
A combination of a call with exercise price X and a pure-discount, risk-less bond that pays X at maturity (option expiration)
Fiduciary call
Financial leverage
Financial leverage = average total assets / average total equity
Discrete uniform random variable
Finite set of possible outcomes with an equal probability
It will cost $20,000 a year for four years when an 8-year old child is ready for college. How much should be invested today if the child will make the first of four annual withdrawals 10-years from today? The expected rate of return is 8%.
First, find the present value of the college costs as of the end of year 9. (Remember that the PV of an ordinary annuity is as of time = 0. If the first payment is in year 10, then the present value of the annuity is indexed to the end of year 9). N = 4; I/Y = 8; PMT = 20,000; CPT → PV = $66,242.54. Second, find the present value of this single sum: N = 9; I/Y = 8; FV = 66,242.54; PMT = 0; CPT → PV = 33,137.76.
Fixed charge coverage
Fixed charge coverage = (EBIT + lease payments) / (interest payments + lease payments)
Bond issued by a firm incorporated in a foreign country that trade on the national bond market of another country in that country's currency
Foreign bond (panda bonds = trade in yuan in China, Yankee bonds = trade in dollars in US)
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
Form 144
Statement filed with the SEC when a company prepares a proxy statement for its shareholders prior to the annual meeting or other shareholder vote
Form DEF-14A
A derivative contract that has a future interest rate, rather than an asset, as its underlying
Forward rate agreement; point is to lock in a certain interest rate for borrowing or lending at some future date
Free cash flow to the firm
Free cash flow to the firm = net income + noncash charges + [interest expense x (1 - tax)] - net capital expenditures - working capital
Futures price formula
Futures price = spot price x (1 + risk-free rate) + storage costs - convenience yield
Unsecured bonds backed by the full faith credit of the issuing governmental entity, which is to say they are supported by its taxing power
General obligation bonds
Time-weighted return
Geometrically linked subperiod returns
Inferior goods for which the quantity demanded decreases when the price decreases, because the negative income effect is larger than the positive substitution effect
Giffen goods
Issued outside of the United States and the issuer's home country (denominated in USD)
Global depository receipts
Portfolio on the efficient frontier that has the least risk
Global minimum variance portfolio
Two assumptions of financial statements, according to the IASB framework
Going concern and accrual accounting
Date on which the shareholders of record are designated to receive the dividend
Holder of record date
A hedge fund charges an incentive fee only on the portion of returns that exceed a stated benchmark
Hard hurdle rate
Yield spreads relative to interest rate swaps (same currency and tenor)
I-spread (interpolated)
Money-weighted return
IRR of the portfolio
Defines the obligations of and restrictions on the borrower and forms the basis for all future transactions between the bondholder and the issuer
Identure
Graphics, Inc. has a deferred tax asset of $4,000,000 on its books. As of December 31, it became more likely than not that $2,000,000 of the asset's value may never be realized because of the uncertainty of future income. Graphics, Inc. should:
If it becomes more likely than not that deferred tax assets will not be fully realized, a valuation allowance that reduces the asset and also reduces income from continuing operations should be established.
Income tax expense
Income tax expense = taxes payables + ∆DTL - ∆DTA
If the limit price is between the best bid and the best ask
Inside the market (making a new market)
Examples include: (1) over-collateralization; (2) cash reserve fund; (3) excess spread account; (4) divide bond into tranches
Internal credit enhancements
Optimal capital budget
Intersection between upward sloping marginal cost of capital curve and downward sloping investment opportunity schedule
The maximum of zero and the amount that the option is in the money
Intrinsic value of an option
Inventory FIFO
Inventory LIFO + LIFO reserve
Graph of the effect of currency depreciation on the trade balance over time
J-curve (in the short run, a trade deficit may increase because current import and export contracts may be fixed in foreign currency units over the near term, and only reflect the exchange rate change over time. In the long run, currency depreciation should decrease a trade deficit)
Probability that two events will both occur
Joint probability
Aggregate demand can be increased through monetary policy (increasing the money supply) or through fiscal policy (increasing government spending, decreasing taxes, or both).
Keynesian economists
Kurtosis for a normal distribution
Kurtosis = 3. Excess kurtosis > 3 and indicates a leptokurtic distribution
FIFO after-tax profit
LIFO after-tax profit + (change in LIFO reserve)(1 − t)
Factors that are considered variable in the short run
Labor and raw materials
Consistent estimator
Larger sample sizes tend to produce more accurate estimates
Total cash flows to investors in an ABS issue are greater, less than or equal to the total interest and principal payments from the underlying asset pool?
Less than; cash flows from the underlying asset pool are used to pay fees to the servicer as well as payments to the ABS investors. Thus payments to investors are less than the total cash flows from the pool of assets
A minimum execution price on sell orders and a maximum execution price on buy orders
Limit order
Analysts often wish to address whether a sample is truly random or whether the data have a pattern indicating that it is not random (tested with the so-called "runs test")
Nonparametric test
Reinvestment risk > market price risk
Long time horizon
A putable bond must offer a lower or higher yield than an otherwise identical non-callable bond?
Lower yield (so the bond sells at a higher price)
Quantile formula
Ly = [(n + 1) x y / 100]
Marginal product and average product
MP intersects the AP maximum from above. MP is initially greater than average product, and then MP and AP intersect. Beyond this intersection, MP is less than AP.
The weighted-average time to the receipt of principal and interest payments, rather than our best estimate of interest rate sensitivity
Macaulay duration
Duration gap
Macaulay duration - investment horizon (a positive duration gap exposes the investor to market price risk from increasing interest rates; a negative duration gap exposes the investor to reinvestment risk from decreasing interest rates)
Modified duration
Macaulay duration / (1 + YTM)
An investor made an investment in a hedge fund at the beginning of the year, when the NAV was 80 million. The NAV after fees for Year 1 was 75 million. For Year 2, the end-of-year value before fees is 90 million. The fund has a 2 and 20 fee structure. Management fees are paid independently of incentive fees and are calculated on end-of-year values. Incentive fees are calculated using a high water mark and a soft hurdle rate of 2%. Total fees paid for Year 2 are:
Management fee = 90 million × 0.02 = 1.8 million. Gross return = (90 / 75) − 1 = 20.0%. The soft hurdle rate was exceeded. Because of the high water mark, incentive fees are paid only on the increase in NAV above the previous year-end NAV after fees of 80 million. Incentive fee = (90 million − 80 million) × 0.20 = 2.0 million. Total fee: 1.8 million + 2.0 million = 3.8 million. Note that the new high water mark is 90 million - 3.8 million = 86.2 million.
In which of the following situations is management most likely to make conservative choices and estimates that reduce the quality of financial reports?
Management might be motivated to "manage earnings" by making conservative choices and estimates in periods when earnings are higher than expected, delaying recognition of some of these earnings to later periods
The additional output that results from employing one more unit of a productive input
Marginal product
The addition to total revenue from selling the additional output that one more unit of an input can produce
Marginal revenue product
Instructs the broker to execute the trade immediately at the best possible price
Market order
Depreciation or devaluation of a currency is more likely to narrow a country's trade deficit if domestic demand for imports and foreign demand for the country's exports are more elastic
Marshall-Lerner condition
Expenses incurred to generate revenue are recognized in the same time period as the revenue
Matching principle
Industry stage: slow growth; consolidation; high barriers to entry; stable pricing; superior firms gain market share
Mature stage
Profitability Index > 1
NPV must be positive and IRR must be greater than the discount rate
A single firm within an industry that has sufficient capacity to meet the entire demand of an industry because at that scale the lowest average total cost is achieved
Natural monopoly
Examples include: (1) prohibitions on the borrower; (2) restrictions on asset sales, additional borrowings
Negative covenants
Shifts in both aggregate demand and aggregate supply are primarily driven by changes in technology over time
Neoclassical economists
An approximate percentage change in a bond's price for a 1% change in yield to maturity
Modified duration; modified duration is a linear estimate of the relation between a bond's price and YTM, whereas the actual relation is convex, not linear
The main factor leading to business cycles and deviations from full-employment equilibrium is monetary policy
Monetarists
The price of a bond with a longer maturity is more or less sensitive to a change in yield than is the price of a bond with a shorter maturity?
More sensitive
What type of distribution describes the relationship between two or more random variables, when the behavior of each random variable is dependent on the others in some way?
Multivariate distribution
Additional compensation or benefits for a member's services
Must be reported to the member's employer in writing
Number of ways to assign different labels
N! / (n1! x n2! x nk!)
Number of ways to choose a subset when order doesn't matter
Number combinations = N! / [(N - R)! x R!]
Number of ways to choose a subset when order does matter
Number of permutations = N! / [(N - R)!]
Open-ended funds v. closed-ended funds
Open-end funds redeem existing shares or issue new shares in accordance with investor demand. Closed-end fund shares are fixed in number and trade on exchanges as though they were common stock
The central bank determines the policy rate
Operational independence
Time value (speculative value) of an option
Option premium - intrinsic value
Option premium formula
Option premium = intrinsic value + time value
The yield a bond with an embedded option would have if it were option-free
Option-adjusted yield; for a callable bond, the option-adjusted yield is lower than the YTM. This is because the call option may be exercised by the issuer, rather than the bondholder. Bond investors require a higher yield to invest in a callable bond than they would require on an otherwise identical option-free bond.
A random variable follows a continuous uniform distribution over 27 to 89. What is the probability of an outcome between 34 and 38?
P(34 ≤ X ≤ 38) = (38 − 34) / (89 − 27) = 0.0645 (X2 - X1) / (b - a)
Margin call price
P0 [(1 - initial margin) / (1 - maintenance margin)]
An analyst wants to determine whether the monthly returns on two stocks over the last year were the same or not. What test should she use if she is willing to assume that the returns are normally distributed?
Paired comparisons test
Measures a characteristic of the underlying population
Parameter
Revenue and expense are recognized as the work is performed
Percentage-of-completion method; (total cost incurred to date / total expected cost of the project)
According to the converged standards for revenue recognition issued in May 2014, a promise to transfer a distinct good or service is most accurately described as a:
Performance obligation
An approximation of the price sensitivity of a portfolio to parallel shifts of the yield curve
Portfolio duration
Examples include: (1) ready cash balances (2) short term funds (3) cash flow management
Primary sources of liquidity
Within the Global Investment Performance Standards (GIPS) are supplemental provisions which must be applied to which of the following asset classes?
Private equity, real estate, and wrap fee/separately managed account (SMA) portfolios
A current account deficit will tend to narrow if...
Private savings increase, government savings increase (either taxes increase or government spending decreases), or domestic investment decreases (X - M) = private savings + government savings - investment
The sum of the differences between price and opportunity cost
Producer surplus
A share of stock together with a put option on the stock
Protective put; cuts your downside losses, but leaves the upside potential alone (unlimited upside gains)
Put option - increase in: (1) Price of asset (2) Exercise price (3) Risk-free rate (4) volatility of asset (5) time to expiration (6) costs of holding underlying asset (7) benefits of holding underlying asset
Put Option (1) decrease (2) increase (3) decrease (4) increase (5) increase, except some Euro puts (6) decrease (7) increase
Put Option: (1) max loss (2) max gain
Put Option: (1) buyer (long) = option cost; seller (short) = X - option cost (2) buyer = X - option cost; seller = option cost
Auditor makes any exceptions to the accounting principles and explains the exceptions in the report
Qualified opinion
Foreign exchange buy-side investors that do not use derivatives
Real money accounts; many mutual funds, pension funds, and insurance companies can be classified as real money accounts
The most appropriate measure of the increase in the purchasing power of a portfolio's value over a given span of time is
Real return (adjusted for the effects of inflation and is used to measure the increase in purchasing power over time)
Financial account
Records investment flows
Which of the following is a disadvantage to bondholders if a bond has a sinking fund provision?
Reinvestment risk is a disadvantage of a sinking fund provision. Some bondholders will be repaid the bond principal earlier than the maturity date. If interest rates have declined since they bought the bonds, these bondholders will only be able to reinvest the returned principal at a lower rate of return.
The percentage difference between the market value and the amount loaned
Repo margin (haircut)
The percentage difference between the repurchase price and the amount borrowed.
Repo rate
Repo rate is... (1) Longer repo term (2) Higher credit quality of the collateral security (3) Collateral security is delivered to the lender (4) Interest rates for alternative sources of funds are higher
Repo rate is... (1) Higher (2) Lower (3) Lower (4) Higher
Bonds issued to finance specific projects, such as airports, toll bridges, hospitals, and power generation facilities
Revenue bonds
Analysis based on one or more specific scenarios (a specific set of outcomes for key variables), which include changes in multiple variables
Scenario analysis
The process of allocating firm resources to assets (or investments) by considering their various risk characteristics and how they combine to meet the organization's risk tolerance
Risk budgeting
Allocating the total risk an organization chooses to accept among its various assets, investments, or activities
Risk budgeting; specifying methods for dealing with particular risks (i.e. purchase additional insurance) is typically outside the scope of a risk budgeting process
Changing the distribution of possible outcomes and is accomplished primarily with derivative contracts
Risk shifting
Risk-free rate replication
Risky asset + derivative = risk free rate
Yield due to a difference between the spot price and futures price, or a difference between two futures prices with different expiration dates
Roll yield; roll yield is positive for a market in backwardation and negative for a market in contango
The risk that an issuer who relies on the commercial paper market as a funding source may not be able to issue new commercial paper when an outstanding issue matures
Rollover risk
Security prices rapidly adjust without bias to the arrival of all new public information; current security prices fully reflect all publicly available information; the investor cannot achieve positive risk-adjusted returns on average by using fundamental analysis
Semi-strong form
Analysis based on hypothetical ("what if ") questions about a single variable
Sensitivity analysis
Indicates how to arrange final settlement of the trade
Settlement instruction
Industry stage: slowing growth; intense competition; industry overcapacity; declining profitability; cost cutting; increased failures.
Shakeout stage
Market price risk > reinvestment risk
Short time horizon
Each item in the population has an equal chance of being selected
Simple random sample
The market model of the expected return on a risky security is best described as a...
Single factor model
Type of bond that provide for the repayment of principal through a series of payments over the life of the issue
Sinking fund provisions
A hedge fund charges an incentive fee on all profits, but only if the fund's rate of return exceeds a stated benchmark
Soft hurdle rate
For an investment with negatively skewed returns, the most appropriate of the following risk measures is:
Sortino ratio
The type of equity security that gives its owners the right to vote the shares of, and receive dividends from, a foreign company is best described as a...
Sponsored depository receipt
Who is legally responsible for paying a tax
Statutory tax incidence
Each share held is assigned one vote in the election of each member of the board of directors
Statutory voting system
Stocks plotted above (below) the SML
Stocks above (below) the SML are undervalued (overvalued); the forecasted rate of return is higher (lower) than the required rate of return justified by CAPM
Divide the population into subgroups based on some relevant characteristic(s) and then make random draws from each group
Stratified random sampling
Prices fully reflect all information from both public and private sources; no group of investors has a monopolistic access to information relevant to the formation of prices, and none should be able to consistently achieve positive abnormal returns
Strong form
A debt covenant designates one of a holding company's subsidiaries as restricted. Which of the following credit-related considerations does this covenant address?
Structural subordination; restricted subsidiaries are those whose cash flows and assets are designated to service the debt of their holding company. Classifying a subsidiary as restricted alleviates structural subordination by making holding company debt rank pari passu with the subsidiary's debt.
The collateral is ABS, RMBS, other CDOs, and CMBS
Structured finance CDOs
What is the test statistic used for the equality of the means of two normally distributed independent populations?
T-statistic
Hedge fund returns
Tended to be better than those of global equities in down equity markets and to lag the returns of global equities in up markets
Length of the swap
Tenor
Consider a stock selling for $23 that is expected to increase in price to $27 by the end of the year and pay a $0.50 dividend. If the risk-free rate is 4%, the expected return on the market is 8.5%, and the stock's beta is 1.9, what is the current valuation of the stock? The stock:
The required return based on systematic risk is computed as: ERstock = Rf + (ERM - Rf) × Betastock, or 0.04 + (0.085 - 0.04) × 1.9 = 0.1255, or 12.6%. The expected return is computed as: (P1 - P0 + D1) / P0, or ($27 - $23 + $0.50) / $23 = 0.1957, or 19.6%. The stock is above the security market line ER > RR, so it is undervalued.
Real business cycle theory, which derives from applying utility theory and budget constraints to macroeconomic models, is associated with...
The New Classical School
The average life of an MBS will be more or less than its weighted average maturity.
The average life will be LESS because of prepayments
An investor is considering the purchase of Security X, which matures in ten years and has a par value of $1,000. During the first five years, X has a 6% coupon with quarterly payments. During the remaining five years, X has an 8% coupon with quarterly payments. The face value is paid at maturity. A second 10-year security, Security Z, has a 6% semiannual coupon and is selling at par. Assuming that X has the same bond equivalent yield as Z, the price of Security X is closest to:
The bond equivalent yield rate on the par bond (Z) is 6% or a 3% semiannual rate. The equivalent quarterly rate, 1.031/2 - 1 = 0.014889. Security X makes 20 quarterly payments of $15 and 20 quarterly payments of $20. We need to use the cash flow function as follows: CF0 = 0; CF1 = 15; F1 = 20; CF2 = 20; F2 = 19; CF3 = 1,020; F3 = 1; I = 1.4889; CPT → NPV = $1,067.27. Note that CF3 contains the final quarterly payment of $20 along with the $1,000 face value payment.
Banks are able to borrow from the Fed at what rate?
The discount rate
The one-year spot rate is 6% and the one-year forward rates starting in one, two and three years respectively are 6.5%, 6.8% and 7%. What is the four-year spot rate?
The four-year spot rate is computed as follows: Four-year spot rate = [(1 + 0.06)(1 + 0.065)(1 + 0.068)(1 + 0.07) ]^1/4 - 1 = 6.57%
In a two-asset portfolio, reducing the correlation between the two assets moves the efficient frontier in which direction?
The frontier extends to the left, or northwest quadrant representing a reduction in risk while maintaining or enhancing portfolio returns.
Which is greater: holding period return or continuously compounded return?
The holding period return is always greater than the continuously compounded return that would be required to generate that holding period return
For a continuous uniform distribution...
The probability density function is a horizontal line segment over a range of values such that the area under the segment (total probability of an outcome in the range) equals one
Beta
The risk inherent to the entire market or an entire market segment. Systematic risk, also known as "undiversifiable risk," "volatility" or "market risk," affects the overall market, not just a particular stock or industry.
Unsystematic risk
The risk that is eliminated by diversification
Binomial probability distribution
There are only two possible outcomes of each trial and the outcomes are mutually exclusive. Example of a discrete probability distribution
Binomial outcomes
They take on whole number values that must start at zero up to the upper limit n.
Parsons Inc. is issuing an annual-pay bond that will pay no coupon for the first five years and then pay a 10% coupon for the remaining five years to maturity. The 10% coupon interest for the first five years will all be paid (without additional interest) at maturity. If the annual YTM on this bond is 10%, the price of the bond per $1,000 of face value is closest to:
This bond has no cash flows for the first five years. It then has a $100 cash flow for years 6 through 10. Additionally, the accrued interest ($500) that wasn't paid in the first five years would have to be paid at the end, along with the principal. A financial calculator using the CF/NPV worksheet can handle this type of problem. The required inputs are CF0 = 0, CF1 = 0, F1 = 5, CF2 = 100, F2 = 4, CF3 = 1,600, F3 = 1, NPV, I = 10%, CPT = 813.69. Note that CF3 is made up of the principal ($1,000) plus the remaining $100 coupon plus the accrued interest ($500) that was not paid during the first five years of the bond's life.
Ex dividend date
Two business days prior to the date of record; the date when the shares can be purchased without the dividend
Debentures
US = unsecured debt; Great Britain = bonds collateralized by specific assets
The probability of an event occurring regardless of past or future events
Unconditional probability
Rowlin Corporation, which reports under IFRS, wrote down its inventory of electronic parts last period from its original cost of 28,000 to net realizable value of 25,000. This period, inventory at net realizable value has increased to 30,000. Rowlin should revalue this inventory to:
Under IFRS, inventory values are revalued upward only to the extent they were previously written down. In this case, that is from €25,000 back up to the original value of €28,000. The increase is reported as gain for the period.
Auditor believes the statements are free from material omissions and errors
Unqualified opinion
Which risk disappears in the portfolio construction process?
Unsystematic risk (diversifiable risk) is the risk that is eliminated when the investor builds a well-diversified portfolio.
Indicates when an order may be filled
Validity instruction
Goods for which the quantity demand increases when the price increases, such as a high-status good for which the consumer gains utility from being seen to consume the good
Veblen goods
A second-price sealed bid auction, in which the winner pays the price bid by the second highest bidder
Vickrey Auction
Current security prices fully reflect all currently available security market data; an investor cannot achieve positive risk-adjusted returns on average by using technical analysis
Weak form
Look-ahead bias
When the analyst uses historical data that was not publicly available at the time being studied
Efficient estimator
While there are many unbiased estimators of the same parameter, the most efficient has a sampling distribution with the smallest variance
The lowest of yield-to-maturity and the various yields-to-call
Yield-to-worst
The spread the investor would capture over the entire Treasury spot- rate curve if the bond was held to maturity
Z-spread
Net increase in common shares
[(average market price - exercise price of the options or warrants) / average market price] x number of common shares the options can be converted into
Money market yield
[(face value - price) / price] x (360 / days)
Bond equivalent yield
[(face value - price) / price] x (365 / days)
Put-call forward parity
[C + X / (1 + Rf)^T] = [P + F0 / (1 + Rf)^T]
Put-call parity
[C + X / (1 + Rf)^T] = [S + P]
A positive (negative) roll yield results from...
a backwardated (contango) market
The LM (IS) curve illustrates...
a positive (negative) relationship between real income and the real interest rate
A covered call position is equivalent to:
a short put (a covered call is a stock + a short call)
A putable bond is made up of...
a straight bond and a long put option; an increase in volatility increases the value of the put option and therefore increases the value of the putable bond
A callable bond is made up of...
a straight bond and a written call option; an increase in volatility increases the value of the call option and decreases the value of the callable bond
Average age of a depreciated asset
accumulated depreciation / annual depreciation expense
Order to be executed only if the whole order can be filled
all-or-nothing order
Current yield
annual cash coupon payment / bond price
Statements required under IAS No. 1
balance sheet, income statement, cash flows, change in owner's equity, explanatory notes
A buy order with a limit price below the best bid, or a sell order with a limit price above the best ask; it will likely not execute until security prices moved toward the limit price
behind the market
Market structure: investors use brokers to locate a counterparty to a trade
brokered market
Impaired asset
carrying value (original cost - accumulated depreciation) > recoverable amount recoverable amount is the greater of an assets fair value less any selling costs and its value in use value in use = PV of the assets future cash flow stream from continued use
Effective annual rate based on continuous compounding
e^R - 1
Accrued interest formula
coupon payment x (t / T) t = number of days from the last coupon payment date until the date the bond trade will settle T = number of days between the last coupon payment and the next
Beta formula
covariance of Asset i's return with the market return / variance of the market return
Expected loss
default risk x loss severity
portfolio's standard deviation of returns / average standard deviation of returns of the individual securities in the portfolio
diversification ratio
The demand for a product tends to be price inelastic if:
few good substitutes for the product are available
Growth in potential GDP formula
growth = growth in labor force + growth in labor productivity
A 5-year bond with a 10% coupon has a present yield to maturity of 8%. If interest rates remain constant one year from now, the price of the bond will be:
higher;a premium bond sells at more than face value, thus as time passes the bond value will converge upon the face value
A firm with earnings per share of $2 decides to repurchase a portion of its shares at their market price of $25. The firm's after-tax cost of debt is 6% and the firm earns a 2% after-tax yield on its excess cash. When the firm repurchases shares, its earnings per share will:
increase if the firm funds the repurchase with debt or uses excess cash to repurchase the shares; the earnings yield on the firm's shares is $2 / $25 = 8%. Because both the firm's after-tax yield on excess cash and its after-tax cost of borrowing are less than the earnings yield, financing a share repurchase either with excess cash or with debt will increase earnings per share
Carol Hull, CFA, is an investment advisor whose prospective client, Frank Peters, presents special requirements. To construct an investment policy statement for Peters, Hull inquires about Peters' investment experience, risk and return objectives, and financial constraints. Peters states that he has a great deal of investment experience in the capital markets and does not wish to answer questions about his tolerance for risk or his other holdings. Under Standard III(C), Suitability, Hull:
is permitted to manage Peters' account without any knowledge of his risk preferences.
Continuously compounded rate of return formula
ln(1 + HPR)
Continuously compounded rate of return
ln(S1 / S0) = ln (1 + HPR) = R
Asset-based valuation approach
market value of assets - market value of liabilities
Three factors of the Fama and French model
market-to-book, firm size, and excess returns on the market (Carhart added a momentum factor based on prior relative price performance)
Interpolate formula
n1 + [(1 - decile) (n2 - n1)]
Real exchange rate (D/F)
nominal exchange rate (D/F) x (CPI F)/(CPI D)
The "up-move factor" in a binomial tree is best described as...
one plus the percentage change in the variable when it increases
Market structure: rules are used to match buyers and sellers
order-driven market
Portfolios below the SML
overvalued because the required return > expected return
Balloon risk
possibility that a commercial mortgage borrower will not be able to refinance the principal that is due at the maturity date of the mortgage; extension risk for CMBS's
Market structure: investors trade with dealers
quote-driven market
The type of technical analysis chart most likely to be useful for intermarket analysis is a...
relative strength chart; relative strength charts display the price of an asset relative to the price of another asset or benchmark over time and this type of chart is useful for demonstrating whether one asset class or market has outperformed or underperformed another
Important points in an IPS are R-R-T-T-L-L-U
risk, return, time horizon, tax situation, liquidity, legal restraints, and unique constraints of a specific investor
Business risk is the combination of...
sales risk, which is the variability of a firm's sales, and operating risk, which is the additional variability in operating earnings (EBIT) caused by fixed operating costs
Coefficient of variation
standard deviation / mean
Zero-volatility spreads adjust for the fact that nominal spreads (between the yields to maturity of two bonds) are theoretically correct only when...
the spot yield curve is flat; zero-volatility spreads are nearly identical to their government spreads
Option-adjusted spread
the spread to the government spot rate curve that the bond would have if it were option-free = Z-spread - option value
This amount by which an option's price is greater than its exercise value is referred to...
time value
Option premium =
time value + intrinsic value
An increase in the real money supply from an initial equilibrium situation will cause households and businesses...
to purchase interestbearing securities
Neutral interest rate
trend rate of real economic growth + target inflation rate
G-spread
yield spread over a government bond = YTM_Bond - YTM_Treasury