See You Soon

QUANTITATIVE METHODS

The real risk-free interest rate represents time preference.

In hypothesis testing, the critical value is determined by the level of significance.

 

ECONOMICS

In geopolitics, cabotage is best described as a multi-tool approach.

In a perfectly competitive market, a firm’s breakeven point in the minimum point of average total cost curve.

With respect to the monetary transmission mechanism, a central bank's policy rate is initially transmitted through the economy via asset prices.

CORPORATE ISSUERS

Enterprise value is most useful when comparing companies with significant differences in capital structure.

Target capital structure is often expressed using book values of equity and debt because capital structure policy is aligned to measures used by third parties.

An increase in utility for a company's products as these products become more widely adopted best describes network effects.

Reduction in a line of credit is considered a pull on liquidity.

 

FINANCIAL STATEMENT ANALYSIS

Deferred tax assets could arise when an asset’s tax base exceed its carrying amount.

A motivation for leasing long term rather than purchasing a high value asset reduced exposure to obsolescence risk.

Under IFRS, there is a single accounting model for both finance and operating leases for lessees.

ROE = ROA*Leverage

Leverage = Average Total Assets / Average Shareholder’s Equity

A signal for manipulation of financial reporting is a history of large expense items classified unusual.

Under US GAAP, purchasing trading securities is classified as an operating activity on the statement of cash flows.

A company is prohibited from reversing the impairment loss on a long-lived asset classified as held for use under US GAAP.

The cost of Bonds most likely requires adjustment for taxes in the calculation of a firm's weighted average cost of capital.

The static trade-off theory of capital structure most likely considers the tax shield provided by debt.

Under the revaluation model, an initial revaluation that increases the carrying value of an asset most likely results in a lower financial leverage ratio.

Costs incurred during the development phase that are related to internally generated, identifiable intangible assets can be capitalized if certain criteria are met.

If inventory that was written down in a previous reporting period subsequently increases in value, the amount of the original write-down can be reversed under IFRS only.

In the year of a change in accounting policy, comparability of the presented financial statements is best with retrospective application.

Deductible temporary differences could arise when taxable income exceeds accounting profit.

An impairment loss on equipment will most likely decrease net profit margin.

Ending retained earning = before retained earnings + net income – dividends.

Cash paid to suppliers = Purchase from suppliers – increase in account payable.

Purchase from suppliers = Cost of goods sold – decrease in inventory.

Fixed charged coverage ratio = (EBIT + Lease payments) / (Interest payments + Lease payments)

The free-cash-flow-to-equity model can be used to value non-dividend paying stocks.

 

EQUITY

Private equity funds invest both in privately held and in publicly traded companies.

A callable bond exhibits negative convexity.

A security's market value and intrinsic value are most likely the same if the market is efficient.

Equal-weighted index requires frequent rebalancing to adjust for price changes.

Callable bond is most likely has the lowest price.

Using the one-period binomial option pricing model, the value of an option will be affected by the volatility of the underlying.

Securities dealers most likely provide liquidity.

A company's cost of equity is a proxy for the minimum required rate of return of investors in the company's equity.

The constituent securities of equity indexes are liquid than fixed-income indexes.

An analyst will most likely put a sell recommendation on a stock when its market value is higher than intrinsic value.

All else being equal, a cash dividend most likely has the same effect on shareholders' wealth as a share repurchase.

According to put-call-forward parity, a long put and a short call is equal to a long bond and a short forward.

Prior to expiration, an at-the-money option most likely trades above intrinsic value.

 

FIXED INCOME

For an option-free bond, effective duration will be equal to modified duration if the yield curve is absolutely flat.

The underlying assets of an asset-backed security are directly owned by the special purpose vehicle.

Analytical duration assumes that government bond yields and spreads are independent variables.

The effective convexity of a bond is a measurement of the effect of a change in a benchmark yield curve.

A bond's price sensitivity to a non-parallel shift in the benchmark yield curve is best measured by key rate duration.

Credit card backed security utilizes credit tranching as a form of credit enhancement.

A Eurodollar bond is denominated in USD.

Revenue bond has the greatest risk of default.

US commercial paper typically requires the issuer to have a backup line of credit.

DERIVATIVES

At initiation, the price of a forward contract is most likely greater than the value of the forward contract.

An American waterfall is more advantageous to the general partner.

In an efficient market, it is more likely that fundamental value will be reflected in the derivatives market before the underlying spot market.

 

ALTERNATIVE INVESTMENTS

Sponsored depository receipts are most likely subject to greater reporting requirements than unsponsored ones.

Arbitrage is best described as an opportunity to earn risk-free returns with no investment capital.

Management fees for private equity funds are most likely based on committed capital.

Funds of hedge funds provides the greatest redemption flexibility.

The earnings multiplier for a stock increases with a decrease in the estimated required rate of return on equity.

A benefit of risk budgeting is that it forces risk trade-offs.

 

PORTFOLIO MANAGEMENT

The capital allocation line is best described as combinations of a risky portfolio and the risk-free asset.

The two-fund separation theorem states that all investors will hold a combination of the risk-free asset and the optimal risky portfolio.

Cross-default provision can result in different rating for parent company and subsidiary.

A life cycle fund will most likely change the asset allocation as the fund nears its target date.

With respect to the capital market line, the market portfolio is best described as the optimal risky portfolio.

During times of severe market turmoil, the risk reduction from portfolio diversification most likely decreases.

Beta accounts for most of the long-term changes in a portfolio's value.

The CAPM states that two assets with the same expected return will have the same covariance of returns with the market.

The Markowitz efficient frontier is above the global minimum-variance portfolio.

ETHICS

M&C can criticize CFA institute on online forums.

Once violation is discovered, a supervisor should increase supervision or place limitation on wrongdoer pending the outcome of the investigation.

M&C who manages pooled assets to a specific mandate are not responsible for determining the suitability of the fund. Index fund>only required to invest in manner consistent with stated mandate.

An analyst can disassociate a third party members opinion from the report.

Different service levels should not be offered selectively and should be available to everyone.

M&C can inform his clients that he is leaving the company for some negative reasons but can’t make disparaging statements about the company.

M&C can enter into independent business line while employed.

A firm is allowed to state that performance is calculated in accordance with the GIPS standards when presenting a segregated account return to the account owner.

 

 -----

QUANTITATIVE METHODS

Rates and Returns

Geometric mean return (time-weighted return) is the most appropriate method for performance measurement.

Effective annual rate = er – 1.

The continuously compounded rate of return = ln(S1/S0)

Continuously compounded rate of return = ln(1 + r)

As long as there is variability in the data, the arithmetic mean is greater than geometric mean, which is greater than the harmonic mean.

The real risk-free interest rate represents time preference.

The real risk-free rate can be thought of as approximately the nominal risk-free rate reduced by the expected inflation rate.

The money-weighted return is the internal rate of return on a portfolio that equates the present value of inflows and outflows over a period of time.

Time-weighted returns are not affected by the timing of cash flows. Money-weighted returns, by contrast, will be higher when funds are added at a favorable investment period.

The net return on a portfolio is its gross return minus management and administrative fees.

T-bill yields can be thought of as nominal risk-free rates because they contain an inflation premium.

A real return is adjusted for the effects of inflation and is used to measure the increase in purchasing power over time.

Statistical Measures of Asset Returns

Coefficient of variation, CV = standard deviation / mean

For a unimodal distribution with negative skewness the median is greater than the mean.

A leptokurtic distribution has fatter tails than a normal distribution.

The degree to which a distribution is not symmetric about its mean is measured by skewness.

Simulation Methods

With bootstrap resampling, the samples pulled from the full dataset are all the same size. Partial datasets are not used.

For any random variable that is lognormally distributed, its natural logarithm (ln) will be normally distributed.

Monte Carlo simulation is necessary to approximate solutions to complex problems.

Estimation and Inference

The central limit theorem concerns the sampling distribution of the sample mean.

The jackknife technique involves calculating the standard deviation of the means from samples.

Stratified sampling is most often used for bond portfolios.

Hypothesis Testing

The Type II error is the error of failing to reject a null hypothesis that is not true. The chance of making a Type II error is called beta risk.

The probability of a Type I error is equal to the significance level of the test.

The power of the test is the probability of rejecting a false null hypothesis.

A chi-square test is a hypothesis test used to assess the value of a population variance.

Simple Linear Regression

The estimated slope coefficient in a simple linear regression is the ratio of the covariance of the regression variables to the variance of the independent variable.

The coefficient of determination for a linear regression is best described as the percentage of the variation in the dependent variable explained by the  variation of the independent variable.

FINANCIAL STATEMENT ANALYSIS

Analyzing Balance Sheet

Under U.S. GAAP, unrealized gains and losses on trading securities are recognized in the income statement.

U.S. GAAP requires equity securities to be classified as trading securities.

Goodwill is subjective and should be removed from the balance sheet for analytical purposes. Even though goodwill is not amortized, it can impact the income statement if it is impaired.

Derivatives can be financial assets or liabilities and are recognized at fair value on the balance sheet.

The carrying value considers both the past acquisition cost and the future expected performance.

Overvaluing the identifiable assets will lead to higher depreciation and lower net income.

Under U.S. GAAP, unrealized gains and losses on available-for-sale securities are recognized in other comprehensive income.

IFRS permits companies to report its value using the revaluation model.

U.S. GAAP requires the cost model for purchased intangible assets.

Bank loans will most likely be issued at face value and reported on the balance sheet at the same amount. If a bond is issued at a premium or discount to par, it will be held at amortized cost.

Trading securities are measured at fair value through profit and loss under both U.S. GAAP and IFRS.

Analyzing Statements of Cash Flows I

Income Statement: Reflects revenue when earned, not when cash is collected.

Cash Flow Statement: Reflects cash receipts when collected, not when revenue was earned.

CFO is calculated from net income and from changes in the current assets and current liabilities.

CFI is calculated from changes in non-current assets.

CFF is calculated from changes in non-current liabilities and equity.

Net income is the first figure under the indirect method, but it is not a part of the statement of cash flows under the direct method.

Indirect method, depreciation must be added to net income, because it is a non-cash expense.

An increase in an asset is a use of cash (-ve adjustment).

An increase in a liability is a source of cash (+ve adjustment).

Analysis of Income Taxes

Accounting profit is usually calculated using straight line depreciation, while taxable income is usually calculated using accelerated depreciation.

Deferred tax assets are created when income tax payable is greater than income tax expense. It decreases future taxes.

Deferred tax liabilities are created when income tax expense is greater than income tax payable. It increases future taxes.

Temporary difference is a difference between the tax base and carrying amount of assets and liabilities.

Permanent difference is a difference between taxable income and pre-tax income.

Statutory tax rate: The tax rate established by law.

Effective tax rate: Tax amount reported on the income-tax statement divided by the pre-tax income.

Cash tax rate: Tax actually paid divided by pre-tax income.

If deferred tax liabilities are expected to reverse in the future they can be classified as liabilities. If they are not expected to reverse in future, they can be classified as equity.

Under IFRS, public and private companies must reconcile. However, under GAAP only public companies are required to reconcile.

EQUITIES

Market Organization and Structure

The short seller must pay all dividends due to the lender of the shorted stock.

An investor sells a stock short to protect against a large loss on this position, the investor is most likely to place a stop buy order.

Stop loss sell orders are placed to protect the gains on a long position.

The short seller cannot withdraw the proceeds of the short sale.

Call markets are markets in which the stock is only traded at specific times.

Continuous markets are markets where trades occur at any time the market is open.

The day order instruction is most accurately referred to as a validity instruction.

A buy limit order is said to be "inside the market" when the limit is between the best bid and the best ask.

A limit order to buy is placed below the current market price.

A limit order to sell is placed above the current market price.

A stop (loss) order to buy is placed above the current market price.

A stop (loss) order to sell is placed below the current market price.

A stop order becomes a market order if the price is hit.

Security Market Indexes

The type of index weighting that produces a portfolio similar to that of a momentum strategy is based on market capitalization.

Creating a bond market index is more difficult than constructing a stock market index due to lack of continuous trade data for bonds.

Most hedge fund indexes are equal-weighted. Equity and fixed income indexes are predominately market capitalization weighted.

Market Efficiency

A portfolio manager should quantify each client's risk tolerance and communicate portfolio policies and strategies.

An efficient capital market would price Hume's stock based on the expectation for earnings per share. Since actual earnings equal expected earnings, the stock price should not change as a result of the announcement.

Tests of the semi-strong form of the EMH require that security returns be risk-adjusted using a market model.

Market efficiency does not assumes that individual market participants correctly estimate asset prices.

Low returns over a three-year period are followed by high returns over the following three years.

Overview of Equity Securities

Equity securities are typically issued to finance a firm's long-lived assets, such as equipment, and long-term projects such as research and development.

An increase in book value of equity may or may not increase the market value of equity.

Common stock is more risky than preferred stock and is expected to provide higher average returns.

Company Analysis Past and Present

In assessing a company's uses of capital, an analyst may look at treasury stock purchases and principal payments on debt.

During a period of increasing sales, compared to firms with lower operating leverage, earnings growth for firms with high operating leverage will be higher.

Company research report front matter section of a incules info like: A target buy price of $12 per share.

 

Company Analysis Forecasting

Contingent gains (e.g., those stemming from lawsuits) are not recorded on the financial statements until they have occurred.

In forecasting revenue, an analyst will look to exclude nonrecurring items because they are not deemed to be sustainable going forward. Gains due to the remeasurement of subsidiary financial statements result from exchange rate changes, and those are not predictable.

In an effort to show better actual results than estimated, management will often project lower revenue growth and higher operating expense growth.

A new debt issuance will increase the amount of debt for a company, with no change to equity. The debt-to-equity ratio, therefore, will increase, which is an increase in financial leverage.

Maintenance-related capital expenditures are typically forecasted to grow by the inflation rate.

 

FIXED INCOME

Fixes-Income Cash Flows and Types

The interest rate cap benefits the borrower who issues a floating rate bond.

Fixed-Income Markets for Corporate Issuers

Reduced rollover risk resulting from standardization is a benefit to investment grade.

Fixed-Income Markets for Government Issuers

The cutoff yield a of the successful competitive bid with the lowest price.

Credit Risk

If economic expansion is expected, purchase corporate bonds and sell Treasury bonds.

Market liquidity risk is the risk of receiving less than market value when selling a bond.

Fixed-Income Securitization

Securitization improves the legal claims of the security holders to the loans that are securitized.

Total cash flows to investors in an ABS issue are less than the total interest and principal payments from the underlying asset pool.

Asset-Backed Security (ABS) Instrument and Market Features

In a structured finance CDO the collateral is a pool of mortgage-backed securities, asset-backed securities, or other CDOs.

Mortgage-Backed Security (MBS) Instrument and Market Features

The pool of loans backing a commercial mortgage-backed security consists of nonrecourse loans only.

 

DERIVATIVES

Forward Commitment and Contingent Claim Features and Instruments

At expiration, the value of a European call option is equal to its intrinsic value.

The settlement price for a futures contract is an average of the trade prices over a period at the end of a trading session.

 

Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives

The calculation of derivatives values is based on an assumption that arbitrage opportunities are exploited rapidly.

Holding costs and benefits have no effect on the value of a forward contract at expiration.

Pricing and Valuation of Forward Contracts and for an Underlying with Varying Maturities

The value of a forward or futures contract is typically zero at initiation.

The most likely use of a forward rate agreement is to lock in an interest rate for future borrowing or lending. An FRA is a forward commitment rather than a contingent claim.

 

ALTERNATIVE INVESTMENTS

Natural Resources

When the benefit of holding a commodity exceeds the carrying cost, the yield curve experiences backwardation.

If a commodity's convenience yield is close to zero, the futures market for that commodity is most likely in contango.

Farmland provides the steadiest cash flows compared to timberland and raw land.

The convenience yield of a commodity is a benefit that reduces the forward price.

Hedge Funds

Survivorship bias eliminates funds that no longer report, meaning that unsuccessful funds that have stopped reporting are not represented in the index performance.

Backfill bias includes new funds after they have successful performance to report. As a result, survivorship and backfill bias can lead to overestimating performance.

Selection bias is likely to result in a misallocation of funds to an index for a particular strategy but is less likely to result in an overestimation of performance compared to survivorship and backfill bias.

The terms of a hedge fund are least likely to be stated in a side letter.

The lower the coefficient of variation, the greater the return for the same level of risk.

Digital Assets

Two major risks of direct investment in a large cryptocurrency are fraud and loss of access.

 

PORTFOLIO MANAGEMENT

Portfolio Risk and Return Part I

The optimal portfolio for each investor is the highest indifference and utility curve that is tangent to the efficient frontier.

There are benefits to diversification as long as the correlation coefficient between the assets is less than 1.

Portfolio Risk and Return Part II

The market portfolio has to contain all the stocks, bonds, and risky assets in existence.

Portfolio Management An Overview

Venture capital fund is least likely to employ large amounts of leverage.

A multi-boutique firm is a holding company that includes a number of different specialist asset managers.

Passive management’s share of industry revenues is smaller than its share of assets under management.

Identification of the client's benchmark would be established in the planning step.

Basics of Portfolio Planning and Construction

A broad market index is an inappropriate benchmark for a portfolio that uses negative screening to address the investor’s ESG concerns.

An IPS does not necessarily, or even typically, require a target return figure.

Tactical asset allocation refers to deviating from a portfolio's target asset allocation weights in the short term.

An asset class should be specified by type of security (e.g., stocks, bonds, alternative assets, cash) and can then be further subdivided by region or industry classification.