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Cfa l3 Notes 3

Cfa l3 Notes 3

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Published by: everest8848 on Jan 20, 2010
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12/13/2012

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READING 32 (INT’L EQUITY BENCHMARKS)
LOS32a.
Discuss the need for float adjustment in the construction of internationalequity benchmarks;
Why do we need float adjustments?High weights of some companies as a result of cross holdings with other companies andhigh PE multiples.When a benchmark index is either very easy or very difficult for a large proportion of managers to beat, something is probably wrong with the benchmark.No international equity benchmark uses full capitalization anymore
LOS32b.
Discuss the trade-offs involved in constructing international indexes,including (1) breadth versus investability, (2) liquidity and crossing opportunitiesversus index reconstitution effects, (3) precise float adjustment versustransactions costs from rebalancing, and (4) objectivity and transparency versus judgment;
1.
 Breadth v Investability
Some international indexes including emerging marketindices include stocks that include illiquid and closely held small stocks andinvestor should choose the index with less breadth and greater liquidity2.
 Liquidity and crossing opportunities v index reconstitution effects
 
Crossing istrading w/o broker. Popular indexes have greater index-level liquidity. But theseindices suffer from reconstitution (inclusion and deletion) effects. So index levelliquidity and crossing opportunities may have poorer performance because of reconstitution effects.3.
Precise float adjustment v transaction costs from rebalancing
Some indexesmake precise float adjustments and revisethese adjustments frequently imposehigher transaction costs on those benchmarking against them than indexes that usefloat bands or broad categories. Float makes sense because transactions costs arereal expenses and what is to be gained by replicating the float of the marketexactly is not as clear.4.
Objectivity and transparency v judgment 
Strict rules versus index committees
 
LOS32c.
Discuss the effect that a country’s classification as either a developedor an emerging market can have on market indexes and on investment in thecountry’s capital markets.
Classification of Countries as developed or emerging and effects on market indexes andcapital markets
Being a part of developed market index is highly desirable because far moreassets are committed to developed than to emerging markets.
The inclusion of a country in an index has a real impact on the average companysize and average level of country development in that index.
There’s no reason for developed, emerging markets segregation.
The historical reason for managers defining themselves as emerging or developedmarkets specialists is that they are not taking undue risk.
They pursue this goal by investing only in developed markets believed to havetransparent accounting rules, liquid exchanges and stable currencies.
But today it’s different.
 
READING 33 (CORPORATE GOVERNANCE)
LOS33a.
Explain the ways in which management may act that are not in the bestinterest of the firm’s owners (moral hazard) and illustrate how dysfunctionalcorporate governance can lead to moral hazard;
The ways which management may not act in the firm’s best interest:1.
 Insufficient effort 
; in wage negotiations, employment supervision, cutting costs2.
 Extravagant investments
; (oil industry) investment in noncore industries3.
 Entrenchment strategies
; taking actions that hurt shareholders as in creativeaccounting to mask bad performance, taking too much or too little risk, resisthostile takeovers, investing in activities that make them indispensable
4.Self-dealing
; managers may increase their private benefits ranging from benign tooutright illegal activities easier to discover than insufficient effort, extravagantinvestments or entrenchment strategies.
LOS33a.
Explain the ways in which management may act that are not in the bestinterest of the firm’s owners (moral hazard) and illustrate how dysfunctionalcorporate governance can lead to moral hazard;
LOS33b.
Evaluate explicit and implicit incentives that can align management’sinterests with those of thefirm’s shareholders;
LOS33c.
Explain the shortcomings of boards of directors as monitors ofmanagement and state and discuss prescriptions for improving board oversight;
LOS33d.
Explain investor activism in relation to corporate governance anddiscuss the limitations of investor activism;
LOS33e.
Critique the effectiveness of debt as a corporate governancemechanism;
LOS33f.
Explain the social responsibilities of the corporation in a “stakeholdersociety” and evaluate the advantages and disadvantages of a corporategovernance structure based on stakeholder rather than shareholder interests;
LOS33g.
Discuss the Cadbury Report recommendations for best practice inmaintaining an effective board of directors whose interests are aligned with thoseof shareholders.

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