Scribd Logo
Upload

Welcome to Scribd!

  • CFA L2 Quicksheet

    Uploaded by

    ahkrab
    99 views6 pages
    formulas

    Original Title

    CFA-L2-Quicksheet

    Copyright

    © © All Rights Reserved

    Available Formats

    PDF or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Report this Document
    formulas

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Flag for inappropriate content
    99 views6 pages

    CFA L2 Quicksheet

    Uploaded by

    ahkrab
    formulas

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Flag for inappropriate content
    of 6
    A Critical CONCEPTS FOR THE 2011 CFA® Exam ETHICAL AND PROFESSIONAL BT Ay 1 Brofessionalism TA) Knowialge ofthe Law 1B) Independenes and Objectivity TiC) Miseepresentation 14D) Misconduct TL Tategrty of Capital Markets (A) Material Nonpublic Information TL (8) Maker Manipuasion ML Duties ro Chien TT (A) Loyaly, Prudence, and Care 1 () Fair Dealing TL © Suitabilig HH} (D) Pesformance Presertaion Ul (E) Preseration of Confidentiality TV Duties co Employers TY) Loyalty IY (B) Adicional Compenstion Arrangements TY (C) Responses of Supervisors ‘V Investment Analysis, Recommendations, and Action ¥ (A) Diligence and Reasonable Basis (8) Connmannicavon with Clients and Prospective Clients V (©) Record Retention VE Confit of Interest VE (A) Disclosure of Coles VIB) Priory’ of Tamactions VIC) Refeal Fees VI Responsibiliis as CPA Tasticute ‘Member or CFA Candidate IT (4) Conduce inthe CFS VII [B) Reference to CFA I Designation, and CTA Program aT Coes Simple Linea Regression Gonelaton: ye = 2a) _Esimated slope coticien: Enimated interes: By =F. Confidence interval foc prediced Yoalue VWW dBoc + Rejecifl> etc ror pale <8 Contre nt (45) Stokes ae Fat xSEof Mahiple Regression Ymby Hb xK,)+ “Te cic ie Fe MSRJ MSE with kand n—k~ tdf(Q-i, ifcance of mgresion + Standard enor ofesiate (SEE = YMSE). Sale SEE means rer fi + Cocfciea of determination (RE ~ RSS / SST). hf aah of cxplined by X's higher RE mean hte ft Regrsion Analysis Prablms + Hererodkedasiny, Nocona nor varance Detect with Beech-Pagan exe, Core ith ‘White corected stndad cro + Auocotlation, Celadon among ctor terms. Dest with Dus Warm er; postive turocorlaon # DW < d, Corec by adjiing Sandan cron sing Hansen method. + Malena. High comeacon among Xs Dace if F-test sigan, es nsigiicane Coney dropping X vases. Model Misspecicaton Oniuing aval ‘arable shoeld be wansformed. Tncores pooling daa. ‘Using lagged dependent A. as independent vb. Foresting the pare Messing independent variables with err Effects of Misspeifcation Regression cofciens te bised and inconsistent Inco confidence in hypothe es of the coufiics ori the modal predictions Linear tend model: =p ryt +=, Logelinear trend model: In'y,)=b) eb + Covariance stationary: mn an vat dont Changeover ime. To deertine time sist Sariance ations (1) poe data 2) run an AR ‘ode! and tex comclios, lor (3) por Dicey Fale re ‘Unit oo: coufcient on lgged dep vl. 1 Sein with unit soe sae covariance sttiona Fie orgs return, Nominal and Real Exchange Rate ‘+ Nominal et. tate (E) price oFone currency in terms of another, observed in FX markers + Real exchange rite =F (P/F) Balance of Payments cuvtent acct + cept 2c + oficial crv account =D Foreign Exchange Dirt queen if quote is pe § (or USD-GBP), his isa direct quoce fiom the perspective of che pound Hid-ash pred cated as percent of king Dice: ask priced rice 99) ask pice Foreign curency ia forward dicount (premio) if Fis blow (show) S, sing dies quotes fd ate i em in da canst pspread = (Gd premise) (pec ra Ccuteny appreciates de + Lomer relative income growth rt. + Lomer relative inflaton ae {Higher domestic ea eres ate + Improved nvement climate Ununicipted shift exp. monctary ple: higher income, aceeated nfl lowe el aterest ae lead to crtency dep, and financial acer defic. Unsaticpated sift exp. cal policy: currency spp utente. deity and final account sol Purchasing Power Parity Lavan price: single, cla comparble good should have sme teal rie in all counties. Relative PPP counties with high nlaon aes should se thei cutencis depen oer Flannery International Fisher Relation Atsures ea ners ates are equal across borders so interest direc] equals expected inition dil ey 1G) ety Si ot) Elis) Ela) ‘Uncovered Interest Rate Parity (Countries with high nominal incest aces should se hee cunencis depreciate! (i cae) stone Sx [Sa] ONO continue. Interest Rate (Counties with high nominal incerest rates will have thir curencies ell at forward discount 19 prevent arbitrage. 5 (va) S” flvn) Cee ibieg "Up the bid and dowa the ask” GeV Ta EES LIFO/FIEO ‘As compated eo LIPO, FIFO results in Laer COGS, Higher rx. Higher net ncome. Higher iavecory balances, Toye es flow (move rx) Higher net and gross margins Higher current rato Leger inventory rurnoer + Lower debe o-oo. LIFO to FIFO “To adjust = LIPO firms financial statements 19 reflec the FIED cose low method: * Add the LIFO reserve to current ases (ending inventor) “+ Subtract the income eso dhe LIEO reserve fom curren ates (a) 4+ Aid she LIFO reserve, net of tax. shareholders sig + Suutace the change inthe LIEO seer fom cogs, + Ad the income rxeson the change in che LEO reserve co income tax expe Depreciation Analysis Average age (in yous) ~ accumlaeed depreciation / annual depreciation expense ‘Average depreciable lie ~ ending gross investment / sual depreciation expense ‘Remaining useful life ~ ending net invesement / sna depreciation expense “Accounting for InterCorp Investments Investment in Financial Assets <20% owned, a0 sig influence 1 Held-o-manarigy at coston BIS; nt and relied fainifosson US. + Avaibbleorsale ar FMV with unrealized gains! loses im equity om BIS; dividends, erst, teased guneflsses on US. + Held forading st FMVs dividends, terest, teal and unrealized gaine/loses on US. + Designated a fir value ike held for ain Investments in Associa: 20-50% onned, ig Influence. With equity method, pro-atashase of fhe invest’ earnings incr BS act also ia US, Dir. eceived decree inverment account (it. aorinlS). [Basiaess Combinations: 50% ownci, contol Acquistion method reglted under US. GAAP snd IFRS. Goodbil ot amortized, subject nual impairments All aera ex 8 cap of ub, combined with paren, excluding inerwomp. tans f L00%%, minority interest act. for share not owned, Joint Vennure: 50% shared control IFRS: Proporonace consol. preferred, similar corel consol. excepe online pro-rata share US. GAAP: Equity medod Financial Elect of Choice of Method Equity scquiston, & proporconare consolidation + Alltree methods report same net income: + Assets nbs, sales are highest under caus lowest under equity method peporconate consolidation in hereen, Differences between IFRS and U.S. GAAP treatment of intercorporate investments include: + Urelized EX gins and lesson available fo sale securities revopnized om income statement under IFRS and a other comprebensive income funder US. GAAP “+ US. GAAP categorizes business combinations 38 mergers, sequsitons or consolidations. IFRS ‘does no dsingush henseen types oF busines ‘sombinations + TERS permits either the "paral goodwill” 0 “fll goodwill” methods value goodwill and noncoocoling interse: US. GAAP requites the ful goodwall method. {+ USIGAAP requires ouiry method for join: ventures Under IFRS, proportionate onslidaion prefered but che equity method is permed Entity isa VIE if any ofthe following: insufficient ask equity investment. Sih ac decision-making righ + Sth do nor absorb losses + Sth noc receive residual benefits. “Te primary benefciay consolidates the VIE Peavon Aezountng + PBO components: current sevice os interes ‘oie, seni gumsloses, benefits paid + Banded satus = plan ases~ PRO, * Pension expense components: current sevice cost interes cot,expeced return on plan aes, prior (ust service cost, ne acta gains. + Aggrenive asumptionllow earnings quality high discount ae, low compensation grown tte high expected recur, ‘Economic Pension Exp. i fem contribusion, fim tomiibution, diff = Borrowing and reas om CEO CFP) Balance Sheet: GAAP ws. IFRS GAAP: net aseliab, = Funded satus ~ economic realy IFRS: net asclib,= funded seas ad), for ‘unrecognized items ‘Underlying Economic Pension Exp sum ofl chy. in PBO (exepr benefits pad) less actual ROA. Also, = hg. in finde status exe. fis ‘contributions. Service cose = operating expense Tnterese and actual ROA sepeted as nonop. income ‘Multinational Operations: Choice of Method Forse contained su, funcional presetaion crreney: mse all-cuzeat method: + Aselibiliesscurrent rte + Common socket httorel ete 1 Tncome statement at average rte Exposuce~sharcholder ein: + Dividends trate when pad Forintgrated ub, functional = presentation crn) use temporal mechod: 1 Monesary serisbiliies a unten te 1+ Nonmoneray asses ibis at historical re © Sales, SGA at average race + COGS, depreciation a historical rate 1 Exposure = monetary asess~ monetary lables, [Necasct position & dpe foreign cartency ~ ls. [Netliab, postion 8 dep. foreign currency = aia. (Original EIS vs. AllCurrent + Pare BS and IS sais unchanged, 1 LLC depreciating translated mised ratios wil be lager + IFLC appreciating, eanslated mined ratios wll be sinallee “Hyperinflation: GAAP vs. IFRS Hyperin = cural- inf.» 10086 over3 yrs GAAD: ste temporal method, IFRS: Is restate foreign ‘ute. tor inf. 2nd, tansce with al-curent. Net rch. power grn/loss reported in income: Accrl-Based Income: zeal parc les persistent than cash por tot) fOArp -NOAs (NOAmp —NOAac)_ (WOApwo* NOMpac)!2 (xt — CFO ~ cH) [ROA NOM)? sr te with lange acral ‘eatnings component. Cale Capital Budgeting Expansion nial outlay = FClnv + WeClnw + CF=G-C-D\l-1) +D=6-QU-D + DT. + TNOCE = Sal, « NWCinv—T(Sal, -B). Capital Budgeting Replacement + Same a expansion, etcepe cent after-tax salvage fold aes reduces initial out. + Tncremental deprecation isin depth. Projects with Unequal Lives + Tease common milkiple of ives. ‘+ Equivalent annal annuity EAA) annuity equal caDV of projec CFs fects of nfiaion + Discount nominal (sel) cash oes at nominal (el rate; unexpected changes in inflation fet project profes reduces the real tx swings fom depreciation: decreases value of fixed payments to bondholders; affects cos and reverts difnent Capital Rationing ‘+ TESNDV projec > epi, choose combination with highest NPY. Real Options + Tiasing abundonmens, expansion, Lesibiliy, Fundamental options Economic and Accounting Income eon ine = AT'CE + Ain projec MV + Econ dep. based on 3 in invenent’s MY. + Econ ine calculated before interes expense (cost of cap reflected in dicount at Ace ne = projec rev.— costs + Ace dep, based on original invesmene cot ‘Incest (financing cos) deducted before cslelting acourting income. ‘Valuation Models + Beon, proc ~ NOPAT WAGE, *+ Residual incomes= NI equity charge courted at equied ern on ety + Chim valuacon separates CEs based on equity cams (iscounted a cost oF equity) and debe holders (discounted at cost of deb) [MM Prop I (No Tare) capil suctureieeevant (oo taxes, tans, or bankruptey cst) [MM Prop If (No exes): inceasel use of cheaper abr increases cor of equity 0 change in WAC, (MM Proposition I (Wih Taxes) cx shield ads sale, vale maximized a 100% eet [MM Proposiion TI (With Taxes): x shield ads valu, WACC miniized ar 100% deb, SWACC; discounted at CORPORATEFINANCE contin Investor Preference Theories «NIM dividend lence theory holds han novtuino-fes word, dividend poles iederane Tecate inivdtliavestoe can crete tr own omemade dividend ct Die pickeaee ooo or roe pee cern ferent ca arate expt uns + ‘Taravenon theory sues hat investor ae ax ave ndbvidends and would prefer companies inated buyback sae, Eflecive Tax Rate on Disidends Double sexton ope ses fi rte = ope + (1 comp.) Impattion seme: cece tx ati he shareholders nd exe Signaling Efets of Dividend Changes Tein ambiguous ign There pokve signal Derren gave gal ules management ss swan profil nese opporuies ‘When the tock goes cx-dividend DO=To) (Tex) ‘Target Payout Ratio Adjustment Model IFcompany entnings ate expected to increase and ‘the curenepayour aioe Below the target payout ‘ato, an investor an estimate future dividends chrough the flloning formals: expected dividend = [io Ap= (Se) ae ee eee ae Alividend coverage ratio = net income / dividends CEE coverage ratio = FCFE (dividends + share repurchases) Shar Repurchases * Share repurchases equivalent o eas dividend, assuming eal x ween + Unexpected share repurchaze ie good news, * Raconal for (1) potential ex advantages, (2) share price seppordsignaling, 3) added exe. (4) ‘offering diurion Flom emplayee sack options, and (5) increasing financial leverage. Dividend Policy Approaches + Residual dividend: dividends based on earnings les und eine to finance capital budget. + Longerterm residual dividend forecos piel badge, encoth dividend payour + Dividend sabi dividend gaomeh aligned wich sarsiable grovel ae, + “Taeget payoue rats long tua aya ao ange (Corporate Governance Objectives 1+ Minute contict of inerest benseen (manages and sbarcholdersand @) drecors and shareholders. Ensure aot ued to benefit invesons and skeholders, ‘Merger Types: horizontal, vertical, conglomerate ‘Merger Mosivations achieve svnegies more rapid groweh, ince mle. power, gin access co unique capabilities, diversi, mgr. personal benefits ax benefits unlock hidden value, achieving int. goals, and bootirappng extings. re Offr Defense Mechanis: poison pills and puts, reincorp. ina sate w restive takcoer laws, staggered hoard elections, reste, ‘oting rights, supermajority voting, ae pice ae cosas alpacas Powe Offer Defense Mechanisms lgtion, greens share rpurch, leveraged cap, the row evel” “Pa man” and ust defences snd whit nightie squire. The Hevdndall Miscan lex HED: kt power =m af qared mi. shares for al indy me. High o 1 HE man seulators more ikely to challenge a merge. Methods to Determine Target Value DCE mecid: get profram FCF discounted at ad WAC Compare company ana tage vale from ‘eae aiation mee on sma eas + takeover promi Conparberamacton analysis ange ae fom ctkewer rnsaon; heoer premium include Merger Valuations Combined ie Van = Vat Ve +5 Tabeaver promis (tage) Gaing = TP =Ty Vp Synergis acquirer) Gaing =S—TP=S— (PVs) ‘Merger Risk & Reward CC ofr: aesuiree assumes isk recs rear Sick ofr: soane of sks rewards shift co arget IF higher confidence in synergies acquit prefers cash ‘Sarge prfers tok Fooms of dvenitares: equity arve-ous spin-off, splicofs, and liquiisons ea INVESTMENTS ‘Alpha fo. expected rerun ~requlted return fromt CAPM, oe APT Franchise Value and Growth Procass Tangible PIE = 1 Franchise PE = franchize factor x growth factor EER GE + LEROE > fem has sussinable compecicne suanige, Fanchie factor» 0. + LEFF 0, higher retention rai implies higher GE higher franchise PE. Inflation Eflects on Valuation 1 Higher ow-ehrough eat implies higher P/E, ll se cqul + [Finfarion oweshrough < 100%, higher ination plies lower DYE, allele eg. Porcers Five Forces/Competiive Strategy L Threat of neweeneranes 7 = mone pricing prose, lower industey pros. 2. Theea ofsubeciucs. le there apace ceiling? More coseffetve, more pricing presure. Buyer repens fo subriute. Swing costa 3. Bargaining power of buyers = funtion af bargaining leverage/prcesestviy. 4. Bigaining power of sper: determined by ifeentision of inputs, presance of sub aps supplier conceatation importance co supple, ‘hss of forward inregeion 5. Rivalry among sing competitors.) ritaley = tisk of desrctvepricelfeturelmarketing wats Function of industry sroweh, fed cos, value sudded, product diferences, branding, divesiy of comperitr. exe batten Key point: Who capeate value added? Eliminating vals risky, aracts competition Strategic Alenatives 2 Yale ec fr sya peat ere ee Industry Analysis alan ieee eens + Eee tps Neel terre eae eee + Henk om WEA ml coe omni Wome « Recat lope pa ETON Done Ca Hoe CP Meds Us ncn de DDND whe Geeta ey 1 Dale ply el ne ae ee Ui ie Fe lata elecided ay Spite + Retirees pes See eeoaeee iscested aes ren + Blais Ny = peels mee Garo Gre sane pel ed gh eee is Neer nos tea eee ere 1 Dilek omedtioe 1 Dita ethane php ere Bee ie kent Oppet Vox E4960 2-Sag Groh Mod Sep clue adi a sep Unt remind epee ee aso eer eae edd y, Dexia] Dytle.—al) mR a Hee . Solving for Requised Reeurn For Gordon (or sible growth) model solving for recur yield ree Cash Flow to Firm (FCFF) ‘suing DEP i only NOC o ‘+ ECEF =NI+ Dep + [Ine (1 —ax rats] ~ Flav =XCinw + EGER ~ [EBIT «(1 ese ae] + Dep FCnw =Wele. ‘+ ECEF = [EBITDA » (1 — erate] + (Dep «ax FC WC. + ECEF = CFO + [lat (1 — rae ate) ~ FCI. Free Cash Flow to Equity (ECER) FCFE = FCEF (ls (0 —1ar ate] + Net borrowing, ‘eealaiian: Ty ano ALTERNATE VESHENTS cent + ECFE =NI + Dep FClnv —WClny + Net bonrosing: + ECEE = NI_[(1 DR) « (FCIny ~ Dep)) = [C1 DR) x WC]. (Used eo foresas.) Single-Stage FCFE/ECFE Models CFR, WACC= FCEE, a + For ECEE valuation: V, + For ECFE valuation: Vp 2-Stage FCFE/FCEE Models Seep I= Calealte FCF in high growth period Step 2: Use single sage FCF model for terminal valu atend of high-growth peiod. Seep 3: Discount interim FCP and reminal ale to time zero ro find stock vale; use WACC for FOFE «for FCFE. Price to Farnings (P/E) Ratio Picblems wich PIE: + Ifearings< 0, PIE meanings. + Vola, eansitery portion of earings makes inerpetation difficule, + Management discretion over accounting choices affecs epored earnings. Justied IE (eteg reat = traling rz = 21+ 8) ms ‘Normalizavion Methods ‘+ Histoieal average EP. + Averige ROE. Price ro Book (P/B) Ratio Advantages: + BV slmoseabmays > 0. + BV more sable din EPS. ‘+ Measures NAV of financilinsccuins. Dissvanagss + Sue differences cause misleading comparisons + Influenced by accounting choices + BV # MV duc ro infaion/technolog. usted v3. = ROE=E re rice ro Sales (PIS) Rain i ‘+ Meaning eve for dsesied firms 4 Sales revenue noe exly manipulted. ‘+ Notas volatile a PE cas, + Usefl in valuing macure celica, and seare-up furs. Disudvanagee: * Highs do ot imply lh profs andes 4 Docs not caprure cost structure difeences + Revenue recognition practices sl distort ales jusiedp/s-=PMa*0— b+) es DuPont Model ROE = (ne income sales! (ale tal sets) x (coral aes / equity) Price ro Cash Flow Ratios Advantages: ‘Cash flow harder to manipelate than EPS ‘Moc stable chan PE. 1 Miigaer earnings quality oncems Disadvantage: + Difficale to esimate ue CFO. 4 CEE bere but more volatile Method of Comparables + im multiple» benchmark implies overalud, + Fim mip benchmark implies underald, + Fundamentals ha fcr multiple should be similar beowcen frm and benchonarc Residual Income Models + Ee E,=(e< 8) = (ROE) ¥ B, + Singleage RI model Ba] + Muleistage RI valsation: Vo= By = (PV of interim high-growch RI) + (PV of continuing RI) ‘Economic Value Added® + EVA= NOPAT—SWACG NOPAT = EBITU—9) * Real Estate (RE) Investment Analy, + CEAT = NOI debe service — axes payable + ERAT = net sling price ~ morrgage balance — 1 Recapeured depreciation: dep taken in anticipation of Fin asses value that did noc macerialize fypes of Real Estate Investments Rae lan: passive and illiquid for speculators and developer. Aparimenss an office buildings: active, moderately liquids ta shelers for high-income investors. Warebuass passive, moderately liquid for passive investors and chose seeking tax shelter Shopping centers: moderaey active, low-liquidiny; for wealthy investors. ‘Hotels and matel active, moderately liquids For those seeking tax shelter Income Property Analysis: Cap Rate “Marker etrarions Ry(ME)= NO! MV Use when income datas available ‘Valuing Income Properties Direct income capitalization tciigue: NO} _ NO}, Beam: Gr income map elnigue (MV's gross income x income mulpier sales price rss income multiplier (M) = Private Equity Valuation pLoc-1 reso | eel peas The DLOC and DLOM ae appli rpc ang ror dane BLOG) DLOM The DLOM vcs wi cel + "An pending IPO or fm se wold dsee ‘he DOM +The payment of dividends would decree the DIOM, 1 eae hight pgmen ie, ter dart) ‘would dese he DLOM. : 2 Conran station nyse wot ince the DOM. * A gst pol ofbeyers would dere the DION + Gree sek and ae uoceran woud increase the DLOM. Sustainable Growth Rate: b ROE. Private Equi Source of oc creation engine Br, fvrable debe financing: super digatent of itrexs beneen mansgement and PE ownership. ta- Valuation sues (VC firm relative to But DCF notes common; equity not deb, primary financing, ay ries of gneve Buyout 1 of mulipe at exis, in deb. VC: pre-oney vation, the investnent, and subsequent equity lation, Componen of peformance (CBO) easings grow, T of maltipleat exit in debe {Bit rer Gin ade oft ude, high rl) IPOs secolry mkt sales MBO: liquidation Paformance Measrement gross IRR.» ceturn For portfolio companies Nec IRR = relevant for LP net Of es & care inert Pafrmance Satine + PLC 9 capita ind by GP; cum sm of capital called down, Mig. 86 of PEC Cred imeres 96 carted nt (change in NAV before ds) NAV before dsb. = prior yz NAV afer dine ‘cap called down ~ mgmt. fees + op resale + NAV after dncib = NAV before dsb. ~ cated ine ~ dit + DPImuie + RVPL mule = (NAV fier disuib) / PIC = LPs nvealined etn. + TVPL mule = DPL male + RVP! mu [NPV'VC & IRR meshed clelte pre-money vl, post money val. ownership action, 8 pice per ‘hare NPV methods tarts ith POST: IRR rth cap. Fase wea Asesing Ris: (1) adj ic axe for prob. of fares) ws scenario alysis fr eim. 1.80 GF: sar wth nt income, add back non cash dy. 8 amo fd. charges. Shere in NWEC and approp. capex Hedge Funds Pafrmance measurement diets doe ro dit in leverage, short positions, in ale, & port. TO. spose investment, aud, and operational tk, ie downside measur ofr, sch as maximum Arado andor vale a ik (VaR Prices inversely rested sock prices over es Ce &infaton. Credie Analysis Hlgh-yied debe ‘+ Teer has senor, shore-erm, floating bank debt. ‘+ Analyze comporate structure, debr seructure Asserbacked debe + Qualiry of colle 4 Servicer quali 1+ Cash doe ses and parmene src + Legal sructue Menicipal bonds “Tax hacked mnigipal bond analsisinvoles: issuer debr structure, budgetary pli leal te fd intergovcenmenal revere avai, and “Maaicial bond credit analysis limits ofthe basic ‘secu flow af funds structure, rte covenants, sed adlcional bonds revs, Sovereign debt * Local vs. foreign cutency rating + Economic isk abilcy copay. = Political ide willingness fo poy. Theories ofthe Term Structure Pare (unbised)expectarons. Forward rates () fanation of expected fare spot rates ES). (cumul, distrib) / PIC = LP’ realized gD COE comtind. 1 Fup doping, ST spor sates. * down sloping, ST sate pot ete fall, + ffl ST spot rte constane. Liguidiey thors F rates ect expestacions of 1S) pla igaiciy premium. Preferred Habitat Theory: Imblance berwcen and supplydemand at mazar range induces Tenders to shi fom preferred habits ro one with ‘peice inbalance Key Rete Duration + MdWalue fom 100 bps A in key rate hae several key ares 76 10-39, + Ensimat effec of non-parallel yd curve sift on oad portfolio vale Valuing Option Free Bonds “To ale option fiee bond withthe binomial we, ssaetat end and dscoune back through che re (Gackwards induction method) Valse 2 year, option ice bond: Step 1: Hind dhe sime one up-nde ae: 1 oda : ees) coe nee sont endo] ‘Value Bond with Embedded Option For bonds with embedded options, ates whether ‘option will be exercised cach node. New Step 3 Step3: (allale bond). Find time 0 value suming year 1 down-node calculated salue than cll pice: a Js alla iy 1+ | Call « noncallle bond — callable bond c= puuable bond — nonpusale bond Option Adjusted Spread + "Option-removed spread” *+ Compensation far liquidity and cers reative cohenchmark. + Spread tha forces model price ~ matkee pice. + OAS » option cost= Z-pread Relative Valuation Analysis IFbenchimark is Teasusies or higher raed bond *+ Bond is undervalued if OAS srequited OAS. * Bond is overvalued if OAS < required OAS, benchmark is isuerspedf + Bond isunderrained sf OAS > 0 + Bonds overvalued # O8S <0. Convercible Bonds * Conversion vale ~ stock price « conversion taco, + Minimum value» say (tesighe valu, conven value, + Marker conversion premium = cometson price — marke pice. + Gallble converble bond = srsgh bond + cll ‘on sock call on bond. MBS Prepayment Risk Prepayment Speed Factos 1 Spread of current we original mortgage ates, 1+ Mosgage xe pach (refinancing busnou), + Hlousing eunover + Lon sesoning and propery location, ‘Coneaction ris cours ae rts fal, peepaymenss se, average life als ‘Burns tsk occu as rates rs, prepayments fll (low), average ie ses: {EMO Prepayment Rik PAC I nanches lowe contraction and exrension risk (due to PAC call) + PAC II ranches somewhat higher contraction anderension rise + Suppor tranches higher sons and extension tsk, + TO srps: vale posiely elated intrest aver alow cveren ates + PO strips negative convexity a low sates, high Commeral MBS + Nonrtecourse so focus on propery ered sk + Loanleve all peoection: prepayment lockout; defeasance; prepayment penal yield ‘maintenance charge. + Poole cll prorecion: eenior and subondinaed tranches, [ABS Credit Enhancement 1 Excernal corporste guarantes Jee of cod, bond innaranee + ern: eserve funds, overollaealiztion, seniors stactue ABS Prepayment Risk ‘+ Closed-end HEL: prepayments alo flected by bomomer cede cit *+ Manufactured bousing loan: low peepaymene isk: small hlnces, high deprecation, love hocrwrer crediting. *+ Anco loan: low prepayment isk: sal balan, high deprecation. “+ Suudene loan: prepayments from defi, loon consolidation, + Ceedic cad receivable: low prepayment rss locke peind, no prepayment on credic cand, Collteaized Debs Oberon (CDO) Structure: enir anche), mezzanine tranches, ‘quity anche Arbitrage driven cash CO: use inerest ate swap. + Cath ow CDO: asvely managed no shore-rerm wading. ‘+ Synthetic CDO: bondholders ake on economic tks of assets bur not legal ownership of thew, link consingeat payment 0 reference asc bond inden) + Advantages of synthetic CDO: no funding, shorter ramp-up period, soit exposure snore cheaply through redicefaulr swap -MBS/ABS Spread Analysis + Phain-anill corporate se Z-spread, + Callablecomporate use OAS (binomial modal) ‘+-MBS: use OAS (Monte Caro mode) + Credit cadlauto ABS: ne Z-speea, + Hlgh-qualey home equity ABS: se OAS, aS Forwands: No Arbiteage Pricing FP28, (0) fare Equity Forward FP (quis) = (Sy PVD) «(14 R,)° Ne “ne faci Forward on Fixed Income Securities FP fut nome) = (Sy —PVC) +R)? Yaa -re-[ Fr | a Fora Rate Agrnnt (FRA 1A served conosco eet tog wins when ts nce lassen mes, ae FRA price is implied forward interest rate for ered begining when FRA exes co undying ieee ee eee eee seta of lar cond back 0 FRA ree alee eee eee csimatedbympid forward te dour Bacco valation date current LIBOR Careney Forward (Interest Rate Parity) (1+Rpe)" (FRc) FP (currency) =$) Fand Sin DC/EC ial |(+Rrc)" "| |(1+Rpe)"* Futures Price Fe=s,xtR,)7 + Focaes > forward when rte and ase aus positively correlated, + Funes «forward when rater and ane vale: negatively corelatcd nutes Aciteage (Cash and ear orto, buy spr, sell furaes today ever ase, pay loan 2 ed. Revere cash and cary shor spo, invest, bay Faure day collect loan, buy asset under Furures ‘onuact, deliver to cover short ale. ‘Costs and! Non- Moneeary Benefits 1 Holding oss increase fares pice; monetary eels reduce faces price 4+ Backardation: fare price « spe price. + Contango furues price > spot price *+ Normal backvardston: fares price « expected spot pric. + Normal cantango: Faure price > expeced spor price “Treasury Bond Futures =o ten) veg Equity Futures p(soek)=S,X(48)" EVD. FP(ind) Es, eer rool Facey ides ig AM et st Tae Sees Gaipes Enel fue wing noes fa Paccal Psy Cs RE Nip ang ct nes 7 Sox saati eas eats kes Lop *+ Flor = portalio of pus on LIBOR. dikes cae DERRATIVES comin. + Collar buy cap and wl oor or sl eap and buy Boor. [Binomial Option Pricing Model Step: Calculate option payots a cna in all sates, Step 2; Caleulate expected value using probabil, 1+R-D ‘UD Step 3: Discount 10 today at sre rate. BSM Assumptions & Limitations ‘+ Assumptions price of undedying flows lognormal dstebutions (continuous sk-fee sate constant and known; ¢ of undetying asec constant and known; fitonless marke tunderving ase has n0 CF: European opeions + Limitations: noe useful for pricing opcons on bond prces/intret rates: mus be estimated; ‘nor constant ove ime ictionless markets assumption ne relists Effect of Each Variable on a Call Option + Asca prie: positively elated + Volutlc of set pice: positively related. + Riskftee rate: positively related. {+ Time ro expiration: value —> 0 2 call anus + Enctcit pric: ncgatvly reared. Dela -Essmates dhe change in value of option fora one ‘une change instock pice. 1 all dele berween 0 and I inceases 2 stock + Gill dele ls: to 0 foe ir out-of the-money cals close 0 1 or far in-the-money cal ‘+ Pu dlta benacen I and 0: increases fiom —1 19 0 as took price incre, 4 Pur deli = cll dels —1 (all ele equa. + Deka closer 0 fr far outoFthe-money puts: love wo 1 foe fr in-the-money pus. Delta Neutral Hedging

    You might also like