CFA L1 R1

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CFA L1 R1

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- Quantitative Methods Management tutorials
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SS 2

14 questions from SS2 and 14 questions from SS3

If you can handle the follow items from SS2 you should be in good shape for the exam.

1. Calculate EAR given stated annual interest rate

2. Calculate PV and FV for Annuities and Lump Sums and Perpetuities

3. Calculate NPV and IRR

4. State Problem with IRR

5. Calculate HPR (Total Return)

6. Calculate TWRR and MWRR

7. State difference between TWRR and MWRR

8. Calculate BDY, HPR, EAY, BEY and MMKT YIELD for a T-Bill

9. Calculate relative and cumulative frequencies

10. Comment on dataset presented

11. Calculate mean, Geometric Mean, harmonic mean, median and mode

12. Calculate range, mean absolute

13. Calculate standard deviation for a sample

14. Use Chebyshev

15. Calculate CV and Sharpe

16. Comment on skewness

17. Calculate covariance and correlation using probabilities

18. Calculate standard deviation using probability

19. Calculate standard deviation and expected return for a portfolio

20. Use Bayes formula

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EAR Example:

Calculate the EAR given the following situations:

a) 8% return compounded semiannually

b) 8% return compounded monthly

TVM Examples:

1.

As of January 1, 2006, an annuity offers $5,000 per year for seven years with the first payment due

January 1, 2011. If the annual interest rate is 11.5%, what is the present value of the annuity?

A

B

C

D

2.

$13,453

$23,185

$15,000

$30,348

A

B

C

D

$5,002

$6,247

$6,710

$7,247

An equity portfolio is worth $10,000 at the beginning for the year. After 6 months the portfolio pays a dividend

of $100 and the investor contributes $300 more to the portfolio. Just before the contribution and dividends, the

portfolio was worth $10,050. At the end of the year, the investor receives $100 in dividends and withdraws an

additional $150 from the portfolio, which has an ending value of $10,700 after the withdrawal has been made.

1. Calculate the MWRR

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T-Bill Example:

A T-Bill matures in 75 days and has a yield of 3.75%

Based on the information given above, calculate the following:

a) Holding Period Return

b) Money Markey Yield

c) Bank Discount Yield

d) Effective Annual Yield

1.

A portfolio manager generates a 5% return in 2009, a 12% return in 2010, a negative 6% return in 2011

and a return of 2% (unannualized) in the first quarter of 2012. The annualized return for the entire period

is:

A

B

2.

4.59%

3.76%

Sharpe ratio

0.333

2.222

3.00

0.333

Coef. of Variation

0.80

0.1875

1.25

1.25

You are looking at an asset with a mean return of 15% and a standard deviation of 5%. Using

Chebyshevs Inequality as an approximation, what is proportion of the assets returns should fall in the

interval (0%, 30%)?

A. 75%.

B. 33%.

4.

4.16%

3.25%

Company As returns exhibit a variance of 0.0225 and a mean return of 0.12. Assume the risk free rate is

0.07, what is the Sharpe ratio and Coefficient of Variation for Company A?

A.

B.

C.

D.

3.

C

D

C. 89%.

D. 11%.

An investor gathers the following P/E Ratio data for MOT, AAPL and RIMM common shares:

MOT: 29x

AAPL: 55x

RIMM: 76x

Based on the information given above, the harmonic mean is closest to:

A. 53.3x

B. 19.9x

C. 15.9x

D. 52.1x

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Probability

Stock X

Stock Y

Bear Market

0.2

-20%

-15%

Normal Market

0.5

18%

20%

Bull Market

0.3

50%

10%

a) The expected return for Stock X and Stock Y.

a) The portfolio expected return, assuming that an investor holds 60% of his assets in Stock Y.

b) The portfolio standard deviation, assuming that an investor holds 60% of his assets in Stock Y.

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Bayes Example:

1.

An analyst expects that 10 percent of all publicly traded companies will experience a decline in earnings

per share (EPS) next year. This analyst has developed a ratio to help forecast a decline in a companys

EPS. If a company is headed for an EPS decline, there is a 70 percent probability that the ratio will be

negative. If the company is not headed for an EPS decline, there is a 20 percent probability that the ratio

will be negative. The analyst randomly selects a company and its ratio is negative. Based on Bayes

theorem, the posterior probability that the company will experience an EPS decline next year is closest

to:

A.

B.

C.

D.

3%.

7%.

18%.

28%.

Example:

1.

Knowing that you are a CFA Level 1 Candidate, your boss has asked you to comment on the following

statements made by the one of the investment managers at the last investor conference.

Statement I:

The geometric mean is more representative than the arithmetic mean as a measure of

central tendency of a data set when it has large outliers.

Statement II. The geometric mean is larger than the arithmetic mean when a distribution is negatively

skewed.

Based on the information presented above, you would be most likely to reply:

A.

B.

C.

D.

Only statement II is correct.

Statement I and statement II are both correct.

Statement I and statement II are both incorrect.

Answers:

Bayes Example: D

Geo Mean Example: A

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The mean absolute deviation represents the mean of the absolute values of the deviations from the mean.

The variance is the mean of the squared deviations from the mean. The standard deviation is the positive

squared root of the variance.

Example:

Given the following sample data, calculate the mean absolute, the variance and the standard deviation.

65

69

71

56

60

Mean Absolute:

XAB = Actual - Expected

n

Variance:

2 = (Actual Expected)2

n-1

Standard Deviation:

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Skewness:

In a distribution skewed to the left (negatively skewed):

Mean < Median < Mode

In a distribution skewed to the right (positively skewed):

Mode < Median < Mean

Example:

1.

Knowing that you are a CFA Level 1 Candidate, your boss has asked you to comment on the following

statements made by the one of the investment managers at the last investor conference.

In a negatively skewed distribution the 90th Percentile is smaller than the 10th

percentile.

Statement II: In a positively skewed distribution the mean is greater than the median and this last one

in turn is greater than the mode.

Statement I:

Based on the information presented above, you would be most likely to reply:

A.

B.

C.

D.

Only statement II is correct.

Statement I and statement II are both correct.

Statement I and statement II are both incorrect.

Answer:

Skewness Example: B

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The annual returns of 708 Portfolio Managers were measured relative to the market index. Of the 708 PMs, 117

matched the index return exactly, (ie. Alpha = 0). The rest of the performance data is given below. Based on

this information calculate the ?

missing items.

Alpha

Absolute

Frequency

Cumulative

Frequency

Relative

Frequency

0

1

2

3

4

5

6

7

8

9

10

11

117

157

158

115

78

?

21

7

6

1

3

1

708

117

274

432

?

625

669

690

697

703

704

707

708

.165

.222

?

.162

.110

.062

.030

.010

.008

.001

.004

.001

.998

Cumulative

Relative

Frequency

.165

.387

.610

.773

.883

?

.975

.983

.993

.994

.999

1.000

a) The percentage of PMs who had an Alpha of 1 or less.

= 0.165 + 0.222 = 0.387 or 38.7%

= 0.008 + 0.001 + 0.004 + 0.001 = 0.14 or 14%

= 0.110 + 0.062 + 0.30 + 0.10 = 0.212 or 21.2%

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Probability Concepts:

Combinations: When Order Does Not Matter

nCr

n!

.

(n r)!(r!)

nP r

n! .

(n r)!

Examples:

1.

You hold 10 stocks and wish to sell 6 of them. How many possible combinations are there:

2.

a)

if order is unimportant?

b)

if order is important?

A portfolio manager has a list of 12 recommended stocks to hold in her portfolio. She is constrained to

hold exactly 6 stocks in her portfolio but can choose among any on the recommended list. How many

possible portfolios are possible given these constraints?

A.

B.

C.

D.

12!.

6!.

12!/6!.

12!/(6! 6!)

Answers:

a)

nCr = 10! / [(6!)(4!)] = 3,628,800 / [(720)(24)] = 210

b)

nPr = 10! / (4!) = 3,628,800 / 24 = 151,200

2.D

Note that in constructing the portfolio the order of the companies chosen is not important, therefore the

correct formula is the combination formula.

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