Adapt CFA Level I

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ETHICAL AND PROFESSIONAL STANDARDS

ETHICAL AND PROFESSIONAL STANDARDS V(B) Communication with Clients and Use TVM keys on BA II Plus:
I(A) Knowledge of the Law Prospective Clients - Cash inflows are positive; outflows are negative.
Obey strictest law that applies. Do not associate Make appropriate disclosures. Distinguish between - Set P/Y = 1
with law-breakers. fact and opinion when presenting investment - N = number of periods
I(B) Independence and Objectivity analysis and recommendations. - I/Y = periodic interest rate in %
Do not offer gifts that might affect someones V(C) Record Retention - PV = present value
independence and objectivity. Refuse gifts or Develop and maintain records to support work and - PMT = level payment amount
disclose to appropriate parties. communications with clients. - FV = future value
I(C) Misrepresentation VI(A) Disclosure of Conflicts Money-Weighted & Time-Weighted Returns
When using an outside source, cite it. Do not Disclose matters that may impair your Money-weighted return: IRR on a portfolio.
promise investment returns. independence and objectivity. Calculate using worksheet and IRR function on
I(D) Misconduct VI(B) Priority of Transactions BA II Plus.
Do not commit fraud. Personal issues that reflect Execute clients transactions before your own. Time-weighted return: Product of (1 + holding
poorly on professional image are a violation. VI(C) Referral Fees period yield) over entire measurement period.
II(A) Material Nonpublic Information Disclose referral fees to clients and employer. Holding Period Yield
Understand what material and nonpublic VII(A) Conduct as Participants in Ending + Interest Received
HPY = 1
means. Do not act or cause others to act on CFA Institute Program Beginning
material nonpublic information. Do not compromise CFA Institutes reputation. Effective Annual Yield
\]^
II(B) Market Manipulation Do not share exam details. EAY = 1 + HPY S 1
Information-based and transaction-based VII(B) Reference to CFA Institute, the CFA Bank Discount Yield
manipulations are not allowed. Designation, and the CFA Program Dollar discount 360
III(A) Loyalty, Prudence, and Care Do not misrepresent or exaggerate CFA Institute r_` =
Face value Days to maturity
Clients come first. Treat clients investment like membership, designation, or candidacy. Money Market Yield (CD Equivalent Yield)
your own but with higher priority. 360 360 r_`
rff = HPY =
III(B) Fair Dealing Days to maturity 360 t r_`
Treat all clients fairly. Communicate investment QUANTITATIVE METHODS
QUANTITATIVE METHODS Bond Equivalent Yield
recommendations and changes simultaneously. Required Rate of Return BEY = 2 1 + EAY h.^ 1
III(C) Suitability nominal risk-free rate = real risk-free rate Type of Measurement Scales
Use a regularly updated IPS during investment nominal risk-free rate + expected inflation rate Nominal: Only differentiates between objects
decisions. Choose suitable investments in a required interest rate = nominal risk-free rate Ordinal: Allows for rank order
portfolio context. required interest rate + default risk premium Interval: Allows for degree of difference
III(D) Performance Presentation required interest rate + liquidity premium Ratio: Has meaningful zero value
Do not misrepresent past performance. Do not required interest rate + maturity risk premium Means
promise future performance. Effective Annual Rates Arithmetic:
III(E) Preservation of Confidentiality EAR = 1 + periodic rate ; 1 1
I

Keep clients information confidential unless: client EAR = >?@ABCAD@DE 1 Population mean, = X N ; N = population size
N
Nno
is involved in illegal activity, you are legally Future Value (FV) and Present Value (PV) O
required, or you have client permission. FV = PV 1 + r I 1
Sample mean, X = X N ; n = sample size
IV(A) Loyalty Annuities n
Nno
Put employers needs first. Understand Ordinary: cash flow at end of time period Geometric:
responsibilities when leaving employer. Consult Due: cash flow at beginning of time period Xs = A
Xo X t X O , where X N 0 for i = 1, 2, , n
employer before taking on outside employment. Perpetuity: cash flow continues forever 1 + Rs =
y
1 + Ro 1 + R t 1 + R O
IV(B) Additional Compensation Arrangements PVJKL = PVM>JNOP>Q 1 + r Harmonic:
Obtain employers written permission before FVJKL = FVM>JNOP>Q 1 + r N
receiving cash or perks. If applicable, obtain other Xz = , where X > 0 for i = 1, 2, , n
PMT I 1
PVRL>RLSKNSQ = Nno X
partys permission. r N

IV(C) Responsibilities of Supervisors Percentiles

y
Supervisors are responsible for reasonably Location of y S} percentile, LQ = n + 1
100
preventing subordinates violations but are not
If LQ is not an integer, use linear interpolation.
responsible for subordinates behavior.
Mean Absolute Deviation
V(A) Diligence and Reasonable Basis o O
Exercise diligence and thoroughness. Support MAD = Nno XN X
O

actions with research and investigation.

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Variance and Standard Deviation Expected Value & Variance of Portfolio Return Normal Distribution
I O
1 X ~ Normal ,
Population variance, t = XN t E RR = wN E R N P < X < + = 0.68
N
Nno Nno
O O O P 2 < X < + 2 = 0.95
1 P 3 < X < + 3 = 0.99
Sample variance, s t = XN X t t R R = wN w Cov R N , R
n1 Nno no Observed value Population mean X
Nno
Z= =
Standard deviation is square root of variance. Market value of investment i standard deviation
wN =
Chebyshevs Inequality Market value of portfolio E R R shortfall level
Shortfall Ratio =
For any distribution with finite variance, the For portfolio with 2 investments:
proportion of observations within k standard E R R = w R + w_ R _ Lognormal Distribution
deviations of the arithmetic mean is at least t R R = wt t R + w_t t R _ - e where X is normally distributed
1 1 k t for all k > 1. + 2w w_ Cov R , R _ - Used to model asset prices
Coefficient of Variation where Cov R , R _ = R R _ R , R _ - Positively skewed
CV = s X; measures dispersion relative to mean Correlation Continuously compounded return from t to t + 1:
Sharpe Ratio SSo
Cov R N , R rS,So = ln = ln 1 + R S,So
mean portfolio return risk-free return N, = Corr R N , R = SS
S} = RN RN
standard deviation of portfolio returns where R S,So is the effective annual rate
1 N, 1
Measures excess return per unit of risk. Sampling
Bayes Formula
Skewness Simple random sampling: Subset of population is
P Info Event P Event
Positive (right) skew: P Event Info = chosen at random
P Info
- Many outliers in right tail Systematic sampling: Every kth observation is
Counting Rules
- Mean > Median > Mode chosen until desired sample size is achieved
Factorial:
Negative (left) skew: Stratified sampling: Simple random samples are
n! = n n 1 n 2 1
- Many outliers in left tail drawn from each subpopulation (strata)
Combination:
- Mean < Median < Mode n! Sampling error: Difference between quantity
n
Zero skewness: O C> = = calculated from sample and its true value
r n r ! r!
- Distribution is symmetrical (e.g. normal) Counts ways to choose r items from n where order Central Limit Theorem (CLT)
- Mean = Median = Mode does not matter, or ways to label n items with 2 For a sample of size n 30 from a population with
1 ONno X N X \ different labels. mean and variance t (populations distribution
Sample skewness
n s\ Permutation: does not matter), the sample mean x
Kurtosis n! approximately follows a normal distribution with
Measure of peakedness of distribution relative OP> = mean and variance t n.
nr !
to a normal distribution. Counts ways to choose r items from n where Standard Error of Sample Mean
Leptokurtic: More peaked than a normal order does matter. Population variance is known: = n
Platykurtic: Less peaked than a normal Multinomial: Population variance is not known: s = s n
Mesokurtic: Same kurtosis as a normal n! Confidence Interval

Excess kurtosis: Kurtosis minus 3 (kurtosis of a no ! nt ! n ! Point estimate Reliability factor Std error
normal distribution is 3) Extension of combination concept; counts ways Point estimate: Estimate of population parameter
1 ONno X N X to label n items with k labels. Reliability factor: Value from distribution of point
Sample kurtosis
n s Discrete Uniform Distribution estimate, such as normal or t-distribution
Probability Rules 1
p x = , x = xo , x t , , x O Examples: x z t n; x t t s n
P AB = P A B P B = P B A P A n
Significance Confidence
P A or B = P A + P B P AB Binomial Distribution t
n level interval
P A = P A So P So + + P A SO P SO p x = p 1 p O , where
x 10% 90% 1.645
Independence
n = number of trials 5% 95% 1.960
P AB = P A P B
p = probability of success 1% 99% 2.575
P AB =P A
E X = np
Expected Value Biases
t X = np 1 p
O Sample selection bias: Excluding subsets of data
Binomial Model
E X = P XN XN because of data availability
Describes asset price movements. Price either
Nno Survivorship bias: A type of sample selection
E X = E X So P So + + E X SO P SO moves up with probability p or down with
bias where funds or companies that no longer
Variance probability 1 p.
exist are excluded
O Continuous Uniform Distribution
Look-ahead bias: Information needed is not
t X = P XN XN E X t
1
f x = , a x b available on the test date
Nno ba
Covariance xa Time-period bias: Data is based on time period
F x = , a x b
O O
ba that makes the results time-period specific
Cov X, Y = P X N , YN X N E X YN E Y
Nno no

Cov X, X = t X

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Steps in Hypothesis Testing Tests Concerning a Single Variance Stochastic Oscillator:
1. State hypotheses (null and alternate). Normal population: Last closing price Low in past 14
%K = 100
2. Select test statistic. n 1 st 1
O High in past 14 Low in past 14
3. Specify significance level. t = , st = xN x t %D = average of last 3 daily %K values
th n1
Nno
4. State decision rule. Moving-average convergence/divergence (MACD)
Degrees of freedom = n 1
5. Collect data; calculate test statistic. oscillator: Consists of MACD line and signal line.
Tests Concerning Two Variances
6. Make decision regarding hypothesis. MACD line is the difference between two
Normal populations:
7. Make economic or business decision. O exponentially smoothed moving averages (12 and
Test Statistic (General) sot 1 t 26 days). Signal line is the exponentially smoothed
F= t, st = xN x for j = 1, 2
Sample statistic Hypothesized value st n 1 average of MACD line (9 days)
Nno

Standard error of sample statistic Degrees of freedom 1 = no 1 Sentiment Indicators
Errors Degrees of freedom 2 = nt 1 Put/call ratio: Volume of put options traded
Decision h True o False Technical Analysis: Charts divided by volume of call options traded
Do not reject Hh Correct Type II Bar chart: Shows open, close, low, and high price. CBOE Volatility Index (VIX): Measures near term
Reject Hh Type I Correct Candlestick chart: Shows open, close, low, and high market volatility calculated by the CBOE
Power of a test = 1 P Type II error price. White body means close > open; dark body Short interest ratio: Number of shares sold short
Hypothesis Test Results means close < open. divided by the average daily trading volume
Type Hypotheses Reject null if Trends Flow-of-Funds Indicators
One-tailed Hh : h Test statistic > Support: Low price range where buying is Arms index (or TRIN): Measures relative extent to
(upper) HP : > h critical value sufficient to stop further decline which money is moving into and out of rising and
One-tailed Hh : h Test statistic < Resistance: High price range where selling is declining stocks
(lower) HP : < h critical value sufficient to stop further increase Mutual fund cash position: Percentage of mutual
Test statistic < Reversal Patterns fund assets held in cash
Hh : = h lower or > Head and shoulders (H&S): Indicate an upcoming Cycles
Two-tailed downtrend following a preceding uptrend Kondratieff wave: 54-year long economic cycles
HP : h upper critical
Inverse H&S: Indicate an upcoming uptrend Elliott Wave Theory
value
following a preceding downtrend Market moves in regular, repeated waves.
Tests Concerning a Single Mean Price target = Neckline Head Neckline Wave sizes: grand supercycle, supercycle, cycle,
Population is normal with known variance: Double/Triple tops: When an uptrend reverses primary, intermediate, minor, minute, minuette,
x h two/three times at about the same high and subminuette.
z-statistic =
n Double/Triple bottoms: When a downtrend Market waves follow ratios of numbers in
Large sample from any population with unknown reverses two/three times at about the same low Fibonacci sequence.
variance (2 choices): Continuation Patterns
x h
t-statistic = , degrees of freedom = n 1 Ascending triangle: Highs form horizontal line;
s n lows form uptrend ECONOMICS ECONOMICS
x h Demand
z-statistic = Descending triangle: Highs form downtrend;
s n lows form horizontal line Demand function: Describes quantity demanded
Small sample from normal population with for a good as a function of own-price, price of
Symmetrical triangle: Highs form downtrend;
unknown population variance: another good, income, and other factors.
lows form uptrend
x h Demand curve: Graphs own-price (y-axis) against
t-statistic = , degrees of freedom = n 1 Rectangle: Highs and lows form horizontal lines
s n quantity demanded (x-axis) for a particular good;
Flag: Parallel trend lines over short period
Tests Concerning Differences between Means typically downward-sloping.
Pennant: Converging trend lines over short period
Normal populations with unknown variances that Movement along demand curve: Quantity
Price-Based Indicators
are assumed equal: demanded changes as own-price changes.
Moving average: Average closing price over a
xo xt o t Change in demand: Changes other than own-price
t-statistic = o t
specified number of periods
sRt sRt will cause demand curve to shift left or right.
+ Golden (Dead) cross: When short-term moving
no nt Supply
t average crosses long-term moving average from
n 1 s + nt 1 stt
sRt =
o o
below (above) Supply function: Describes quantity supplied as a
no 1 + nt 1
Bollinger bands: Lines representing moving function of own-price, wage rate paid to labor, and
Degrees of freedom = no + nt 2
average and moving average +/ set number of other factors.
Normal populations with unknown variances that
standard deviations from average price Supply curve: Graphs own-price (y-axis) against
are assumed unequal:
Momentum Oscillators quantity supplied (x-axis) for a particular good;
xo xt o t
t-statistic = Rate of Change (ROC) Oscillator: typically upward-sloping.
o t
sot stt Movement along supply curve: Quantity supplied
+ M = V Vx 100
no nt
t V = last closing price changes as own-price changes.
sot stt
+ Vx = closing price x days ago, typically 10 Change in supply: Changes other than own-price
no nt
Degrees of freedom = t will cause supply curve to shift left or right.
so no t st n t ROC oscillator crossing 0 in the same direction as
+ t t
no nt the trend direction is buy/sell signal
Tests Concerning Mean Differences Relative Strength Index:
Normal populations with unknown variances: 100 Up changes
RSI = 100 , RS =
d Jh 1 + RS Down changes
t-statistic = , degrees of freedom = n 1
sJ

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Market Equilibrium Income and Substitution Effects Perfect Competition
Quantity demanded equals quantity supplied at Price of Good X decreases: - Many firms
equilibrium price. Substitution Consumption - Identical products
Income effect
Equilibrium is stable if price departure will cause effect of Good X - Very low barriers to entry
price to converge back to equilibrium. Positive Positive Increase - Firms have no pricing power
Equilibrium is unstable if price departure will Negative Profit maximization:
cause price to diverge away from equilibrium. Positive (smaller than Increase - P = MR = MC
Auctions substitution) - P > ATC implies economic profit
Ascending price: Potential buyers openly bid, Negative - P < ATC implies economic loss
starting from a low price. Highest bid wins. Positive (larger than Decrease Monopolistic Competition
First price sealed bid: Bids are not revealed until substitution) - Many firms
end of auction. Highest bid wins. Normal good: Positive income effect - Differentiated products (via advertising)
Second price sealed bid (Vickery): Like first price Inferior good: Negative income effect - Low barriers to entry
sealed bid but winner pays second-highest bid. Giffen good: Negative income effect larger than - Firms have some pricing power
Descending price (Dutch): Price is incrementally positive substitution effect Profit maximization:
lowered until all units are sold. Each bidder pays Veblen good: Higher price increases demand - MR = MC
his/her own bid price. Profit Measures Oligopoly
Modified Dutch: Same as the regular Dutch except Accounting profit = Total revenue - Few firms
all bidders pay the last bid price. Total accounting costs - Similar products (close substitutes)
Surpluses Economic profit = Total revenue - High barriers to entry
Consumer surplus: Area of triangle above price Total economic costs - Firms have substantial pricing power
and below demand curve. Economic profit = Accounting profit (price collusion possible)
Producer surplus: Area of triangle below price Total implicit costs Profit maximization:
and above supply curve Normal profit = Accounting profit - MR = MC
Deadweight loss: Loss of surplus, such as from Economic profit Monopoly
price ceiling, price floor, or per-unit tax. Revenue Terms - One firm
Own-Price Elasticity of Demand Total revenue (TR): Price times quantity; P Q - Highly differentiated product
%QJ Average revenue (AR): TR Q - No close substitutes for product
ERJ =
%P Marginal revenue (MR): TR Q - Significant barriers to entry
ERJ > 1: elastic Cost Terms - Firm has considerable pricing power
ERJ < 1: inelastic Total fixed cost (TFC): Sum of fixed costs (price discrimination)
ERJ = : perfectly elastic Total variable cost (TVC): Sum of variable costs Profit maximization:
Total costs (TC): TFC + TVC - MR = MC
ERJ = 0: perfectly inelastic
Average fixed cost (AFC): TFC Q Market Power Measures
Income Elasticity of Demand
Average variable cost (AVC): TVC Q N-firm concentration ratio: Sum of market share
%QJ QJ I
EJ = = Average total cost (ATC): AFC + AFV or TC Q of the N largest firms in the industry
%I I QJ
Marginal cost (MC): TC Q Herfindahl-Hirschman Index (HHI): Sum of squares
EJ > 0: normal good of market share of the N largest firms
Shutdown & Breakeven
EJ < 0: inferior good Gross Domestic Product (GDP)
Perfect competition:
Cross-Price Elasticity of Demand Nominal GDP: GDP in terms of current prices
AR = ATC: Break even
%QJ QJ PQ Real GDP: GDP in terms of base-year prices
ERJ = = AR ATC: Stay in the market
%PQ PQ QJ GDP deflator: Nominal GDP Real GDP 100
AVC AR < ATC: Stay in short run; exit in long
ERJ > 0: substitutes AR < AVC: Shut down in short run; exit in long GDP = C + I + G + X M
ERJ < 0: complements Imperfect competition: C = consumption; I = investment
Indifference Curves TR = TC: Break even G = government spending
- Combinations of two goods with equal utility. TC > TR > TVC: Continue operation in short run; X = exports; M = imports
- Slopes downward and convex towards origin. shutdown in long run National Income
- Slope at any point is marginal rate of substitution TR < TVC: Shutdown in short and long run Sum of:
(MRS), the rate at which consumer will exchange Productivity - Employee compensation
Good X for Good Y. Marginal revenue product (MRP) of labor: - Corporate and government pretax profit
- Same consumers curves cannot cross. Change in TR Change in quantity of labor - Interest income
Budget Constraint Profit maximization: - Unincorporated business net income
For 2 goods, X and Y, the budget constraint is MRPo MRPO - Rent
== = 1 - Indirect business taxes, less subsidies
represented by P Q + P Q Income. Price of input 1 Price of input n
Consumer Equilibrium Personal Income
Point where highest indifference curve is attained = National income Indirect business taxes
without violating budget constraint, i.e. budget Corporate income taxes
constraint is tangent to indifference curve. Undistributed corporate profits
+ Transfer payments

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Expenditure and Income Equality Monetary Policy Exchange Rate Calculations
GT = SI XM Required reserves CPI
Required reserve ratio = Real ex. rateJ = Nominal ex. rateJ
G T = fiscal balance Total deposits CPIJ
S I = savings minus domestic investment Money multiplier = 1 Reserve requirement Forward exchange rateJ 1 + iJ
=
X M = trade balance Fisher effect: R OM;NOP = R >LP + L Spot exchange rateJ 1 + i
IS and LM Curves Central Bank Roles Cross rate: S _ = S S _
IS curve: Negative relationship between real - Sole currency supplier Forward exchange rates in points:
interest rates and real income (goods market) - Bank of banks and government - Unit of points is last decimal place in spot
LM curve: Positive relationship between real - Regulate and supervise payments system exchange rate quote
interest rates and income (money market) - Lender of last resort - Example: If spot exchange rate is quoted in 4
Quantity theory of money: MV = PY - Gold and foreign exchange reserves holder decimal places, each point is 0.0001.
M = real money supply; V = money velocity - Operate monetary policy Exchange Rate Regimes
P = price level; Y = real GDP Tools to Implement Monetary Policy Formal dollarization: No own currency; adopt
Factors Increasing Aggregate Demand (AD) Policy rate: Expansionary when less than neutral another countrys currency
- Increased consumer wealth interest rate; contractionary otherwise Monetary union: Adopt common currency
- Optimistic business expectations Reserve requirement: Increase/decrease funds Currency board: Commitment to exchange
- Expectations of higher consumer income available for lending and money supply domestic currency for specified foreign currency at
- High capacity utilization Open market operations: Buy/sell government fixed exchange rate
- Expansionary policies (monetary and fiscal) bonds to increase/decrease money supply Fixed peg: Currency is pegged to foreign currency
- Depreciating exchange rate Fiscal Policy: Spending Tools (or basket of currencies) within 1% margin
- Increased global economic growth Transfer payments: Redistribution of wealth (e.g. Target zone: Fixed peg with wider margin
Factors Increasing SR Aggregate Supply (AS) Social Security and unemployment benefits) Crawling peg: Exchange rate is pegged and
- Increased labor productivity Current spending: Spending on goods and services adjusted periodically
- Decreased input prices Capital spending: Spending on infrastructure Crawling bands: Margin increases over time,
- Expectations of higher output prices Fiscal Policy: Revenue Tools usually to transition from fixed peg to floating
- Decrease in business taxes/increase in subsidies Direct taxes: Tax on income (e.g. income taxes, Managed floating: Monetary authority intervenes
- Appreciating exchange rate corporate taxes, capital gains taxes) to manage exchange rate without a target level
Factors Increasing LR Aggregate Supply (AS) Indirect taxes: Tax on goods and services Independently floating: Exchange rate is
- Increased supply and quality of labor Fiscal Multiplier market determined
- Increased supply of natural resources 1
= , where MPC = marginal
- Increased stock of physical capital 1 MPC 1 t
Technological improvements propensity to consume; t = tax rate FINANCIAL REPORTING AND ANALYSIS
FINANCIAL REPORTING
Business Cycle Phases Gains from Trade Accrual Accounting
Trough (lowest point) Absolute advantage: Can produce at lower cost Cash movement before accounting recognition:
Expansion (comes after trough) Comparative advantage: Opportunity cost of - Unearned revenue: Liability; cash received before
Peak (highest point) producing good is lower good or service provided
Contraction (comes after peak) Trade Restrictions - Prepaid expenses: Asset; cash paid before
Business Cycle Theories Tariffs: Taxes on imported goods expense incurred
Neoclassical: Free market; invisible hand Quotas: Limits on quantity of imported goods Cash movement after accounting recognition:
Austrian: Neoclassical plus money and government Export subsidies: Government payment to - Accrued revenue: Asset; cash not yet received
Keynesian: Advocate government fiscal policy exporting firms after good or service provided
Monetarist: Maintain steady money supply growth Minimum domestic content: Minimum domestic - Accrued expenses: Liability; cash not yet paid for
New classical: Applies microeconomic analysis product requirement in goods expenses incurred
to macroeconomics Voluntary export restraint: Voluntarily limiting FASB, IASB, and IOSCO
Unemployment exports, often to avoid tariffs or quota FASB: Sets forth Generally Accepted Accounting
Unemployed: Jobless people who are seeking jobs Regional Trading Blocs Principles (GAAP) in the U.S.
Labor force: People with a job or unemployed Free trade area (FTA): No barriers to flow of goods IASB: Establishes International Financial Reporting
Unemployment rate: Unemployed Labor force and services among members Standards (IFRS) outside the U.S.
Type Result of Customs union (CU): FTA + common trade policy FASB-IASB Convergence: In May 2014, FASB and
among non-members IASB each issued converged standard for
Frictional Temporary transitions
Common market (CM): CU + free movement of revenue recognition.
Structural Long-run changes in economy
factors of production among members IOSCO: Not a regulatory authority but
Cyclical Changes in economic activity
Economic union (EU): CM + common economic members regulate most of the worlds
Inflation institution and coordination of economic policies financial capital markets
Deflation: Negative inflation rate Monetary union (MU): EU + common currency Income Statement Components
Disinflation: Declining inflation rate Balance of Payments Components Gross profit: Revenue less direct costs to produce
Hyperinflation: Extremely high inflation rate Current account: Merchandise and services, income good or service
Cost-push: From decrease in aggregate supply receipts, unilateral transfers Operating profit: Gross profit less selling, general,
Demand-pull: From increase in aggregate demand Capital account: Capital transfers, non-financial and administrative expenses
Laspeyres index: Use base consumption basket assets sales/purchases
Paasche index: Use current consumption basket Financial account: Government-owned assets
Fisher index: Laspeyres Paasche abroad, foreign-owned assets in the country

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Revenue Recognition Methods IFRS: Purchases
Payables turnover =
Percentage-of-completion: Item Classification Average trade payables
- Used under IFRS and U.S. GAAP when outcome of Dividends paid Operating/Financing Number of days 365
=
long-term contract can be reliably measured. of payables Payables turnover
Interest paid Operating/Financing
- Revenue, expense, and profit are recognized Number of days 365
Dividends received Operating/Investing =
of payables Payables turnover
based on percentage of completion. Interest received Operating/Investing
Revenue
- Percentage of completion is cost incurred to date Income taxes Operating Total asset turnover =
Average total assets
divided by total expected cost. Tax expense from
Investing Revenue
Completed contract: investing transaction Fixed asset turnover =
Average net fixed assets
- Used under U.S. GAAP when outcome of long- Tax expense from Revenue
Working capital
term contracts cannot be reliably measured. Financing =
financing transaction turnover Average working capital
- Revenue, expense, and profit are recognized only
Liquidity Ratios
when the contract is complete. CFO Direct Method Current assets
- Under IFRS, revenue is recognized to the extent of - Convert each accrual-based item in the income Current ratio =
Current liabilities
contract costs, which means profit is recognized statement to cash inflow/outflow. Marketable
Cash + + Receivables
at completion. - CFO is net of cash inflows and outflows. Quick ratio = securities
Current liabilities
Installment & Cost recovery: CFO Indirect Method
Cash + Marketable securities
- Under U.S. GAAP, if collectivity is certain, revenue - Start with net income Cash ratio =
Current liabilities
is recognized at time of sale. Profit is cash - Add noncash expenses Marketable
Cash + + Receivables
collected multiplied by expected profit as - Subtract gains/adding losses from financing or Defensive securities
=
investing cash flows interval Average daily expenditures
percentage of revenue
- Add/subtract asset and liability adjustments Cash Days of Days of Number
- If collectivity is uncertain, use the cost recovery
conversion = sales + inventory of days
method, where profit is only recognized when the based on accrual accounting cycle outstanding payables
on hand
project cost is recovered Free Cash Flow (FCF) Solvency Ratios
Earnings per Share Measures cash available for discretionary purposes Total debt
Net income Preferred dividends Free cash flow to the firm (FCFF): Cash available to Debt-to-equity =
Basic = Total shareholders' equity
Weighted average of shares outstanding equity owners and debt holders. Total debt
Diluted = FCFF = NI + NCC + I 1 t FCI WCI Debt-to-capital =
Total shareholders'
Total debt +
Convertible Convertible FCFF = CFO + I 1 t FCI equity
Net Preferred
+ preferred + debt 1 Total debt
income dividends
dividends interest NI = net income Debt-to-assets =
Total assets
Weighted Shares from Shares from Shares issuable NCC = noncash charges (e.g. depreciation)
average + preferred + convertible + from stock Average total assets
options
I = interest expense Financial leverage =
shares shares debt Average total equity
Only include potentially dilutive security in FCI = fixed capital investment
EBIT
calculation after checking that it is dilutive. WCI = working capital investment Interest coverage =
Interest payments
Balance Sheet Components Free cash flow to equity (FCFE): Cash flow available
Fixed EBIT + Lease payments
Accounts receivable: Reported at net realizable to common shareholders charge =
coverage Interest payments + Lease payments
value based on bad debt expense. Bad debt FCFE = CFO FCI + NB
expense increases allowance for doubtful accounts, NB = net borrowing = debt issued debt repaid Profitability Ratios
Common-Size Analysis Net income
which contras accounts receivables. Net profit margin =
Vertical: Revenue
Inventory: Gross profit
IFRS LIFO not permitted; inventories reported at - Represent each item on income statement as Gross profit margin =
Revenue
lower of cost or net realizable value. percentage of revenue. EBIT
- Represent each item on balance sheet as Operating profit margin =
U.S. GAAP LIFO permitted; inventories reported Revenue
at lower of cost or market. percentage of total assets. EBT
Pretax margin =
Property, plant, and equipment (PP&E): - Represent each item on cash flow statement as Revenue
percentage of total cash inflows/outflows. Net income
IFRS can be reported using cost model or Return on assets ROA =
Horizontal: Average total assets
revaluation model; recoverable amount is greater
EBIT
of (1) fair value less selling costs, and (2) value in - Express each item relative to its value in a Return on total capital =
Average total capital
use (PV of assets future cash flow stream); loss common base period
Net income
recoveries are allowed. Activity Ratios Return on equity ROE =
Average total equity
U.S. GAAP only cost model is allowed; loss Annual sales
Receivables turnover = Valuation Ratios
Average receivables
recoveries not allowed. Dividends declared
Days of sales 365 Dividend payout ratio =
Cash Flow Statement Components = NI available to common
outstanding Receivables turnover
U.S. GAAP: Retention rate RR = 1 Dividend payout ratio
Cost of goods sold
Item Classification Inventory turnover = Sustainable growth rate g = RR ROE
Average inventory
Dividends paid Financing Price per share
Days of inventory 365 P/E Ratio =
Interest paid Operating = Earnings per share
on hand Inventory turnover
Dividends received Operating
Interest received Operating
All taxes Operating

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DuPont Analysis U.S. GAAP Leases
Net income Revenue - Generally, both research and development costs Finance (Capital) lease:
ROE = are expensed.
Revenue Equity - Purchase of asset financed with debt
ROE = Net profit margin Equity turnover Acquired in business combination:
- Lessee will recognize asset value in balance sheet
Net income Revenue Assets Acquirer allocates purchase price to each
ROE = and report depreciation expense.
Revenue Assets Equity asset acquired on fair value basis; excess
Operating lease:
Net profit Asset Leverage recorded as goodwill
ROE = - Rental arrangement
margin turnover ratio Capitalizing vs. Expensing
NI EBT EBIT Revenue Assets
- Lessee will not recognize asset/liability on
- Capitalizing increases assets on the balance sheet
ROE = balance sheet but will make periodic lease
EBT EBIT Revenue Assets Equity and increases investing cash outflow on the
ROE =
Tax Interest EBIT Asset Financial
statement of cash flows. payments recognized as rental expense.
burden burden margin turnover leverage
- Expensing reduces net income by the after-tax Conditions requiring a lease to be a finance lease:
Inventory Valuation Methods and Systems
expenditure amount in the period it is incurred. IFRS
Specific identification:
Impairment of PP&E and Intangible Assets - Title transferred to lessee at end of lease.
- Each unit sold is matched with its actual cost.
U.S. GAAP: - Bargain purchase option available to lessee.
- Permissible under U.S. GAAP and IFRS.
- Asset tested for impairment only when firm may - Lease term is majority of assets economic life.
Weighted average cost:
not recover carrying value through future use. - PV of lease payment is close to fair value.
- Average cost/unit is cost of goods available for
- Asset is impaired when carrying value exceeds - Asset is so specialized that only lessee can use
sale divided by quantity available for sale.
assets future undiscounted cash flows. asset without significant modifications.
- Permissible under U.S. GAAP and IFRS.
- Impaired assets value is written down to fair U.S. GAAP (lease must be treated as finance lease if
First-in, first-out (FIFO):
value and a loss is recognized. any of the following criteria are met)
- Assume first item purchased is first item sold.
- Loss recoveries are not permitted. - Title transferred to lessee at end of lease.
- Permissible under U.S. GAAP and IFRS.
IFRS: - Bargain purchase option available to lessee.
Last-in, first-out (LIFO):
- Asset tested for impairment annually. - Lease period is 75% of assets economic life.
- Assume last item purchased is first item sold.
- Asset is impaired when carrying value exceeds - PV of lease payments is 90% of fair value.
- Permissible under U.S. GAAP but not IFRS.
recoverable amount. Pension
Perpetual vs. periodic inventory system:
- Impaired assets value is written down to Defined contribution: Firm periodically contributes
- Perpetual system matches each unit sold with
recoverable amount and a loss is recognized. to employees retirement account during
immediate prior purchases.
- Loss can be reversed if asset value recovers, but employment. Employer contribution is expensed in
- Periodic system matches total units sold for the
only up to carrying value before impairment loss period incurred.
period with total purchases for the same period.
was recognized. Defined benefit: Firm makes periodic payments to
Under FIFO, ending inventory and COGS are the
Income Taxes employee after retirement. Over- (under-) funded
same for periodic or perpetual. Under weighted
Deferred tax assets (DTA): Created when taxes plan recognized as asset (liability).
average cost and LIFO, they may be different.
payable exceeds income tax expense due to Financial Reporting Quality Spectrum
LIFO reserve: Must be reported by firms using LIFO
temporary differences. Examples: 1. Compliant with GAAP; decision useful; adequate
method; used to adjust LIFO COGS and ending
- Assets tax base > carrying amount and sustainable earnings
inventory (EI) to FIFO-equivalent values.
- Liabilitys carrying amount > tax base 2. Compliant with GAAP; decision useful;
EI = EI + LIFO Reserve
Deferred tax liabilities (DTL): Created when taxes inadequate and unsustainable earnings
COGS = COGS LIFO Reserve
payable is less than income tax expense due to 3. Compliant with GAAP; reporting choices biased;
Income tax = Income tax
temporary differences. Examples: inadequate and unsustainable earnings
+ LIFO Reserve t
- Assets carrying amount > tax base 4. Compliant with GAAP; earnings actively
LIFO liquidations:
- Liabilitys tax base > carrying amount managed (increased/decreased/smoothed)
- Caused when units sold exceed units purchased
Tax base of assets: Amount that will be deducted on 5. Not compliant with GAAP; numbers presented
for LIFO company
the tax return as assets benefits are realized. based on companys actual economic activities
- May result in higher gross profit than otherwise
Tax base of liabilities: Carrying value of liability 6. Not compliant with GAAP; numbers fictitious
Depreciation Methods
minus amount that will be deductible on the or fraudulent.
Straight-line:
tax return. Aggressive vs. Conservative Accounting
Cost Salvage value
Depreciation = Impact of tax rate changes: Aggressive Conservative
Depreciable life
Income tax = Taxes payable + DTL DTA Costs capitalized Costs expensed
Double-declining balance (DDB):
Bonds Longer useful life Shorter useful life
2
DepreciationS = Book valueS Premium bond: Coupon rate > yield at issuance Higher salvage value Lower salvage value
Depreciable life
Units-of-production: Discount bond: Coupon rate < yield at issuance Straight-line method Accelerated method
Cost Salvage Zero-coupon bond: Bond with no coupons Delayed impairment Early impairment
DepreciationS = Output unitsS Issuance costs: U.S. GAAP capitalized as an asset;
Total output recognition recognition
Intangible Assets IFRS reduces initial bond liability Smaller allowance Larger allowance for
Purchased: Record at fair value (assumed equal to Derecognition of debt: If an issuer redeems a bond for doubtful accounts doubtful accounts
purchase price) before maturity, a gain/loss (book value minus
Developed internally: redemption price) is recognized.
IFRS Debt covenants: Affirmative borrower promises
- Research expenditures are expensed. to do certain things; negative borrower promises
- Development expenditures are capitalized. to refrain from certain things.

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CORPORATE FINANCE
CORPORATE FINANCE Measures of Leverage PORTFOLIO MANAGEMENT
PORTFOLIO MANAGEMENT
Net Present Value (NPV) Degree of operating leverage (DOL): Portfolio Management Process
I
CFN % Operating income Q PV Planning: List objectives and constraints in IPS
NPV = Outlay DOL = =
1+r N % Units sold Q PV F Execution: Asset allocation, security analysis,
Nno
Degree of financial leverage (DFL): portfolio construction
Ignore sunk costs.
% Net income Q PV F Feedback: Monitoring and rebalancing,
Use worksheet function on BA II Plus: DFL = =
% Operating income Q P V F C performance measurement and reporting
- Cash inflows are positive; outflows are negative.
Degree of total leverage (DTL): Risk Management
- F01, F02, etc. refer to cash flow frequencies. % Net income Q PV
DTL = = Risk management framework:
- CPT + NPV to compute NPV; CPT + IRR for IRR. % Units sold Q PV FC - Risk governance
NPV decision rules: DTL = DOL DFL - Risk identification and measurement
- Accept projects with positive NPV. Breakeven - Risk infrastructure
- Reject projects with negative NPV. F+C
Breakeven: Q _ = - Defined policies and processes
- If only one of multiple mutually exclusive projects PV
- Risk monitoring, mitigation, and management
can be accepted, accept project with highest NPV. F
Operating breakeven: Q _ = - Communications
Internal Rate of Return (IRR) PV
Q = quantity; P = price; V = variable cost/unit - Strategic analysis or integration
IRR is r such that NPV = 0.
F = fixed operating cost; C = fixed financial cost Risk tolerance: Which risks are acceptable and how
IRR decision rules:
Dividends much risk should be taken
- Accept if IRR > required rate of return.
- Cash dividends and stock dividends do not affect Risk budgeting: How the risks should be taken
- Reject if IRR < required rate of return.
shareholder wealth. Financial risks: Arise from financial market
- Go with NPV decision if IRR decision does not
- Stock splits are essentially stock dividends. activities (e.g. market, credit, liquidity risk)
match NPV decision.
Payment chronology: Non-financial risks: Arise from within entity or
Payback Period
- Declaration date company declares dividend from external (e.g. operational, legal, regulatory,
- Number of years required for cumulative cash
- Ex-dividend date two days before HOR date political, model, tail risk)
flows to equal initial investment.
- Holder-of-record (HOR) date shareholders Risk measures: Standard deviation, beta, duration,
- Does not take into account time value of money.
listed on company records will be deemed to have delta, gamma, VaR, CVaR, etc.
Discounted Payback Period
ownership of shares to receive dividends Risk modification: By prevention and avoidance,
Number of years required for cumulative
- Payment date company pays dividends transfer (insurance), or shifting (derivatives)
discounted cash flows to equal initial investment.
Share Repurchases Indifference Curve
Profitability Index (PI)
PV of future cash flows NPV Changes in earnings per share (EPS): E(Ri) Moderate'Risk
PI = =1+ Cost of debt < Earnings yield EPS increases High'Risk Aversion
CFh CF
Aversion
Accept if PI > 1; reject if PI < 1. Cost of debt > Earnings yield EPS decreases Low'Risk

Expected'Return
Aversion
Crossover Rate Changes in book value per share (BVPS):
Risk'Neutral
- Rate at which NPV profile of two projects cross. Stock price < BVPS BVPS increases
- Calculated as IRR of difference in cash flows. Stock price > BVPS BVPS decreases
Weighted Average Cost of Capital (WACC) Working Capital Management Risk'Seeking
WACC = wJ k J 1 t + wR k R + wL k L Primary sources of liquidity: Sources from normal
wJ = percentage of debt in capital structure daily operations (e.g. cash balances, short-term
wR = percentage of preferred stock funding, collections/payments management) 0 !i
Secondary sources of liquidity: Sources that may Standard'Deviations
wL = percentage of common stock
change a companys financial and operating Minimum-Variance Portfolios
t = tax rate
positions (e.g. asset liquidation, renegotiation of
k J = cost of debt E(Rp)
debt, bankruptcy protection, reorganization)
k R = cost of preferred stock = DR P Markowitz(EfDicient(Frontier
Drag on liquidity: Delayed cash inflows
k L = cost of common stock Pull on liquidity: Accelerated cash outflows
Expected(Return

k L = Do Ph + g dividend discount model Cost of trade credit (CTC): Cost of not taking the
k L = R + E R ; R CAPM discount for early payment
k L = R + E R ; R + CRP revised CAPM
\]^ Minimum<Variance
%discount JPQ RPS JNMKOS
CTC = 1 + 1 Global( Frontier
Pure-Play Method Project Beta 1 %discount Minimum<
Delevered asset beta for comparable company: Corporate Governance Variance
- Board should be independent of management. Portfolio
1 - Audit committee should resolve conflicts
PLS = LKNSQ 0 !p
DM;RP>PL between auditor and management in a way that
1 + 1 t M;RP>PL Portfolio(Standard(Deviations
EM;RP>PL
favors shareholders. Capital Allocation Line (CAL)
Relevered project beta for subject firm: - Compensation committee should
Line representing possible combinations of risk-
DKLS provide shareholders with executive
R>MLS = PLS 1 + 1 t KLS free assets and optimal risky asset portfolio.
EKLS compensation information.
E RN R
Flotation Costs - Firms should have strong code of ethics. E RR = R + R
N
Correct way to account for flotation costs is to - Confidential voting and remote proxy voting
promote shareholder interests. Capital Market Line (CML)
adjust initial investment, not to increase WACC.
Takeover defenses (provisions to make CAL with risky portfolio being market portfolio.
company less attractive to hostile bidder) harm E RR = R +

R

shareholder interests.

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Borrowing vs. Lending Ratios Weighting
Sharpe RR R PN
wN =

Total risk
Price I
ratio R no P

M- ; 1
RR R R; R Equal wN =
squared R N
fN Q N PN
Treynor RR R Market capitalization wNf =

Systematic
I
no f Q P
ratio R

risk
FN
Jensens Fundamental wN = I

R R R + R R ; R no F
alpha

Behavioral Finance
Investment Policy Statements (IPS) - Loss aversion: Dislike losses
Investment objectives: Risk objectives, - Overconfidence: Overconfident in abilities
return objectives - Representativeness: Rely too much on current
Beta Constraints: Liquidity, time horizon, tax concerns, state when assessing probabilities
Systematic risk = Non-diversifiable / market risk legal and regulatory factors, unique circumstances - Gamblers fallacy: Estimate future probabilities
Unsystematic risk = Diversifiable risk Asset Allocation based on recent outcomes
Total risk = Systematic risk + Unsystematic risk Strategic asset allocation: Set of exposures to IPS- - Mental accounting: Keep track of gains and losses
Cov R N , R ; N,; N permissible asset classes expected to achieve the separately for different investments
N = =
t; ; clients long-term objectives - Conservatism: Slow to make changes
Capital Asset Pricing Model (CAPM) Tactical asset allocation: Decision to deliberately - Disposition effect: Avoid realizing losses and seek
Assumptions: deviate from policy exposures to systematic risk to realize gains
- Investors are risk-averse, utility-maximizing, factors intended to add value based on forecasts of - Narrow framing: Focus on issues in isolation
near-term returns of those asset classes. Forms of Market Efficiency
rational individuals.

- Markets are frictionless. Market Prices Reflect:

- All investors plan for same single holding period. Past market Public Private
EQUITY EQUITY Form
- Investors have homogeneous expectations. data info info
Positions
- Investments are infinitely divisible. Weak
Long positions are owned and benefit from
- Investors are price takers. Semi-strong
price appreciation.
E R R = R + N E R ; R Short positions are owned and benefit from Strong
Security Market Line (SML) price depreciation.

Porters Five Forces Framework

Graphical representation of CAPM: Leveraged Positions
- Threat of substitute products
SML Position
E(Rp) Leverage ratio = - Bargaining power of customers
Equity
- Bargaining power of suppliers
Maximum initial leverage ratio
1 - Threat of new entrants
E(Rm) M
Expected*Return

!i =*!m = - Intensity of rivalry

Intial margin requirement
8R i Industry Life Cycle
Rm Margin Call Price
*=* Embryonic
pe Ph 1 Initial margin
Slo
1 Maintenance margin Slow growth, high prices, high failure risk,
Rf Orders significant investment required
Execution instruction: How to fill the order Growth
0 !i
(e.g. market order, limit order) Rapidly increasing demand, improving
1.0
Beta Validity instruction: When the order may be filled profitability, falling prices, low competition

(e.g. day order, fill or kill)
Identifying Mispriced Stocks Shakeout
Clearing instruction: How to settle the trade
SML Slowing growth, intense competition,
E(Rp) Price Return Index
I declining profitability
Stock Z Nno nN PN
Stock X V = Mature
D
Expected*Return

Price Return over Single Period Little or no growth, industry consolidation,

PNo PNh high entry barriers
Stock Y PR N =
PNh Decline
I
Vo Vh Negative growth, excess capacity,
Rf PR = = wN PR N high competition
Vh
Nno
Dividend Discount Model (DDM)
Total Return over Single Period
0 !i DS
PNo PNh + IncN
Beta TR N = Vh =
PNh 1+r S
Sno
Based on the graph above, I O
Vo Vh + Inc DS PO
- Stock X is underpriced. TR = = wN TR N Vh = +
Vh 1+r S 1+r O
- Stock Y is overpriced. Nno Sno

- Stock Z is fairly priced. Price Return Index over Multiple Periods Perpetual preferred stock; constant dividend:
V = Vh 1 + PR o 1 + PR t 1 + PR Dh
Vh =
Total Return Index over Multiple Periods r
V = Vh 1 + TR o 1 + TR t 1 + TR

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Gordon constant growth model: Yield Measures for Money Market Instrument: Convexity

Dh 1 + g S Dh (1 + g) Do Add-on Rate (AOR) Basis PV + PV 2 PVh
Vh = = = ApproxCon =
1+r S rg rg Days Yield t PVh
Sno PV = FV 1 + AOR
Year %PV K = AnnModDur Yield
g = Earning retention rate ROE Implied Forward Rate (IFR) 1
g = 1 Dividend payout ratio ROE _ + AnnConvexity Yield t
1 + z
1 + IFR ,_ = 1 + z_ _ 2
Multistage DDM: PV + PV 2 PVh
O Yield Spreads over Benchmark Yield Curve EffCon =
DS PO PMT PMT PMT + FV Curve t PVh
Vh = + PV = + + +
1+r S 1+r O 1 + zo + Z o 1 + zt + Z t 1 + zI + Z I Duration gap = Macaulay duration
Sno
DOo OAS = Z-spread Option value in basis points Investment horizon
PO =
r g Asset-Backed Securities Credit Analysis
DOo = Dh 1 + g O 1 + g Securitization Process E[Loss] = Pr(Default) Loss severity
Price Multiples - A special purpose vehicle (SPV) buys assets from Loss severity = 1 Recovery rate
Ph Do /Eo the seller firm and issues asset-backed securities Credit Ratings
= (ABS) against the assets.
Eo rg Investment grade: Baa3/BBB- and above
Price per share - A servicer (could be same entity as seller) collects
Non-investment grade: Ba1/BB+ and below
P B= funds and performs other related responsibilities.
Book value per share Four Cs of Credit Analysis
Residential Mortgage Loans
Price per share - Capacity
P CF = - Interest: fixed, adjustable, convertible
Cash flow per share - Collateral
- Amortization: full, partial, interest-only
Price per share - Covenants
P S= - Prepayment: penalty, no penalty
Net sales per share - Foreclosure: non-recourse, recourse - Character
Enterprise value EV Residential Mortgage-Backed Securities Yields and Spreads
= MV Common equity + MV Preferred stock - Agency RMBS issued by government agencies and Yield on a corporate bond is sum of:
+ MV Debt Cash + Short term investments must have conforming loans
- Real risk-free interest rate
- Non-agency RMBS issued by private companies
- Expected inflation rate
and may have non-conforming loans
- Maturity premium
FIXED INCOME FIXED INCOME - Pass-through rate: coupon rate on the MBS
- Prepayment risk: contraction (faster-than- - Liquidity premium
Callable Bonds
expected prepayments), extension (slower-than- - Credit spread
VPPL MOJ = VNon-callable bond VP
expected prepayments) Yield spread = Liquidity premium + Credit spread
Putable Bonds Return impact Modified duration Spread
- Prepayment rates are compared to the PSA
VKSPL MOJ = VNon-putable bond + VKS 1
benchmark CPR
Convertible Bonds + Convexity Spread t
Collateralized Mortgage Obligations 2
Conversion price: Price per share at which bond - Securities backed by pool of RMBS
can be converted into shares - Structured with tranches with varying exposures
Conversion ratio: Number of common shares to prepayment risks DERIVATIVES DERIVATIVES
each bond can be converted into - A sequential-pay CMO has principal and Forward Contract
Conversion value: Current share price prepayments paid to the tranches in sequence Value of -year forward contract at:
Conversion ratio - PAC CMO have predictable cash flows and
Initiation Vh T = 0
support tranches with more contraction or
Conversion premium: Convertible bonds price Expiration V T = S Fh (T)
extension risk
Conversion value Time t VS T = SS PVS benefit
Collateralized Debt Obligations
Bond Pricing with Spot Rates Securities backed by pool of debt obligations, such + PVS cost Fh (T) 1 + r S

PMT PMT PMT + FV as corporate bonds, leveraged bank loans, or credit Forward price of an asset:
PV = + + +
1 + zo o 1 + zt t 1 + zI I default swap on securities
Fh T = Sh 1 + r FV benefit + FV cost
CR: Coupon Rate; MDR: Market Discount Rate Duration
Forwards vs. Futures
MacDur
CR = MDR Price = Par Value Par ModDur = Compared to forwards, futures are:
1 +
CR < MDR Price < Par Value Discount K - standardized contracts traded on an exchange
%PV = AnnModDur Yield
CR > MDR Price > Par Value Premium - guaranteed by clearinghouse
PV PV
Flat Price, Accrued Interest, and Full Price ApproxModDur = - marked-to-market and settled daily
2 Yield PVh
PV K = PV PS + AI = PV 1 + r S ApproxModDur = ApproxMacDur 1 + r - regulated
AI = t T PMT PV PV Swaps
Yield Measures EffDur =
2(Curve) PVh Two parties exchange a series of cash flows.
Annual cash coupon payment PortfolioDur = wo Do + wt Dt + + wI DI Option Styles
Current yield =
Flat price - European options can only be exercised at
MoneyDur = AnnModDur PV K
Annual cash Amortized expiration.
+ PV K MoneyDur Yield
coupon payment gain/loss
Simple yield = PV PV - American options can be exercised at any time
Flat price Price value of a basis point =
2 during the life of the option.
Yield-to-call (YTC) = IRR assuming the bond is
Basis point value = MoneyDur 0.0001 Option Values
called early at the stated call price
Exercise/intrinsic value of a
Yield-to-worse = min YTC, yield-to-maturity
European call = Max 0, S X
Yield Measures for Money Market Instrument:
Exercise/intrinsic value of a
Discount Rate (DR) Basis
European put = Max 0, X S
Days
PV = FV 1 DR
Year

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Option Moneyness Hedge Fund Fees: Note:
Option Moneyness Call Put - 2 and 20 2% management fee and 20% - Always clear the TVM worksheet before
In-the-money SS > X SS < X incentive fee starting a new calculation.
- Hard hurdle rate incentive fee calculated on - For bonds, PMT and FV should have the same
At-the-money SS = X SS = X
returns above the hurdle rate sign, and opposite signs to PV.
Out-of-the-money SS < X SS > X
- Soft hurdle rate incentive fee calculated on Cash Flow Worksheet ( CF , NPV , IRR )
Factors Impacting Option Values entire return if hurdle rate is cleared For non-level payments
Increase in Call Put - High water mark incentive fee only applies to Input ( CF )
Value of underlying profits after previous losses have been recovered CF0: Initial cash flow
Exercise price Private Equity C01: 1st distinct cash flow after initial cash flow
Time to expiration * Leveraged buyouts: F01: Frequency of CO1.
Risk-free rate - Going private transactions C0n: nth distinct cash flow.
- Management buyouts current management F0n: Frequency of C0n.
Volatility of underlying
team is involved in the acquisition Note:
Payments on underlying
- Management buy-ins current management team - Always clear the CF worksheet before starting
Cost of carry is being replaced by the acquiring team a new calculation.
*Except for some deep-in-the-money put options Venture capital: - The use of F0n is optional. You can leave them as
Option Boundaries - Formative-stage financing angel investing, 1 and input repeating cash flows multiple times. If
European options: seed-stage financing, early stage financing you do so, C01 will be the cash flow at time 1, C02
ch Max 0, Sh X 1 + r - Later-stage financing after commercial will be the cash flow at time 2, and so on.
ph Max 0, X 1 + r Sh production and sales have begun but before IPO Output ( NPV , IRR )
American options: - Mezzanine-stage financing prepare to go public I: Effective interest rate per period (in %)
Ch ch ; Ph ph Exit strategies:
NPV + CPT : Solve for net present value
Ch Max 0, Sh X 1 + r Trade sale, IPO, recapitalization, secondary sales,
IRR + CPT : Solve for internal rate of return
Ph Max 0, X Sh write-off/liquidation

Put-Call Parity Real Estate

sh + p h = ch + X 1 + r Examples: Residential property, commercial real
CFA CANDIDATE CHECKLIST
CFA CANDIDATE CHECKLIST
Put-Call-Forward Parity estate, REIT investing, mortgage-backed securities,
Source:
F h T 1 + r + ph = ch + X 1 + r timberland, and farmland
http://www.cfainstitute.org/programs/cfaprogram/c
Option Strategies Real estate valuation: comparable sales, income,
ourseofstudy/Pages/candidate_checklist.aspx
Fiduciary call = Long call + Long risk-free bond and cost approaches
Several Months Before Exam Day
Protective put = Long asset + Long put Commodities
Review testing policies.
Covered call = Short call + Long asset Contango: Little/no convenience yield; futures
Confirm international travel passport is valid.
Option Strategies Profit price > spot price
Ensure you have the necessary travel
Long call Max 0, S X ch Backwardation: High convenience yield; futures
documents to get to the test center.
Short call Profit(Long call) price < spot price
The Month Before Exam Day
Long put Max 0, X S ph Roll yield: Spot price Futures price
Review and print your exam admission ticket on
Short put Profit(Long put) Futures price: Spot price 1 + + Storage
clean, blank paper.
Covered call Profit(Short call) Sh costs Convenience yield
If the name on your exam admission ticket does

Protective put Profit(Long put) Sh not match the name on your passport exactly,

update your name in your CFA Institute account
BA II PLUS CALCULATOR TIPS
BA II PLUS CALCULATOR TIPS
as soon as possible. Reprint your ticket after the
Basic Operations
ALTERNATIVE INVESTMENTS
ALTERNATIVE INVESTMENTS name change.
2ND : Access secondary functions (in yellow)
General Check directions to the test center and special
Compared to traditional investments, alternative ENTER : Send value to a variable instructions for travel and parking.
investments exhibit: 2ND + ENTER : Toggle between options Plan travel route to the test center.
- lower liquidity : Navigate between variables/options The Week Before Exam Day
- narrow manager specialization STO + 0 - 9 : Store current value into memory Plan to dress in layers as temperatures at test
- low correlation with traditional investments RCL + 0 - 9 : Recall value from memory centers can vary.
- less regulation and lower transparency Time Value of Money (TVM) Plan your lunch.
- limited historical risk and return data For annuity, loan, and bond calculations Review instructions for filling out answer sheet.
- unique legal and tax considerations N : Number of periods Review the CFA exam personal belongings
Hedge Funds I/Y : Effective interest rate per period (in %) policy (link at end of section).
Strategies: What to Bring to the Test Center
PV : Present value
- Event-driven seek to profit from Valid international travel passport
PMT : Payment/coupon amount
short-term events Exam admission ticket
FV : Future value/redemption value
- Relative value seek to profit from pricing At least one approved calculator
discrepancies between related securities CPT + one of the above : Solve for unknown No. 2 or HB pencils
- Macro emphasize a top-down approach to 2ND + BGN : Toggle between ordinary annuity Eraser
identifying global economic trends and annuity due Pencil sharpener
- Equity hedge take positions in equity and equity 2ND + CLR TVM : Clear TVM worksheet CFA Exam Personal Belongings Policy
derivative securities http://www.cfainstitute.org/about/governance/p
olicies/Pages/personal_belongings_policy.aspx

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 NOTES

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