Cfa Level 1 Formula Sheet PDF

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QUANTITATIVE METHODS
The Future Value of a Single Cash Flow

FVN = PV (1+ r)N
The Present Value of a Single Cash Flow
PV = FV
(1+ r)N
PVAnnuity Due = PVOrdinary Annuity (1 + r)

FVAnnuity Due = FVOrdinary Annuity (1 + r)
Present Value of a Perpetuity
PMT
PV(perpetuity) = I/Y
Continuous Compounding and Future Values

FVN = PVe rs * N
Effective Annual Rates

EAR = (1 + Periodic interest rate)N- 1
Net Present Value

N
CFt
NPV = t
t=0
(1 + r)
where
CFt = the expected net cash flow at time t
N = the investments projected life
r = the discount rate or appropriate cost of capital
Bank Discount Yield
D 360
rBD = F t
where:
rBD = the annualized yield on a bank discount basis.
D = the dollar discount (face value purchase price)
F = the face value of the bill
t = number of days remaining until maturity
Holding Period Yield

HPY = P1 - P0 + D1 = P1 + D1 - 1
P0 P0
where:
P0 = initial price of the investment.
P1 = price received from the instrument at maturity/sale.
D1 = interest or dividend received from the investment.
2011 ELAN GUIDES 3

Effective Annual Yield

EAY= (1 + HPY)365/t - 1
where:
HPY = holding period yield
t = numbers of days remaining till maturity
HPY = (1 + EAY)t/365 - 1
Money Market Yield

RMM = 360 rBD
360 - (t rBD)
RMM = HPY (360/t)
Bond Equalent Yield
BEY = [(1 + EAY) ^ 0.5 - 1]
Population Mean
Where,
xi = is the ith observation.
Sample Mean
Geometric Mean
Harmonic Mean
with Xi > 0 for i = 1, 2,..., N.
2011 ELAN GUIDES 4

Percentiles
where:
y = percentage point at which we are dividing the distribution
Ly = location (L) of the percentile (Py) in the data set sorted in ascending order
Range
Range = Maximum value - Minimum value
Mean Absolute Deviation
Where:
n = number of items in the data set
= the arithmetic mean of the sample
Population Variance
where:
Xi = observation i
= population mean
N = size of the population
Population Standard Deviation
Sample Variance
Sample variance =
where:
n = sample size.
2011 ELAN GUIDES 5

Sample Standard Deviation
Coefficient of Variation
Coefficient of variation
where:
s = sample standard deviation
= the sample mean.
Sharpe Ratio
where:
= mean portfolio return
= risk-free return
s = standard deviation of portfolio returns
Sample skewness, also known as sample relative skewness, is calculated as:
(X - X)
i
3
SK =
[ n
(n - 1)(n - 2) ] i=1
s
3
As n becomes large, the expression reduces to the mean cubed deviation.

(X - X)
i=1
i
3
SK 3
n s
where:
2011 ELAN GUIDES 6

Sample Kurtosis uses standard deviations to the fourth power. Sample excess kurtosis is
calculated as:
( )
n
KE = n(n + 1)
(X - X)
i=1
i
4
3(n - 1)
2
4

(n - 1)(n - 2)(n - 3) s (n - 2)(n - 3)
As n becomes large the equation simplifies to:

(X - X)
i=1
i
4
KE 4
3
n s
where:
For a sample size greater than 100, a sample excess kurtosis of greater than 1.0 would be
considered unusually high. Most equity return series have been found to be leptokurtic.
Odds for an event
Where the odds for are given as a to b, then:
Odds for an event
Where the odds against are given as a to b, then:
2011 ELAN GUIDES 7

Conditional Probabilities
Multiplication Rule for Probabilities
Addition Rule for Probabilities
For Independant Events
P(A|B) = P(A), or equivalently, P(B|A) = P(B)
P(A or B) = P(A) + P(B) - P(AB)

P(A and B) = P(A) P(B)
The Total Probability Rule

P(A) = P(AS) + P(ASc)
P(A) = P(A|S) P(S) + P(A|Sc) P(Sc)
The Total Probability Rule for n Possible Scenarios

P(A) = P(A|S1) P(S1) + P(A|S2) P(S2) + ...+ P(A|Sn) P(Sn)
where the set of events {S1, S2,..., Sn} is mutually exclusive and exhaustive.
Expected Value

i=1
Where:
Xi = one of n possible outcomes.
2011 ELAN GUIDES 8

Variance and Standard Deviation

2 2
(X) = E{[X - E(X)] }
n
(X) = P(Xi) [Xi - E(X)]

2 2
i=1
The Total Probability Rule for Expected Value
1. E(X) = E(X|S)P(S) + E(X|Sc)P(Sc)

2. E(X) = E(X|S1) P(S1) + E(X|S2) P(S2) + ...+ E(X|Sn) P(Sn)
Where:
E(X) = the unconditional expected value of X
E(X|S1) = the expected value of X given Scenario 1
P(S1) = the probability of Scenario 1 occurring
The set of events {S1, S2,..., Sn} is mutually exclusive and exhaustive.
Covariance
Cov (XY) = E{[X - E(X)][Y - E(Y)]}
Cov (RA,RB) = E{[RA - E(RA)][RB - E(RB)]}
Correlation Coefficient
Cov (RA,RB)
Corr (RA,RB) = (RA,RB) =
(A)(B)
Expected Return on a Portfolio
Where:
Portfolio Variance
Variance of a 2 Asset Portfolio
2011 ELAN GUIDES 9

Variance of a 3 Asset Portfolio
Bayes Formula
Counting Rules
The number of different ways that the k tasks can be done equals n1 n2 n3 nk.
Combinations
Remember: The combination formula is used when the order in which the items are assigned the
labels is NOT important.
Permutations
Discrete uniform distribution

F(x) = n p(x) for the nth observation.
Binomial Distribution

where:
p = probability of success
1 - p = probability of failure
= number of possible combinations of having x successes in n trials. Stated differently, it is the number
of ways to choose x from n when the order does not matter.
Variance of a binomial random variable
2011 ELAN GUIDES 10

The Continuous Uniform Distribution

P(X < a), P (X >b) = 0
x2 -x1
P (x1 X x2 ) = b - a
Confidence Intervals
For a random variable X that follows the normal distribution:

The 90% confidence interval is - 1.65s to + 1.65s
The following probability statements can be made about normal distributions
Approximately 50% of all observations lie in the interval

z-Score
z = (observed value - population mean)/standard deviation = (x )/
Roys safety-first criterion
Minimize P(RP< RT)

where:
RP = portfolio return
RT = target return
Shortfall Ratio
Continuously Compounded Returns
= continuously compounded annual rate
2011 ELAN GUIDES 11

Sampling Error
Sampling error of the mean = Sample mean - Population mean =
Standard Error of Sample Mean when Population variance is Known
where:
= the standard error of the sample mean
= the population standard deviation
n = the sample size
Standard Error of Sample Mean when Population variance is Not Known
where:
= standard error of sample mean
s = sample standard deviation.
Confidence Intervals
Point estimate (reliability factor standard error)
where:
Point estimate = value of the sample statistic that is used to estimate the population
parameter
Reliability factor = a number based on the assumed distribution of the point
estimate and the level of confidence for the interval (1- ).
Standard error = the standard error of the sample statistic (point estimate)
where:
= The sample mean (point estimate of population mean)
z/2 = The standard normal random variable for which the probability of an
observation lying in either tail is / 2 (reliability factor).
= The standard error of the sample mean.
n
where:
= sample mean (the point estimate of the population mean)
= the t-reliability factor
= standard error of the sample mean
2011 ELAN GUIDES 12

Test Statistic
Sample statistic - Hypothesized value

Test statistic =
Standard error of sample statistic
Power of a Test
Power of a test = 1 - P(Type II error)
Decision Rules for Hypothesis Tests
Decision H0 is True H0 is False
Do not reject H0 Correct decision Incorrect decision

Type II error
Reject H0 Incorrect decision Correct decision

Type I error Power of the test
Significance level = = 1 - P(Type II
P(Type I error) error)
Confidence Interval
[( sample
)(
statistic
-
critical
value )( standard
error )] (

population
parameter ) [(

sample
)(
statistic
+
critical
value )( standard
error )]
x - (z) ( ) 0 x + (z) ( )
Summary
Null Alternate Fail to reject
Type of test hypothesis hypothesis Reject null if null if P-value represents
One tailed H0 : 0 Ha : 0 Test statistic > Test statistic Probability that lies
(upper tail) critical value critical value above the computed
test test statistic.
One tailed H0 : 0 Ha : 0 Test statistic < Test statistic Probability that lies
(lower tail) critical value critical value below the computed
test test statistic.
Two-tailed H0 : =0 Ha : 0 Test statistic < Lower critical Probability that lies

Lower critical value test above the positive
value statistic value of the computed
Test statistic > Upper critical test statistic plus the
Upper critical value probability that lies
value below the negative
value of the computed
test statistic
2011 ELAN GUIDES 13

t-Statistic
x - 0
t-stat =
Where:
x = sample mean
0= hypothesized population mean
s = standard deviation of the sample
n = sample size
z-Statistic
x - 0 x - 0
z-stat = z-stat =

Where: Where:
x = sample mean x = sample mean
0= hypothesized population mean 0= hypothesized population mean
= standard deviation of the population s = standard deviation of the sample
n = sample size n = sample size
Tests for Means when Population Variances are Assumed Equal
Where:
s12 = variance of the first sample

s22 = variance of the second sample
n1 = number of observations in first sample
n2 = number of observations in second sample
degrees of freedom = n1 + n2 -2
2011 ELAN GUIDES 14

Tests for Means when Population Variances are Assumed Unequal
t-stat
Where:
s12 = variance of the first sample

s22 = variance of the second sample
n1 = number of observations in first sample
n2 = number of observations in second sample
Paired Comparisons Test
Where:
d = sample mean difference
sd = standard error of the mean difference=
sd = sample standard deviation
n = the number of paired observations
Hypothesis Tests Concerning the Mean of Two Populations - Appropriate Tests
Relationship Assumption
Population between regarding
distribution samples variance Type of test
Normal Independent Equal t-test pooled

variance
Normal Independent Unequal t-test with

variance not
pooled
Normal Dependent N/A t-test with

paired
comparisons
2011 ELAN GUIDES 15

Chi Squared Test-Statistic
Where:
n = sample size
s2 = sample variance
2 = hypothesized value for population variance
0
Test-Statistic for the F-Test
Where:
s12 = Variance of sample drawn from Population 1
s22 = Variance of sample drawn from Population 2
Hypothesis tests concerning the variance.
Hypothesis Test Concerning Appropriate test statistic
Variance of a single, normally distributed Chi-square stat

population
Equality of variance of two independent, F-stat

normally distributed populations
Setting Price Targets with Head and Shoulders Patterns
Price target = Neckline - (Head - Neckline)
Setting Price Targets for Inverse Head and Shoulders Patterns
Price target = Neckline + (Neckline - Head)
Momentum or Rate of Change Oscillator
M = (V - Vx) 100
where:
M = momentum oscillator value
V = last closing price
Vx = closing price x days ago, typically 10 days
2011 ELAN GUIDES 16

Relative Strength Index
100
RSI = 100
1 + RS
(Up changes for the period under consideration)

where RS =
(|Down changes for the period under consideration|)
Stochastic Oscillator
%K = 100
( C L14
H14 L14 )
where:
C = last closing price
L14 = lowest price in last 14 days
H14 = highest price in last 14 days
%D (signal line) = Average of the last three %K values calculated daily.
Short Interest ratio

Short interest
Short interest ratio =
Average daily trading volume
Arms Index
Number of advancing issues / Number of declining issues

Arms Index =
Volume of advancing issues / Volume of declining issues
2011 ELAN GUIDES 17

ECONOMICS
ECONOMICS
DEMAND AND SUPPLY ANALYSIS: INTRODUCTION
The demand function captures the effect of all these factors on demand for a good.
Demand function: QDx = f(Px, I, Py, . . .) (Equation 1)
Equation 1 is read as the quantity demanded of Good X (QDX) depends on the price of
Good X (PX), consumers incomes (I) and the price of Good Y (PY), etc.
The supply function can be expressed as:
Supply function: QSx = f(Px, W, . . .) (Equation 5)
The own-price elasticity of demand is calculated as:
%QDx
EDPx = (Equation 16)
%Px
If we express the percentage change in X as the change in X divided by the value of X,

Equation 16 can be expanded to the following form: Slope of demand
function.
Coefficient on own-
QDx price in market
%QDx QDx QDx Px
EDPx =
%Px
=
Px
Px
= ( Px )( )
QDx
(Equation 17)
demand function
Arc elasticity is calculated as:
(Q0 - Q1)
100
% change in quantity demanded % Qd (Q0 + Q1)/2
EP = = =
% change in price % P (P0 - P1)
100
(P0 + P1)/2
2011 ELAN GUIDES 18

ECONOMICS
Income Elasticity of Demand
Income elasticity of demand measures the responsiveness of demand for a particular good
to a change in income, holding all other things constant.
Same as coefficient
on I in market
demand function
(Equation 11)
QDx
%QDx QDx QDx I
EDI =
%I
=
I
I
= ( I )( )
QDx
(Equation 18)
% change in quantity demanded

EI =
% change in income
Cross-Price Elasticity of Demand
Cross elasticity of demand measures the responsiveness of demand for a particular good to
a change in price of another good, holding all other things constant.
Same as coefficient
on PY in market
demand function
(Equation 11) QDx
%QDx QDx QDx Py
EDPy =
%Py
=
Py
Py
= ( Py )( )
QDx
(Equation 19)
% change in quantity demanded

EC =
% change in price of substitute or complement
2011 ELAN GUIDES 19

ECONOMICS
DEMAND AND SUPPLY ANALYSIS: CONSUMER DEMAND
he Utility Function
In general a utility function can be represented as:
U = f(Qx1, Qx2,..., Qxn)
DEMAND AND SUPPLY ANALYSIS: THE FIRM
Accounting Profit
Accounting profit (loss) = Total revenue Total accounting costs.
Economic Profit
Economic profit (also known as abnormal profit or supernormal profit) is calculated as:
Economic profit = Total revenue Total economic costs
Economic profit = Total revenue (Explicit costs + Implicit costs)
Economic profit = Accounting profit Total implicit opportunity costs
Normal Profit
Normal profit = Accounting profit - Economic profit
Total, Average and Marginal Revenue
Table 2: Summary of Revenue Terms 2
Revenue Calculation
Total revenue (TR) Price times quantity (P Q), or the sum of individual units
sold times their respective prices; (Pi Qi)
Average revenue (AR) Total revenue divided by quantity; (TR / Q)
Marginal revenue (MR) Change in total revenue divided by change in quantity; (TR
/ Q)
2011 ELAN GUIDES 20

ECONOMICS
Total, Average, Marginal, Fixed and Variable Costs
Table 5: Summary of Cost Terms 3

Costs Calculation
Total fixed cost (TFC) Sum of all fixed expenses; here defined to include all
opportunity costs
Total variable cost (TVC) Sum of all variable expenses, or per unit variable cost
times quantity; (per unit VC Q)
Total costs (TC) Total fixed cost plus total variable cost; (TFC + TVC)
Average fixed cost (AFC ) Total fixed cost divided by quantity; (TFC / Q)
Average variable cost (AVC) Total variable cost divided by quantity; (TVC / Q)
Average total cost (ATC) Total cost divided by quantity; (TC / Q) or (AFC + AVC)
Marginal cost (MC) Change in total cost divided by change in quantity;

(TC / Q)
Marginal revenue product (MRP) of labor is calculated as:
MRP of labor = Change in total revenue / Change in quantity of labor
For a firm in perfect competition, MRP of labor equals the MP of the last unit of labor times
the price of the output unit.
MRP = Marginal product * Product price
A profit-maximizing firm will hire more labor until:
MRPLabor = PriceLabor
Profits are maximized when:
MRP1 MRPn
= ... =
Price of input 1 Price of input n
2 Exhibit 3, pg 106, Volume 2, CFA Program Curriculum 2012
2011 ELAN GUIDES 21

ECONOMICS
THE FIRM AND MARKET STRUCTURES
The relationship between MR and price elasticity can be expressed as:
MR = P[1 (1/EP)]
In a monopoly, MC = MR so:
P[1 (1/EP)] = MC
N-firm concentration ratio: Simply computes the aggregate market share of the N largest
firms in the industry. The ratio will equal 0 for perfect competition and 100 for a monopoly.
Herfindahl-Hirschman Index (HHI): Adds up the squares of the market shares of each of the
largest N companies in the market. The HHI equals 1 for a monopoly. If there are M firms
in the industry with equal market shares, the HHI will equal 1/M.
AGGREGATE OUTPUT, PRICE, AND ECONOMIC GROWTH
Nominal GDP refers to the value of goods and services included in GDP measured at current
prices.
Nominal GDP = Quantity produced in Year t Prices in Year t
Real GDP refers to the value of goods and services included in GDP measured at base-year
prices.
Real GDP = Quantity produced in Year t Base-year prices
GDP Deflator
Value of current year output at current year prices

GDP deflator = 100
Value of current year output at base year prices
Nominal GDP
GDP deflator = 100
Real GDP
2011 ELAN GUIDES 22

ECONOMICS
The Components of GDP
Based on the expenditure approach, GDP may be calculated as:
GDP = C + I + G + (X M)
C = Consumer spending on final goods and services

I = Gross private domestic investment, which includes business investment in capital
goods (e.g. plant and equipment) and changes in inventory (inventory investment)
G = Government spending on final goods and services
X = Exports
M = Imports
Expenditure Approach
Under the expenditure approach, GDP at market prices may be calculated as:
This equation is just GDP = Consumer spending on goods and services

a breakdown of the
expression for GDP + Business gross fixed investment
we stated in the + Change in inventories
previous LOS, i.e.
GDP = C + I + G + + Government spending on goods and services
(X M). + Government gross fixed investment
+ Exports Imports
+ Statistical discrepancy
Income Approach
Under the income approach, GDP at market prices may be calculated as:
GDP = National income + Capital consumption allowance

+ Statistical discrepancy (Equation 1)
National income equals the sum of incomes received by all factors of production used to
generate final output. It includes:
Employee compensation
Corporate and government enterprise profits before taxes, which includes:
o Dividends paid to households
o Corporate profits retained by businesses
o Corporate taxes paid to the government
Interest income
Rent and unincorporated business net income (proprietors income): Amounts earned
by unincorporated proprietors and farm operators, who run their own businesses.
Indirect business taxes less subsidies: This amount reflects taxes and subsidies that
are included in the final price of a good or service, and therefore represents the
portion of national income that is directly paid to the government.
2011 ELAN GUIDES 23

ECONOMICS
The capital consumption allowance (CCA) accounts for the wear and tear or depreciation
that occurs in capital stock during the production process. It represents the amount that must
be reinvested by the company in the business to maintain current productivity levels. You
should think of profits + CCA as the amount earned by capital.
Personal income = National income

Indirect business taxes
Corporate income taxes
Undistributed corporate profits
+ Transfer payments (Equation 2)
Personal disposable income = Personal income Personal taxes (Equation 3)
Personal disposable income = Household consumption + Household saving
(Equation 4)
Household saving = Personal disposable income

Consumption expenditures
Interest paid by consumers to businesses
Personal transfer payments to foreigners (Equation 5)
Business sector saving = Undistributed corporate profits

+ Capital consumption allowance (Equation 6)
GDP = Household consumption + Total private sector saving + Net taxes
The equality of expenditure and income
S = I + (G T) + (X M) (Equation 7)
The IS Curve (Relationship between Income and the Real Interest Rate)
Disposable income = GDP Business saving Net taxes
S I = (G T) + (X M) (Equation 7)
2011 ELAN GUIDES 24

ECONOMICS
The LM Curve
Quantity theory of money: MV = PY
The quantity theory equation can also be written as:
M/P and MD/P = kY
where :
k = I/V
M = Nominal money supply
MD = Nominal money demand
MD/P is referred to as real money demand and M/P is real money supply.
Equilibrium in the money market requires that money supply and money demand be equal.
Money market equilibrium: M/P = RMD
Solow (neoclassical) growth model
Y = AF(L,K)
Where:
Y = Aggregate output
L = Quantity of labor
K = Quantity of capital
A = Technological knowledge or total factor productivity (TFP)
Growth accounting equation
Growth in potential GDP = Growth in technology + WL(Growth in labor)

+ WK(Growth in capital)
Growth in per capital potential GDP = Growth in technology

+ WK(Growth in capital-labor ratio)
Measures of Sustainable Growth
Labor productivity = Real GDP/ Aggregate hours
Potential GDP = Aggregate hours Labor productivity
This equation can be expressed in terms of growth rates as:
Potential GDP growth rate = Long-term growth rate of labor force + Long-term labor
productivity growth rate
2011 ELAN GUIDES 25

ECONOMICS
UNDERSTANDING BUSINESS CYCLES
Unit labor cost (ULC) is calculated as:
ULC = W/O
Where:
O = Output per hour per worker

W = Total labor compensation per hour per worker
MONETARY AND FISCAL POLICY
Required reserve ratio = Required reserves / Total deposits
Money multiplier = 1/ (Reserve requirement)
The Fischer effect states that the nominal interest rate (RN) reflects the real interest rate (RR)
and the expected rate of inflation (e).
RN = RR + e
The Fiscal Multiplier
Ignoring taxes, the multiplier can also be calculated as:
o 1/(1-MPC) = 1/(1-0.9) = 10
Assuming taxes, the multiplier can also be calculated as:

1
[1 - MPC(1-t)]
INTERNATIONAL TRADE AND CAPITAL FLOWS
Balance of Payment Components
A countrys balance of payments is composed of three main accounts.

The current account balance largely reflects trade in goods and services.
The capital account balance mainly consists of capital transfers and net sales of
non-produced, non-financial assets.
The financial account measures net capital flows based on sales and purchases of
domestic and foreign financial assets.
2011 ELAN GUIDES 26

ECONOMICS
CURRENCY EXCHANGE RATES

The real exchange rate may be calculated as:
Real exchange rateDC/FC = SDC/FC (PFC / PDC)
where:
SDC/FC = Nominal spot exchange rate
PFC = Foreign price level quoted in terms of the foreign currency
PDC = Domestic price level quoted in terms of the domestic currency
The forward rate may be calculated as:
1 (1 + rDC) (1 + rDC) This version of the

FDC/FC = or FDC/FC = SDC/FC formula is perhaps
SFC/DC (1 + rFC) (1 + rFC) easiest to remember
because it contains
the DC term in
numerator for all
three components:
FDC/FC, SDC/FC
and (1 + rDC)
Forward rates are sometimes interpreted as expected future spot rates.
Ft = St+1
(St + 1) (rDC rFC)

S(DC/FC)t + 1 =
S (1 + rFC)
Exchange Rates and the Trade Balance
The Elasticities Approach
Marshall-Lerner condition: XX + M(M 1) > 0
Where:
X = Share of exports in total trade
M = Share of imports in total trade
X = Price elasticity of demand for exports
M = Price elasticity of demand for imports
2011 ELAN GUIDES 27

FINANCIAL REPORTING AND ANALYSIS
2
Exhibit 10, pg 72, Vol 3, CFA Program Curriculum 2012
2011 ELAN GUIDES 28

Basic EPS
Basic EPS = Net income Preferred dividends
Weighted average number of shares outstanding
Diluted EPS
Diluted EPS =
[ Net income -
Preferred
dividends ] +
Convertible
preferred +
dividends
[
Convertible
debt (1 - t)
interest
]
Shares from Shares from
Weighted Shares
conversion of conversion of
average + + + issuable from
convertible convertible
shares stock options
preferred shares debt
Comprehensive Income
Net income + Other comprehensive income = Comprehensive income
Gains and Losses on Marketable Securities
Held-to-Maturity Available-for-sale Trading

Securities Securities Securities
Balance Sheet Reported at cost or Reported at fair value. Reported at fair value.
amortized cost.
Unrealized gains or losses
due to changes in
market values are reported
in other comprehensive
income within owners
equity.
Items recognized Interest income Dividend income. Dividend income.

on the income
statement Realized gains Interest income. Interest income.
and losses.
Realized gains Realized gains and losses.
and losses.
Unrealized gains and
losses due to changes in
market values.
2011 ELAN GUIDES 29

Cash Flow Classification under U.S. GAAP
CFO
Inflows Outflows
Cash collected from customers. Cash paid to employees.
Interest and dividends received. Cash paid to suppliers.
Proceeds from sale of securities held for trading. Cash paid for other expenses.
Cash used to purchase trading
securities.
Interest paid.
Taxes paid.
CFI
Inflows Outflows
Sale proceeds from fixed assets. Purchase of fixed assets.
Sale proceeds from long-term investments. Cash used to acquire LT investment
securities.
CFF
Inflows Outflows
Proceeds from debt issuance. Repayment of LT debt.
Proceeds from issuance of equity instruments. Payments made to repurchase stock.
Dividends payments.
Cash Flow Statements under IFRS and U.S. GAAP
IFRS U.S. GAAP

Classification of Cash Flows
Interest and dividends received CFO or CFI CFO

Interest paid CFO or CFF CFO
Dividend paid CFO or CFF CFF

Dividends received CFO or CFI CFO
Taxes paid CFO, but part of the tax can be CFO
categorized as CFI or CFF if it is clear
that the tax arose from investing or
financing activities.
Bank overdrafts Included as a part of cash equivalents. Not considered a part of cash equivalents
and included in CFF.
Presentation Format
CFO Direct or indirect method. The former is Direct or indirect method. The former is
(No difference in CFI and preferred. preferred. However, if the direct method
CFF presentation) is used, a reconciliation of net income
and CFO must be included.
Disclosures
Taxes paid should be presented separately If taxes and interest paid are not explicitly
on the cash flow statement. stated on the cash flow statement, details
can be provided in footnotes.
2011 ELAN GUIDES 30

Free Cash Flow to the Firm
FCFF = NI + NCC + [Int * (1 tax rate)] FCInv WCInv
FCFF = CFO + [Int * (1 tax rate)] FCInv
Free Cash Flow to Equity
FCFE = CFO - FCInv + Net borrowing
Inventory Turnover
Cost of goods sold
Inventory turnover =
Average inventory
Days of Inventory on Hand

365
Days of inventory on hand (DOH) =
Inventory turnover
Receivables Turnover
Revenue
Receivables turnover =
Average receivables
Days of Sales Outstanding

365
Days of sales outstanding (DSO) =
Receivables turnover
Payables Turnover
Purchases
Payables turnover =
Average trade payables
Number of Days of Payables

365
Number of days of payables =
Payables turnover
Working Capital Turnover

Revenue
Working capital turnover =
Average working capital
Fixed Asset Turnover

Revenue
Fixed asset turnover =
Average fixed assets
Total Asset Turnover

Revenue
Total Asset Turnover =
Average total assets
2011 ELAN GUIDES 31

Current Ratio
Current assets
Current ratio =
Current liabilities
Quick Ratio
Cash + Short-term marketable investments + Receivables
Quick ratio =
Current liabilities
Cash Ratio
Cash + Short-term marketable investments
Cash ratio =
Current liabilities
Defensive Interval Ratio

Cash + Short-term marketable investments + Receivables
Defensive interval ratio =
Daily cash expenditures
Cash Conversion Cycle

Cash conversion cycle = DSO + DOH Number of days of payables
Debt-to-Assets Ratio
Total debt
Debt-to-assets ratio =
Total assets
Debt-to-Capital Ratio
Total debt
Debt-to-capital ratio =
Total debt + Shareholders equity
Debt-to-Equity Ratio
Total debt
Debt-to-equity ratio =
Shareholders equity
Financial Leverage Ratio

Financial leverage ratio =
Average total equity
Interest Coverage Ratio

EBIT
Interest coverage ratio =
Interest payments
Fixed Charge Coverage Ratio

EBIT + Lease payments
Fixed charge coverage ratio =
Interest payments + Lease payments
Gross Profit Margin

Gross profit
Gross profit margin =
Revenue
2011 ELAN GUIDES 32

Operating Profit Margin

Operating profit
Operating profit margin =
Revenue
Pretax Margin
EBT (earnings before tax, but after interest)
Pretax margin =
Revenue
Net Profit Margin

Net profit
Net profit margin =
Revenue
Return on Assets
Net income
ROA =
Net income + Interest expense (1 Tax rate)
Adjusted ROA =
Operating income or EBIT
Operating ROA =
Return on Total Capital

EBIT
Return on total capital =
Short-term debt + Long-term debt + Equity
Return on Equity
Net income
Return on equity =
Average total equity
Return on Common Equity

Net income Preferred dividends
Return on common equity =
Average common equity
DuPont Decomposition of ROE

Net income
ROE =
Average shareholders equity
2-Way Dupont Decomposition

Net income Average total assets
ROE =
Average total assets Average shareholders equity
ROA Leverage
Net income Revenue Average total assets
ROE =
Revenue Average total assets Average shareholders equity
Net profit margin Asset turnover Leverage
2011 ELAN GUIDES 33

Interest burden Asset turnover
Net income EBT EBIT Revenue Average total assets

ROE =
EBT EBIT Revenue Average total assets Avg. shareholders equity
Tax burden EBIT margin Leverage
Price- to-Earnings Ratio

Price per share
P/E =
Earnings per share
Price to Cash Flow
Price per share
P/CF =
Cash flow per share
Price to Sales
Price per share
P/S =
Sales per share
Price to Book Value
Price per share
P/BV =
Book value per share
Per Share Ratios
Cash flow from operations

Cash flow per share =
Average number of shares outstanding
EBITDA
EBITDA per share =
Average number of shares outstanding
Common dividends declared

Dividends per share =
Weighted average number of ordinary shares
Dividend Payout Ratio
Common share dividends
Dividend payout ratio =
Net income attributable to common shares
Retention Rate
Net income attributable to common shares Common share dividends
Retention Rate =
Net income attributable to common shares
Growth Rate
Sustainable growth rate = Retention rate ROE
2011 ELAN GUIDES 34

LIFO versus FIFO (with rising prices and stable inventory levels.)
LIFO versus FIFO when Prices are Rising
LIFO FIFO
COGS Higher Lower
Income before taxes Lower Higher
Income taxes Lower Higher
Net income Lower Higher
Cash flow Higher Lower
EI Lower Higher
Working capital Lower Higher
Effect on Effect on
Type of Ratio Numerator Denominator Effect on Ratio
Profitability ratios. Income is lower Sales are the same Lower under LIFO.
NP and GP margins under LIFO because under both.
COGS is higher
Debt to equity Same debt levels Lower equity under Higher under LIFO
LIFO
Current ratio Current assets are Current liabilities Lower under LIFO
lower under LIFO are the same.
because EI is lower.
Quick ratio Assets are higher as Current liabilities Higher under LIFO
a result of lower are the same
taxes paid
Inventory turnover COGS is higher Average inventory Higher under LIFO

under LIFO is lower under LIFO
Total asset turnover Sales are the same Lower total assets Higher under LIFO
under LIFO
2011 ELAN GUIDES 35

Financial Statement Effects of Capitalizing versus Expensing
Effect on Financial Statements
Initially when the cost is Noncurrent assets increase.

capitalized Cash flow from investing activities decreases.
In future periods when the asset Noncurrent assets decrease.

is depreciated or amortized Net income decreases.
Retained earnings decrease.
Equity decreases.
When the cost is expensed Net income decreases by the entire after-tax
amount of the cost.
No related asset is recorded on the balance
sheet and therefore, no depreciation or
amortization expense is charged in future
periods.
Operating cash flow decreases.
Expensed costs have no financial statement
impact in future years.
Capitalizing Expensing
Net income (first year) Higher Lower
Net income (future years) Lower Higher
Total assets Higher Lower
Shareholders equity Higher Lower
Cash flow from operations Higher Lower
Cash flow from investing Lower Higher
Income variability Lower Higher
Debt to equity Lower Higher
2011 ELAN GUIDES 36

Straight Line Depriciation

Original cost - Salvage value
Depreciation expense =
Depreciable life
Accelerated Depriciation
2
DDB depreciation in Year X = Book value at the beginning of Year X
Depreciable life
Estimated Useful Life

Gross investment in fixed assets
Estimated useful life =
Annual depreciation expense
Average Cost of Asset

Accumulated depreciation
Average age of asset =
Remaining Useful Life

Net investment in fixed assets
Remaining useful life =
Treatment of Temporary Differences
Carrying amount is greater.

Tax base is greater.
Carrying amount is greater.
Tax base is greater.
2011 ELAN GUIDES 37

Income Tax Accounting under IFRS versus U.S. GAAP

IFRS U.S. GAAP
ISSUE SPECIFIC TREATMENTS
Revaluation of fixed Recognized in equity as deferred Revaluation is prohibited.
assets and intangible taxes.
assets.
Treatment of Recognized as deferred taxes No recognition of deferred

undistributed profit except when the parent company taxes for foreign subsidiaries
from investment in is able to control the distribution that fulfill indefinite reversal
subsidiaries. of profits and it is probable that criteria.
temporary differences will not No recognition of deferred
reverse in future. taxes for domestic
subsidiaries when amounts
are tax-free.
Treatment of Recognized as deferred taxes No recognition of deferred

undistributed profit except when the investor controls taxes for foreign corporate
from investments in the sharing of profits and it is joint ventures that fulfill
joint ventures. probable that there will be no indefinite reversal criteria.
reversal of temporary differences
in future.
Treatment of Recognized as deferred taxes Deferred taxes are recognized

undistributed profit except when the investor controls from temporary differences.
from investments in the sharing of profits and it is
associates. probable that there will be no
reversal of temporary differences
in future.
DEFERRED TAX MEASUREMENT
Tax rates. Tax rates and tax laws enacted Only enacted tax rates and
or substantively enacted. tax laws are used.
Deferred tax asset Recognized if it is probable that Deferred tax assets are
recognition. sufficient taxable profit will be recognized in full and then
available in the future. reduced by a valuation
allowance if it is likely that
they will not be realized.
DEFERRED TAX PRESENTATION
Offsetting of deferred Offsetting allowed only if the Same as in IFRS.
tax assets and liabilities. entity has right to legally enforce
it and the balance is related to a
tax levied by the same authority.
Balance sheet Classified on balance sheet as Classified as either current or

classification. net noncurrent with noncurrent based on
supplementary disclosures. classification of underlying
asset and liability.
2011 ELAN GUIDES 38

Effective Tax rate

Income tax expense
Effective tax rate =
Pretax income
Income Tax Expense

Income tax expense = Taxes Payable + Change in DTL - Change in DTA
Income Statement Effects of Lease Classification
Income Statement Item Finance Lease Operating Lease

Operating expenses Lower Higher
Nonoperating expenses Higher Lower
EBIT (operating income) Higher Lower
Total expenses- early years Higher Lower
Total expenses- later years Lower Higher
Net income- early years Lower Higher
Net income- later years Higher Lower
Balance Sheet Effects of Lease Classification

Balance Sheet Item Capital Lease Operating Lease
Assets Higher Lower

Current liabilities Higher Lower
Long term liabilities Higher Lower
Total cash Same Same
Cash Flow Effects of Lease Classification

CF Item Capital Lease Operating Lease
CFO Higher Lower
CFF Lower Higher
Total cash flow Same Same
2011 ELAN GUIDES 39

Impact of Lease Classification on Financial Ratios
Numerator Denominator Ratio Better or

under Finance under Finance Worse under
Ratio Lease Lease Effect on Ratio Finance Lease
Asset turnover Sales- same Assets- higher Lower Worse
Return on assets* Net income lower Assets- higher Lower Worse

in early years
Current ratio Current assets- Current Lower Worse

same liabilities-
higher
Leverage ratios Debt- higher Equity same. Higher Worse

(D/E and D/A) Assets higher
Return on equity* Net income lower Equity same Lower Worse

in early years
* In early years of the lease agreement.
Financial Statement Effects of Lease Classification from Lessors Perspective

Financing Lease Operating Lease
Total net income Same Same
Net income (early years) Higher Lower
Taxes (early years) Higher Lower
Total CFO Lower Higher
Total CFI Higher Lower
Total cash flow Same Same
2011 ELAN GUIDES 40

Definitions of Commonly Used Solvency Ratios
Solvency Ratios Description Numerator Denominator
Leverage Ratios
Debt-to-assets ratio Expresses the percentage Total debt Total assets

of total assets financed by
debt
Debt-to-capital ratio Measures the percentage Total debt Total debt + Total
of a companys total capital shareholders equity
(debt + equity) financed by
debt.
Debt-to-equity ratio Measures the amount of Total debt Total shareholders

debt financing relative to equity
equity financing
Financial leverage ratio Measures the amount of Average total assets Average shareholders
total assets supported by equity
one money unit of equity.
Coverage Ratios
Interest coverage ratio Measures the number of EBIT Interest payments

times a companys EBIT
could cover its interest
payments.
Fixed charge coverage ratio Measures the number of EBIT + Lease Interest payments +
times a companys earnings payments Lease payments
(before interest, taxes and
lease payments) can cover
the companys interest and
lease payments.
2011 ELAN GUIDES 41

Adjustments related to inventory:
EIFIFO = EILIFO + LR
where
LR = LIFO Reserve
COGSFIFO = COGSLIFO - (Change in LR during the year)
Net income after tax under FIFO will be greater than LIFO net income after tax by:
Change in LIFO Reserve (1 - Tax rate)
When converting from LIFO to FIFO assuming rising prices:
Equity (retained earnings) increase by:

LIFO Reserve (1 - Tax rate)
Liabilities (deferred taxes) increase by:

LIFO Reserve (Tax rate)
Current assets (inventory) increase by:

LIFO Reserve
Adjustments related to property, plant and equipment:
Gross investment in fixed assets Accumulated depreciation Net investment in fixed assets
= +
Annual depreciation expense Annual depreciation expense Annual depreciation expense
Estimated useful or depreciable Average age of asset Remaining useful life

life
Annual depreciation expense times The book value of the asset divided
The historical cost of an asset the number of years that the asset by annual depreciation expense
divided by its useful life equals has been in use equals equals the number of years the asset
annual depreciation expense under accumulated depreciation. has remaining in its useful life.
the straight line method. Therefore, Therefore, accumulated
the historical cost divided by annual depreciation divided by annual
depreciation expense equals the depreciation equals the average
estimated useful life. age of the asset.
2011 ELAN GUIDES 42

Categories of Marketable Securities and Accounting Treatment
Unrealized and
Balance Sheet Realized Gains and Income (Interest &
Classification Value Losses Dividends)
Held-to-maturity Amortized cost Unrealized: Not Recognized on
(Par value +/- reported income statement.
unamortized Realized:
premium/ discount). Recognized on
income statement.
Held-for-trading Fair Value. Unrealized: Recognized on

Recognized on income statement.
income statement.
Realized:
Recognized on
income statement.
Available-for-sale Fair Value. Unrealized: Recognized on

Recognized in other income statement.
comprehensive
income.
Realized:
Recognized on
income statement.
2011 ELAN GUIDES 43

Inventory Accounting under IFRS versus U.S. GAAP

Permitted Cost Changes in Balance
Balance Sheet Recognition Methods Sheet Value
U.S. GAAP Lower of cost or LIFO. Permits inventory

market. FIFO. write downs,
Weighted average but not reversal of
cost. write downs.
Permits inventory
IFRS Lower of cost or net FIFO.
realizable value. Weighted Average write downs,
Cost. and also reversals of
write downs.
Property, Plant and Equipment

Effects of Changes
Changes in Balance in Balance Sheet
Balance Sheet Sheet Value Value
U.S. GAAP Cost minus Does not permit upward No effect.

accumulated revaluation.
depreciation.
IFRS Cost minus Permits upward The increase in the assets

accumulated revaluation. value from revaluation is
depreciation. reported as a part of equity
Asset is reported at fair unless it is reversing a
value at the revaluation previously-recognized
date less accumulated decrease in the value of the
depreciation following asset.
the revaluation.
A decrease in the value of
the asset is reported on the
income statement unless it
is reversing a previously-
reported upward
revaluation.
2011 ELAN GUIDES 44

Long-Term Investments
Percent Ownership Extent of Control Accounting Treatment
Less than 20% No significant control Classified as held-to-maturity, trading,

or available for sale securities.
20% - 50% Significant Influence Equity method.
More than 50% Significant Control Consolidation.
Shared (joint ventures) Joint Control Equity method/ proportionate

consolidation.
Treatment of Identifiable Intangible Assets
Changes in Effects of Changes in

Balance Sheet Balance Sheet
Balance Sheet Value Value
U.S. GAAP Only purchased intangibles Does not permit No effect.

may be recognized as upward
assets. Internally developed revaluation.
items cannot be recognized
as assets.
Reported at cost minus

accumulated amortization
for assets with finite useful
lives.
Reported at cost minus

impairment for assets with
infinite useful lives.
IFRS Only purchased intangibles Permits upward An increase in value is

may be recognized as revaluation. recognized as a part of
assets. Internally developed equity unless it is a
items cannot be recognized Assets are reversal of a
as assets. reported at fair previously recognized
value as of the downward revaluation.
Reported at cost minus revaluation date
accumulated amortization less subsequent A decrease in value is
for assets with finite useful accumulated recognized on the
lives. amortization. income statement
unless it is a reversal
Reported at cost minus of a previously
impairment for assets with recognized upward
infinite useful lives. revaluation.
2011 ELAN GUIDES 45

Long-Term Contracts
Outcome can be reliably Outcome cannot be reliably

estimated estimated
U.S. GAAP Percentage-of-completion Completed contract
method. method.
IFRS Percentage-of-completion Revenue is recognized to the
method. extent that it is probable to
recover contract costs.
Profit is only recognized at project

completion.
2011 ELAN GUIDES 46

CORPORATE FINANCE
CORPORATE FINANCE
Net Present Value (NPV)
where
CFt = after-tax cash flow at time, t.
r = required rate of return for the investment. This is the firms cost of capital adjusted
for the risk inherent in the project.
Outlay = investment cash outflow at t = 0.
Internal Rate of Return (IRR)
Average Accounting Rate of Return (AAR)
Average net income

AAR =
Average book value
Profitability Index
PV of future cash flows NPV

PI = = 1 +
Initial investment Initial investment
Weighted Average Cost of Capital
Where:
wd = Proportion of debt that the company uses when it raises new funds
rd = Before-tax marginal cost of debt
t = Companys marginal tax rate
wp = Proportion of preferred stock that the company uses when it raises new funds
rp = Marginal cost of preferred stock
we = Proportion of equity that the company uses when it raises new funds
re = Marginal cost of equity
To Transform Debt-to-equity Ratio into a components weight
2011 ELAN GUIDES 47

CORPORATE FINANCE
Valuation of Bonds
where:
P0 = current market price of the bond.
PMTt = interest payment in period t.
rd = yield to maturity on BEY basis.
n = number of periods remaining to maturity.
FV = Par or maturity value of the bond.
Valuation of Preferred Stock
Dp
Vp =
rp
where:
Vp = current value (price) of preferred stock..
Dp = preferred stock dividend per share.
rp = cost of preferred stock.
Required Return on a Stock
Capital Asset Pricing Model
re = RF + i[E(RM) - RF]
where
[E(RM) - RF] = Equity risk premium.
RM = Expected return on the market.
i = Beta of stock . Beta measures the sensitivity of the stocks returns to
changes in market returns.
RF = Risk-free rate.
re = Expected return on stock (cost of equity)
Dividend Discount Model
where:
P0 = current market value of the security.
D1= next years dividend.
re = required rate of return on common equity.
g = the firms expected constant growth rate of dividends.
2011 ELAN GUIDES 48

CORPORATE FINANCE
Rearranging the above equation gives us a formula to calculate the required return on equity:
Sustainable Growth Rate
Where (1 - (D/EPS)) = Earnings retention rate
Bond Yield plus Risk Premium Approach
To Unlever the beta
To Lever the beta
Country Risk Premium
Country risk Sovereign yield Annualized standard deviation of equity index

=
premium spread Annualized standard deviation of sovereign
bond market in terms of the developed market
currency
Amount of capital at which a components cost of capital changes

Break point =
Proportion of new capital raised from the component
Degree of Operating Leverage
Percentage change in operating income

DOL =
Percentage change in units sold
2011 ELAN GUIDES 49

CORPORATE FINANCE
Q (P V)
DOL =
Q (P V) F
where:
Q = Number of units sold
P = Price per unit
V = Variable operating cost per unit
F = Fixed operating cost
Q (P V) = Contribution margin (the amount that units sold contribute to covering fixed
costs)
(P V) = Contribution margin per unit
Degree of Financial Leverage
Percentage change in net income

DFL =
Percentage change in operating income
[Q(P V) F](1 t) [Q(P V) F]

DFL = =
[Q(P V) F C](1 t) [Q(P V) F C]
where:
Q = Number of units sold
P = Price per unit
C = Fixed financial cost
t = Tax rate
Degree of Total Leverage
Percentage change in net income

DTL =
Percentage change in the number of units sold
DTL = DOL DFL
Q (P V)
DTL =
[Q(P V) F C]
where:
Q = Number of units produced and sold
P = Price per unit
2011 ELAN GUIDES 50

CORPORATE FINANCE
Break point
PQ = VQ + F + C
where:
P = Price per unit
Q = Number of units produced and sold
V = Variable cost per unit
F = Fixed operating costs
The breakeven number of units can be calculated as:
F+C
QBE =
PV
Operating breakeven point
PQOBE = PV + F
F
QOBE =
PV
2011 ELAN GUIDES 51

CORPORATE FINANCE
Purchases = Ending inventory + COGS - Beginning inventory
2011 ELAN GUIDES 52

CORPORATE FINANCE
Face value - Price

% Discount =
Price
365
Inventory turnover
Accounts payable
Number of days of payables =
Average days purchases
Accounts payable 365
=
Purchases / 365 Payables turnover
2011 ELAN GUIDES 53

CORPORATE FINANCE
2011 ELAN GUIDES 54

PORTFOLIO MANAGEMENT
Holding Period Return
Pt Pt-1 + Dt P Pt-1 D
R= = t + t = Capital gain + Dividend yield
Pt-1 Pt-1 Pt-1
PT + DT
= -1
P0
where:
Pt = Price at the end of the period
Pt-1 = Price at the beginning of the period
Dt = Dividend for the period
Holding Period Returns for more than One Period
R = [(1 + R1) (1 + R2) .... (1 + Rn)] 1
where:
R1, R2,..., Rn are sub-period returns
Geometric Mean Return

1/n
R = {[(1 + R1) (1 + R2) .... (1 + Rn)] } 1
Annualized Return
n
rannual = (1 + rperiod) - 1
where:
r = Return on investment
n = Number of periods in a year
2011 ELAN GUIDES 55

Portfolio Return
Rp = w1R1 + w2R2
where:
Rp = Portfolio return
w1 = Weight of Asset 1
w2 = Weight of Asset 2
R1 = Return of Asset 1
R2 = Return of Asset 2
Variance of a Single Asset

T
2
(R - )
t=1
t
2
=
T
where:
Rt = Return for the period t
T = Total number of periods
= Mean of T returns
Variance of a Representative Sample of the Population
2
(R - R)
t=1
t
2
s =
T-1
where:
R = mean return of the sample observations
2
s = sample variance
Standard Deviation of an Asset
T T
(R - )
t=1
t
2
(R - R)
t=1
t
2
= s=
T T-1
Variance of a Portfolio of Assets
N
2
=
P w w Cov(R ,R )
i,j = 1
i j i j
N N
2
=
P w Var(R ) +
i=1
2
i i
i,j = 1, i j
wiwjCov(Ri,Rj)
2011 ELAN GUIDES 56

Standard Deviation of a Portfolio of Two Risky Assets
Utility Function
2
U = E(R) A
2
where:
U = Utility of an investment
E(R) = Expected return
2
= Variance of returns
A = Additional return required by the investor to accept an additional unit of risk.
Capital Allocation Line
The CAL has an intercept of RFR and a constant slope that equals:
Expected Return on portfolios that lie on CML
E(Rp) = w1Rf + (1 - w1) E(Rm)
Variance of portfolios that lie on CML
2 2 2 2 2
= w1 f + (1 - w1) m + 2w1(1 - w1)Cov(Rf,Rm)
Equation of CML
E(Rm) - Rf
E(Rp) = Rf + p
m
where:
y-intercept = Rf = risk-free rate
E(Rm) - Rf
slope = = market price of risk.
m
2011 ELAN GUIDES 57

Systematic and Nonsystematic Risk
Total Risk = Systematic risk + Unsystematic risk
Return-Generating Models
k k
E(Ri) - Rf = E(F ) = [E(R ) - R ] + E(F )

j=1
ij j i1 m f
j=2
ij j
The Market Model
Ri = i + iRm + ei
Calculation of Beta
Cov(Ri,Rm) i,mim i,mi

i = 2
= 2
=
m m m
The Capital Asset Pricing Model
E(Ri) = Rf + i[E(Rm) Rf]
Sharpe ratio
Rp Rf
Sharpe ratio =
p
Treynor ratio
Rp Rf
Treynor ratio =
p
2
M-squared (M )
2 m
M = (Rp Rf) Rm Rf
p
Jensens alpha
pRp [RfpRm Rf)]
Security Characteristic Line
Ri RfiiRm Rf)
2011 ELAN GUIDES 58

EQUITY
EQUITY
The price at which an investor who goes long on a stock receives a margin call is calculated
as:
(1 - Initial margin)
P0
(1 Maintenance margin)
The value of a price return index is calculated as follows:

N
nP
i=1
i i
VPRI =
D
where:
VPRI = Value of the price return index
ni = Number of units of constituent security i held in the index portfolio
N = Number of constituent securities in the index
Pi = Unit price of constituent security i
D = Value of the divisor
Price Return
The price return of an index can be calculated as:
VPRI1 VPRI0
PRI =
VPRI0
where:
PRI = Price return of the index portfolio (as a decimal number)
VPRI1 = Value of the price return index at the end of the period
VPRI0 = Value of the price return index at the beginning of the period
The price return of each constituent security is calculated as:
Pi1 Pi0
PRi =
Pi0
where:
PRi = Price return of constituent security i (as a decimal number)
Pi1 = Price of the constituent security i at the end of the period
Pi0 = Price of the constituent security i at the beginning of the period
2011 ELAN GUIDES 59

EQUITY
The price return of the index equals the weighted average price return of the constituent
securities. It is calculated as:
PRI = w1PR1 + w2PR2 + ....+ wNPRN

where:
PRI = Price return of the index portfolio (as a decimal number)
PRi = Price return of constituent security i (as a decimal number)
wi = Weight of security i in the index portfolio
N = Number of securities in the index
Total Return
The total return of an index can be calculated as:
VPRI1 VPRI0 IncI

TRI =
VPRI0
where:
TRI = Total return of the index portfolio (as a decimal number)
VPRI1 = Value of the total return index at the end of the period
VPRI0 = Value of the total return index at the beginning of the period
IncI = Total income from all securities in the index held over the period
The total return of each constituent security is calculated as:
P1i P0i Inci

TRi =
P0i
where:
TRi = Total return of constituent security i (as a decimal number)
P1i = Price of constituent security i at the end of the period
P0i = Price of constituent security i at the beginning of the period
Inci = Total income from security i over the period
The total return of the index equals the weighted average total return of the constituent
securities. It is calculated as:
TRI = w1TR1 + w2TR2 + ....+ wNTRN

where:
TRI = Total return of the index portfolio (as a decimal number)
TRi = Total return of constituent security i (as a decimal number)
wi = Weight of security i in the index portfolio
2011 ELAN GUIDES 60

EQUITY
Calculation of Index Returns over Multiple Time Periods
Given a series of price returns for an index, the value of a price return index can be calculated
as:
VPRIT = VPRI0 (1 + PRI1) (1 + PRI2) ... (1 + PRIT)
where:
VPRI0 = Value of the price return index at inception
VPRIT = Value of the price return index at time t
PRIT = Price return (as a decimal number) on the index over the period
Similarly, the value of a total return index may be calculated as:
VTRIT = VTRI0 (1 + TRI1) (1 + TRI2) ... (1 + TRIT)
where:
VTRI0 = Value of the index at inception
VTRIT = Value of the index at time t
TRIT = Total return (as a decimal number) on the index over the period
Price Weighting
Pi
wiP = N
P
i=1
i
Equal Weighting
1
wiE =
N
where:
wi = Fraction of the portfolio that is allocated to security i or weight of security i
Market-Capitalization Weighting
QiPi
wiM = N
QP
j=1
j j
where:
Qi = Number of shares outstanding of security i
Pi = Share price of security i
2011 ELAN GUIDES 61

EQUITY
The float-adjusted market-capitalization weight of each constituent security is calculated as:
fiQiPi
wiM = N
fQP
j=1
j j j
where:
fi = Fraction of shares outstanding in the market float
Qi = Number of shares outstanding of security i
Pi = Share price of security i
Fundamental Weighting
Fi
wiF = N
F
j=1
j
where:
Fi = A given fundamental size measure of company i
Return Characteristics of Equity Securities
Total Return, Rt = (Pt Pt-1 + Dt) / Pt-1

where:
Pt-1 = Purchase price at time t 1
Pt = Selling price at time t
Dt = Dividends paid by the company during the period
Accounting Return on Equity
NIt NIt
ROEt = =
Average BVEt (BVEt + BVEt-1)/2
Dividend Discount Model (DDM)
2011 ELAN GUIDES 62

EQUITY
One year holding period:
Multiple-Year Holding Period DDM
where:
Pn = Price at the end of n years.
Infinite Period DDM (Gordon Growth Model)

1 2 3
D0 (1 + gc) D0 (1 + gc) D0 (1 + gc) D0 (1 + gc)
PV0 = 1 + 2 + 3 +...+
(1 + ke) (1 + ke) (1 + ke) (1 + ke)
This equation simplifies to:
1
D0 (1 + gc) D1
PV = 1 =
(ke - gc) ke - g c
The long-term (constant) growth rate is usually calculated as:
gc = RR ROE
Multi-Stage Dividend Discount Model
where:
Dn = Last dividend of the supernormal growth period

Dn+1 = First dividend of the constant growth period
The Free-Cash-Flow-to-Equity (FCFE) Model
FCFE = CFO FC Inv + Net borrowing
2011 ELAN GUIDES 63

EQUITY
Analysts may calculate the intrinsic value of the companys stock by discounting their
projections of future FCFE at the required rate of return on equity.
FCFEt
V0 = (1 + k )
t=1 e
t
Value of a Preferred Stock
When preferred stock is non-callable, non-convertible, has no maturity date and pays dividends
at a fixed rate, the value of the preferred stock can be calculated using the perpetuity formula:
D0
V0 =
r
For a non-callable, non-convertible preferred stock with maturity at time, n, the value of the
stock can be calculated using the following formula:
n Dt F
V0 = (1 + r)
t=1
t
+
(1 + r)
n
where:
V0 = value of preferred stock today (t = 0)
Dt = expected dividend in year t, assumed to be paid at the end of the year
r = required rate of return on the stock
F = par value of preferred stock
Price Multiples
P0 D1/E1
=
E1 r-g
Market price of share

Price to cash flow ratio =
Cash flow per share
Market price per share

Price to sales ratio =
Net sales per share
Market value of equity

Price to sales ratio =
Total net sales
2011 ELAN GUIDES 64

EQUITY
Current market price of share

P/BV =
Book value per share
Market value of common shareholders equity

P/BV =
Book value of common shareholders equity
where:
Book value of common shareholders equity =
(Total assets - Total liabilities) - Preferred stock
Enterprise Value Multiples
EV/EBITDA
where:
EV = Enterprise value and is calculated as the market value of the companys common stock
plus the market value of outstanding preferred stock if any, plus the market value of debt,
less cash and short term investments (cash equivalents).
2011 ELAN GUIDES 65

FIXED INCOME
FIXED INCOME
Bond Coupon
Coupon = Coupon rate Par value
Coupon Rate (Floating)

Coupon Rate = Reference rate + Quoted margin
Coupon Rate (Inverse Floaters)

Coupon rate = K L (Reference rate)
Callable Bond Price

Price of a callable bond = Value of option-free bond Value of embedded call option
Putable Bond Price

Price of a putable bond = Value of option-free bond + Value of embedded put option
Dollar Duration
Dollar duration = Duration Bond value
Inflation-Indexed Treasury Securities
TIPS coupon = Inflation adjusted par value (Stated coupon rate/2)
Nominal spread
Nominal spread (Bond Y as the reference bond) = Yield on Bond X Yield on Bond Y
Relative Yield spread

Yield on Bond X Yield on Bond Y
Relative yield spread =
Yield on Bond Y
Yield Ratio
Yield on Bond X
Yield ratio =
Yield on Bond Y
After-Tax Yield
After-tax yield = Pretax yield (1- marginal tax rate)
Taxable-Equalent Yield
Tax-exempt yield
Taxable-equivalent yield =
(1 marginal tax rate)
2011 ELAN GUIDES 66

FIXED INCOME
Bond Value
Maturity value
Bond Value =
(1+i) years till maturity 2
where i equals the semiannual discount rate
Valuing a Bond Between Coupon Payments.
Days between settlement date and next coupon payment date

w=
Days in coupon period
where:
w = Fractional period between the settlement date and the next coupon payment date.
Expected cash flow

Present value t =
(1 + i) t 1 + w
Current Yield
Annual cash coupon
Current yield =
Bond price
Bond Price
Bond price
where:
Bond price = Full price including accrued interest.
CPNt = The semiannual coupon payment received after t semiannual periods.
N = Number of years to maturity.
YTM = Yield to maturity.
Formula to Convert BEY into Annual-Pay YTM:

2
Annual-pay yield = 1 + ( Yield on bond equivalent basis
2
-1 ]
Formula to Convert Monthly Cash Flow Yield into BEY
BEY = [(1 + monthly CFY)6 1] 2
Discount Basis Yeild

360
d = (1-p)
N
2011 ELAN GUIDES 67

FIXED INCOME
Z-Spread
Z-spread = OAS + Option cost; and OAS = Z-spread - Option cost
Duration
V- - V+
Duration =
2(V0)(y)
where:
y = change in yield in decimal
V0 = initial price
V- = price if yields decline by y
V+ = price if yields increase by y
Portfolio Duration
Portfolio duration = w1D1 + w2D2 + ..+ wNDN
where:
N = Number of bonds in portfolio.
Di = Duration of Bond i.
wi = Market value of Bond i divided by the market value of portfolio.
Percentage Change in Bond Price

Percentage change in bond price = duration effect + convexity adjustment
= {[-duration (y)] + [convexity (y)2]} 100
where:
y = Change in yields in decimals.
Convexity
V+ + V- - 2V0
C= 2
2V0(y)
Price Value of a Basis Point

Price value of a basis point = Duration 0.0001 bond value
2011 ELAN GUIDES 68

DERIVATIVES
DERIVATIVES
FRA Payoff
Floating rate at expiration FRA rate (days in floating rate/ 360)
1 + [Floating rate at expiration (days in floating rate/ 360)
Numerator: Interest savings on the hypothetical loan. This number is positive when the floating rate
is greater than the forward rate. When this is the case, the long benefits and expects to receive a payment
from the short. The numerator is negative when the floating rate is lower than the forward rate. When this
is the case, the short benefits and expects to receive a payment from the long.
Denominator: The discount factor for calculating the present value of the interest savings.
2011 ELAN GUIDES 69

DERIVATIVES
Call Option Payoffs
Intrinsic Value of a Call Option

Intrinsic value of call = Max [0, (St - X)]
Put Option Payoffs
Moneyness and Intrinsic Value of a Put Option
2011 ELAN GUIDES 70

DERIVATIVES
Option Premium
Option premium = Intrinsic value + Time value
Put-Call Parity
C0 + X = P0 + S0
T
(1 + RF)
Synthetic Derivative Securities
Strategy Consisting of Value Equals Strategy Consisting of Value
fiduciary long call + C0 + X = Protective long put + long P0 + S0

call long bond (1 + RF)T put underlying asset
long long C0 = Synthetic long put + long P0 + S0

call call call underlying asset - X/(1+RF)T
+ short bond
long long P0 = Synthetic put long call + short C0 - S0

put put underlying asset +X/(1+RF)T
+ long bond
long long S0 = Synthetic long call C0

underlying underlying underlying + long bond + X/(1+RF)T
asset asset asset + short put - P0
long long X = Synthetic long put + long P0 + S0

bond bond (1 + RF)T bond underlying asset - C0
+ short call
Option Value Limits

Option Minimum Value Maximum Value
European call ECt 0 ECt St

American call ACt 0 ACt St
European put EPt 0 EPt X/ (1 + RFR)T
American put APt 0 APt X
2011 ELAN GUIDES 71

DERIVATIVES
Option Value Bounds
Interest Rate Call Holders Payoff
= Max (0, Underlying rate at expiration - Exercise rate) (Days in underlying Rate) NP
360
where: NP = Notional principal
Interest Rate Put Holders Payoff
= Max (0, Exercise rate Underlying rate at expiration) (Days in underlying rate) NP
360
where:
NP = Notional principal
Net Payment for a Fixed-Rate-Payer
Net fixed-rate paymentt = (Swap fixed rate - LIBORt-1 )(No. of days/360)(NP)

where:
NP equals the notional principal.
2011 ELAN GUIDES 72

DERIVATIVES
Summary of Options Strategies

Call Put
CT = max(0,ST - X) PT = max(0,X - ST)
Value at expiration = CT Value at expiration = PT
Profit: CT - C0 Profit: PT - P0
Holder Maximum profit = Maximum profit = X - P0
Maximum loss = C0 Maximum loss = P0
Breakeven: ST* = X + C0 Breakeven: ST* = X - P0
CT = max(0,ST-X) PT = max(0,X - ST)

Value at expiration = CT Value at expiration = PT
Writer Profit: CT - C0 Profit: PT - P0
Maximum profit = C0 Maximum profit = P0
Maximum loss = Maximum loss = X - P0
Breakeven: ST* = X + C0 Breakeven: ST* = X - P0
Where: C0, CT = price of the call option at time 0 and time T

P0, PT = price of the put option at time 0 and time T
X = exercise price
S0, ST = price of the underlying at time 0 and time T
V0, VT = value of the position at time 0 and time T
profit from the transaction: VT - V0
r = risk-free rate
Covered Call
Value at expiration: VT = ST - max(0,ST - X)

Profit: VT - S0 + C0
Maximum profit = X - S0 + C0
Maximum loss = S0 - C0
Breakeven: ST* = S0 - C0
Protective Put
Value at expiration: VT = ST + max(0,X - ST)

Profit: VT - S0 - P0
Maximum profit =
Maximum loss = S0 + P0 - X
Breakeven: ST* = S0 + P0
2011 ELAN GUIDES 73

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Thousands of

40% Discount for Retakers.

lan Guides Kaplan Schweser Stalla

Member of CFA Institute Prep Yes Yes Yes

Video instruction (approx hrs) 70 50 60

LOS Trackers Yes No No

Applicable on each Only applicable on Stalla Promise

Offers electronic versions of Yes No No

Offers individual videos and Yes No No

* Not available as a stand-alone product

The Future Value of a Single Cash Flow

PVAnnuity Due = PVOrdinary Annuity (1 + r)

Present Value of a Perpetuity

Continuous Compounding and Future Values

Effective Annual Rates

Net Present Value

Bank Discount Yield

Holding Period Yield

2011 ELAN GUIDES 3

Effective Annual Yield

Money Market Yield

RMM = HPY (360/t)

Bond Equalent Yield

BEY = [(1 + EAY) ^ 0.5 - 1]

with Xi > 0 for i = 1, 2,..., N.

2011 ELAN GUIDES 4

Mean Absolute Deviation

Population Standard Deviation

2011 ELAN GUIDES 5

Sample Standard Deviation

Sample skewness, also known as sample relative skewness, is calculated as:

As n becomes large, the expression reduces to the mean cubed deviation.

2011 ELAN GUIDES 6

As n becomes large the equation simplifies to:

Odds for an event

Where the odds for are given as a to b, then:

Odds for an event

Where the odds against are given as a to b, then:

2011 ELAN GUIDES 7

Multiplication Rule for Probabilities

Addition Rule for Probabilities

For Independant Events

P(A|B) = P(A), or equivalently, P(B|A) = P(B)

P(A or B) = P(A) + P(B) - P(AB)

The Total Probability Rule

The Total Probability Rule for n Possible Scenarios

2011 ELAN GUIDES 8

Variance and Standard Deviation

(X) = P(Xi) [Xi - E(X)]

The Total Probability Rule for Expected Value

1. E(X) = E(X|S)P(S) + E(X|Sc)P(Sc)

Expected Return on a Portfolio

Variance of a 2 Asset Portfolio

2011 ELAN GUIDES 9

Variance of a 3 Asset Portfolio

Discrete uniform distribution

Variance of a binomial random variable

2011 ELAN GUIDES 10

The Continuous Uniform Distribution

For a random variable X that follows the normal distribution:

The following probability statements can be made about normal distributions

Approximately 50% of all observations lie in the interval

Roys safety-first criterion