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CFA Level 1 ‑ Secret Sauce

Here is my version of Schweser's secret sauce. This set contains formulas and key concepts
247 terms madelinepage1313

What are financial statement notes 1) details about the information summarized in the financial statements
(footnotes)? 2) summarize accounting methods and assumptions, estimates,
contingencies, acquisitions and disposals.
3) *They are audited.*
4) discuss the fiscal period covered by the statements and the inclusion of
consolidated entities
5) additional information on items such as business acquisitions or disposals,
legal actions, employee benefit plans, contingencies and commitments,
significant customers, sales to related parties, and segments of the firm
What is management's commentary *required to discuss *
(MD&A)? 1) trends, significant events and uncertainties that affect the firm's liquidity,
capital resources and results of operations
2) effects of inflation
3) impact of off‑balance‑sheet obligations and contractual obligations
4) accounting policies that require significant judgement by management
5) forward‑looking expenditures and divestitures

*not required to discuss*


1) discontinued operations
2) extraordinary items, and other unusual or infrequent events

*some parts may be unaudited; one of the most useful sections of the annual
report*
What is "other comprehensive changes which result from *foreign currency translation, minimum pension
income"? liability adjustments, or unrealized gains and losses on investments
(securities held‑for‑trading)*; flows to accumulated other comprehensive
income on balance sheet
What is the super duper expanded assets = liabilities
accounting equation? + contributed capital
+ beginning retained earnings
+ revenue ‑ expenses ‑ dividends
What are the 4 owner's equity 1) capital (par value of common stock)
accounts? 2) additional paid‑in capital
3) retained earnings
4) *accumulated other comprehensive income (OCI)*
What are the two qualitative RF
characteristics that make financial 1) relevance
information useful? 2) faithful representation
What are the three characteristics PCM
of relevance? 1) predictive value
2) confirmatory value
3) materiality
What are the three characteristics CNF
of faithful representation? 1) complete
2) neutral (absence of bias)
3) free from error
What are the three aspects of a TCC
coherent financial reporting 1) transparency
framework? 2) comprehensiveness
3) consistency
What are the 4 qualitative CTVU
characteristics that enhance 1) comparability
relevance and faithful 2) verifiability
representation under IFRS? 3) timeliness
4) understandability
What are the major differences 1) IASB: performance elements are income and expenses
between GAAP and IFRS? *FASB: performance elements are revenues, expenses, gains, losses, and
comprehensive income*
2) *FASB*: an asset as a future economic benefit
*IASB*: an asset is a resource from which a future economic benefit is
expected
3) The word *probable* is used by the FASB to define assets and liabilities
4) *FASB does not allow the values of most assets to be adjusted upward*
What is the net income formula? = revenues
‑ ordinary expenses
+ other income
‑ other expense
+ gains ‑ losses
OR
= ending equity
+ dividends
‑ stockholder investments
‑ beginning equity
What is the percentage of outcome of long‑term contract *CAN BE* reliably measured; same for IFRS
completion method? and GAAP; *more aggressive*; income and balance sheet will differ from
completed contract ‑ cash flows are not different
net income = [(total cost incurred / total cost) x total revenue] ‑ total cost
incurred

What is the "under completed when outcome of a long‑term contract *CANNOT* be reliably measured
contract method"? *IFRS*: pairs revenue and expense together, costs are expensed when
incurred and profit is recognized only at completion.
*GAAP*: revenue, expense and profit are recognized ONLY when the contract
is completed
What is the formula for straight‑line = (orig cost ‑ *salvage value*) / depreciable life
depreciation?
What is the formula for double‑ = *2 / depreciable life in years x book value at beg of year*; *does not use
declining balance? salvage value but depreciation stops when residual value has been reached*
Where are discontinued operations same for both US GAAP and IFRS; must be physically and operationally
reported? distinct from the rest of the firm; management has decided to dispose of but
either hasn't done so or did dispose of in the current period after the
operation had generated income or losses; reported separately in the income
statement, net of tax, after income from continuing operations; should be
excluded by the analyst when forecasting future earnings
What are extraordinary items? US GAAP: *unusual AND infrequent items*; reported separately net of tax and
appears on the income statement below discontinued operations
IFRS: *does not allow extraordinary treatment in the income statement
What are unusual or infrequent events which are either unusual in nature or infrequent in occurrence but not
items? both; included in income from continuing ops & reported before tax.
EX:
1) G/L from from sale of assets or part of business
2) Provisions for environmental remediation, impairments, write‑offs, write‑
downs, restructuring.
3) Integration expense for recently acquired business
What is the basic EPS formula? net income ‑ preferred dividends
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
weighted avg of common shares out
What is the diluted EPS formula? = net income
‑ [preferred dividends]
+ [*convertible* prf.dividends]
+ [*convertible* debt int.] (1‑t)
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
(weighted avg. of c/s o/s)
+ (shares from conversion of conv. pfd. shares)
+ (shares from conversion of conv. debt)
+ (shares issuable from stock options)

only income from continuing operations is considered


What is the treasury stock method? new shares = [(avg mkt price − exercise price) / avg mkt price] x [# of
options out]
What is the statement of *net income + other comprehensive income*; includes all changes in equity
comprehensive income? except for owner contributions and distributions (e.g. issuing stock,
repurchasing stock, and paying dividends)
What is accumulated other *subsection in equity* where "other comprehensive income" is accumulated
comprehensive income (OCI)? (summed or "aggregated"); difference between net income and
comprehensive income; *represents certain gains and losses not recognized
in the P&L account.*
How do you calculate ending =beginning stockholder's equity + contributed capital + net income ‑
stockholder's equity? dividends
What are treasury shares (stock)? stock that has been reacquired by the issuing firm but not yet retired;
*reduces stockholder's equity*; has no voting rights; does not receive
dividends
How do you calculate ending cash Operating cash flow
balances? + Investing cash flow
+ Financing cash flow
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= Chg in cash balance
+ Beg cash balance
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= Ending cash balance
How do you calculate FCFF = NI
+ non‑cash charges
+ interest expense x (1 ‑ tax rate)
‑ capex (net capital expenditure)
‑ working capital investment
What is receivables turnover? annual sales / average receivables
What is days sales outstanding 365 / receivables turnover
(DSO)?
What is inventory turnover? COGS / average inventory
What is days of inventory on hand? 365 / inventory turnover
What is payables turnover? purchases / average payables
purchases = ending inventory ‑ beginning inventory + COGS
What is number of days of 365 / payables turnover
payables?
What is total asset turnover? revenue / average total assets
What is fixed asset turnover? revenue / average net fixed assets
What is working capital turnover? revenue / average working capital
What is the quick ratio? cash + marketable securities + receivables / current liabilities
What is the cash ratio? cash + marketable securities / current liabilities
What is the cash conversion cycle DSO + DOH ‑ DPO
(CCC)?
How do you calculate income Net Sales
available to common? ‑ COGS
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= Gross Profit
‑ Operating expenses
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= Operating Profit (EBIT)
‑ Interest
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= Earnings before taxes (EBT)
‑ Taxes
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= Earnings after taxes (EAT)
+/‑ Below the line items adjusted for tax
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= Net Income
‑Preferred Dividends
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= Income available to common
What is the original three‑part ROE = Net Profit Margin
DuPont formula? x Asset TO
x Leverage Ratio
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= (NI/Sales)
x (Sales/Assets)
x (Assets/Equity)
What is the extended five‑part ROE [NI / EBT]
DuPont formula? x [EBT / EBIT]
x [EBIT / revenue]
x [revenue / total assets]
x [total assets / total equity]

tax burden
x interest burden
x EBIT margin
x asset turnover
x financial leverage
What is the sustainable growth rate =RR x ROE
formula? RR = (1 ‑ dividend payout ratio)
FIFO results in (assuming 1) big inventory
inflationary period) 2) current ratio = big
3) working capital = big
4) COGS = small
5) net income = big
6) higher taxes
7) lower cash flows
LIFO results in (assuming 1) small inventory
inflationary period) 2) current ratio = small
3) working capital = small
4) COGS = big
5) net income = small
6) lower taxes
7) higher cash flows
FIFO inventory = LIFO inventory + LIFO reserve
FIFO COGS = LIFO COGS ‑ ∆ LIFO reserve
FIFO after‑tax profit? = LIFO after‑tax profit
+ [(∆ LIFO reserve) (1 − t)]
How is CFO/CFI affected when CFO: higher
expenditures are capitalized? CFI: lower; *capitalized expenditure is reported as an outflow*
How is CFO/CFI affected when CFO: lower
expenditures are expensed? CFI: higher; the expense flowed through the income statement & CFO
statement. CFI is higher than normal because there is *no outflow for
investing activities*
Under IFRS where can interest as either an *operating expense OR an investing activity*
expense be reported?
What is the units‑of‑production [original cost ‑ salvage value / life in output units] x output units in the
method? period
What is a revaluation surplus *a component of shareholder's equity* that reports the revaluation upward of
account? an asset's value above its historical cost; this is not reported on the income
statement and is only allowed under IFRS
How are impairments recognized if carrying value > *undiscounted CF* from asset's use and disposal
under GAAP?
What is the income tax expense = taxes payable + ∆DTL ‑ ∆DTA
equation?
if taxes paid > income tax expense create DTA
if taxes paid < income tax expense create DTL
How do you calculate a DTL? = (pretax income − taxable income) × tax rate
How is interest expense calculated beginning bond value x *market rate of interest*
for a discount or premium bond?
How do you calculate the ending *beginning book value + interest expense ‑ coupon*
book value of a bond liability?
According to SAS No. 99 what are 1) *incentive/pressure* (the motive to commit fraud)
the three conditions that are usually 2) *opportunity* (weak internal controls)
present when fraud occurs? 3) *attitude/rationalization* (mindset that fraud is justified)
What are some examples of 1) *bill‑and‑hold arrangements* whereby revenue is recognized before the
aggressive recognition of revenue? goods are shipped
2) *holding the accounting period open* past year‑end
3) *sales‑type leases* whereby the lessor recognizes a sale, and profit, at the
inception of the lease, especially when the lessee does not capitalize the
lease
4) *early revenue recognition*: IE before fulfilling all of the terms and
conditions of sale
5) *recognizing revenue from swaps* and barter transactions with third
parties
What are some indications of low 1) boosting revenue w/non‑operating income and nonrecurring gains
quality earnings? 2) delaying expense recognition
3) abnormal use of operating leases by lessees
4) *hiding expenses by classifying them as extraordinary or nonrecurring*
5) LIFO liquidations ‑ used to boost earnings when more inventory is moved
but that cannot go on forever, only so much inventory can be sold
6) abnormal gross margins and operating margin as compared to industry
peers
7) extending useful lives of long‑term assets
8) aggressive pension assumptions
9) year‑end surprises
10) equity method investments and off‑balance sheet special purpose
entities
11) other off‑balance‑sheet financing arrangements including debt
guarantees
What are the 3 C's for credit 1) *Character*: management's reputation and history of repayment
analysis? 2) *Collateral*: ability to pledge specific collateral reduces lender risk
3) *Capacity*: ability to repay debt. requires LT view of firms prospect.
What are 4 way to terminate a 1) Mutual termination
swap? 2) Offsetting contract
3) Resale
4) swaption
What are the 4 major characteristics 1) delivery time
of futures contracts? 2) quality/qty of the goods
3) manner of delivery
*what is not included is delivery price*
What is a Eurodollar deposit? USD time‑deposits outside of the US. Banks borrow dollars from other banks
by issuing Eurodollar time deposits (*certificates of deposit*), which are
essentially unsecured loans. The rate of the loans is LIBOR (London Interbank
Offer Rate)

What is Euribor? Europe Interbank Offer Rate; a daily reference rate based on the averaged
interest rates at which Eurozone banks offer to lend unsecured funds to other
banks in the euro wholesale money market (or interbank market)
What is a forward rate agreement A forward rate agreement can be viewed as a forward contract to
(FRA)? borrow/lend money at a certain rate at some future date. FRAs:
1) settle in cash
2) no actual loan is made
3) *creditworthiness of the parties involved need not be considered.*
Considering forward rates, if long has right to borrow at below market rates and short has obligation to
floating rate > fixed rate lend. *The long will receive a payment.*
Considering forward rates, if short will receive cash payment from the long (right to lend at higher than
floating rate < fixed rate market rates)
What is the FRA formula?

Why do we discount the future since the interest savings would come at the end of the loan period, the cash
payout from a forward rate payment at settlement of the forward is the present value of the interest
agreement (FRA)? savings
What are the methods of settlement *Delivery*: seller delivers the good to the buyer
for a forward contract? *Cash*: buyer and seller exchange the net cash value at the settlement date.
This method is much more common.
How does the concept of margin in in the futures market no funds are loaned to the buyer of the futures and
the futures market differ from the consequently there are no interest charges
concept of margin in the stock
market?
What are the four ways to terminate 1) *short can deliver the goods* and the long can accept the delivery and pay
a futures contract? the contract price
2) *cash‑settlement*, delivery is not an option
3) make an *offsetting trade* (*most common*)
4) *exchange for physicals* (find a trader with an opposite position to your
own and deliver the goods and settle up off the floor of the exchange. ex‑pit
transaction)
How do you solve futures contract 1) *identify all the important elements in the question*
margin problems? a) how many contracts are long/short?
b) what is the contract price?
c) how many units does each contract represent?
d) what is the initial margin per contract
e) what is the maintenance margin per contract
2) *start solving the problem*
a) take difference between initial price and next day's price
b) multiply: (a) x (units in contract) x (number of contracts)
c) next day's account value = initial margin ‑ b
What are four synthetic portfolios 1) c = S + p ‑ (X / (1+RFR) ^ T)
illustrating put‑call parity? 2) p = c ‑ S + (X / (1+RFR) ^ T)
3) S = c ‑ p + (X / (1+RFR) ^ T)
4) S + p ‑ c = (X / (1+RFR) ^ T)
What are the maximum and Min: c ≥ MAX[0, S ‑ [X / (1+RFR)^T‑t]]
minimum values for a European call Max: S
option?
What are the maximum and Min: p ≥ MAX[0, [X / (1+RFR)^T‑t] ‑ S]
minimum values of a European put Max: X / (1+RFR)^T‑t
option?
What are the maximum and Min: C ≥ MAX[0, S ‑ [X / (1+RFR)^T‑t]]
minimum values for a American call Max: S
option?
What are the maximum and Min: P ≥ MAX[0, X‑S]
minimum values of a American put Max: X
option?
What is the general formula for (fixed rate ‑ floating rate) x (days/360) x notional
interest rate swaps?
If the net‑fixed payment is positive the fixed pays, floating receives
...
If the net‑fixed payment is negative the floating pays, fixed receives
...
What is the cost method? value is determined by the *replacement cost* of improvements plus an
estimate for the value of the land
What is the sales comparison value is determined by the price of a *similar property* or properties from
method? recent transactions
What is the income method? uses a discounted cash flow model to estimate the present value of the future
income produced by the property; this method uses NOI (net operating
income) divided by estimated market required rate of return (or cap rate).
Ignores changes to NOI and does not take in to account an investors income
tax implications
How do you calculate NOI? = rental income x (1 ‑ vacancy rate)
‑ insurance costs
‑ property taxes
‑ utility expense
‑ repair / maintenance costs

*no financing cost or depreciation when calculating NOI*


What is the discounted after‑tax net present value of an investment equals the present value of after‑tax cash
cash flow method? flows, discounted at the investor's required rate of return, minus the equity
portion of the investment. Only projects w/a NPV > 0 should be accepted.
What are the stages of venture 1) *seed stage*: provide capital for r&d
capital investing? 2) *early stage*
a) start‑up financing: complete product development
b) first stage financing: refers to the funding of the transition to commercial
production and sales of the product
3) *formative stage*
4) *later stage*: company is still private, company needs second and third
stage financing. Third stage financing would fund a major expansion of the
company. *Mezzanine or bridge financing would enable a company to take
the steps necessary to go public*
How do calculate whether to invest 1) estimate probability of failure for each year until a payment is expected
in a start‑up? 2) take each probability and subtract it from 1 and multiply them all together:
this is the probability of success
3) discount the expected payout to the present and multiply that value by the
probability of success (value from #2)
4) subtract probability of success from 1 to get the probability of failure and
multiply that value by the initial cash outlay
5) add the two numbers together:
*[PV x P(success)] + [CF0 x P(failure)]*
How do you calculate after‑tax cash =NOI
flows? ‑ Depreciation
‑ first mtge payment
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= blah x (1 ‑ marginal income tax rate)
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= after‑tax blah
+ depreciation
‑ (mtge payment ‑ (amt borrowed * mkt rate of interest))
What are the three sources of 1) *Collateral yield*: the return on the cash used as margin
return for a commodity investment? 2) *Roll Yield*: the return from rolling forward the maturity
3) *Spot price*: changes to the price
What are the capital budgeting 1) decisions are based on cash flows, not accounting income
principals? 2) Cash flows based on opportunity costs & taxes
3) timing of cash flows is important
4) Cash flows are analyzed on *after‑tax basis*
5) *financing costs are reflected in the projects required rate of return and
thus should not be included in incremental cash flows.*
What is the discounted payback uses present values of the projects estimated cash flows. Number of years it
period? takes a project to recover its initial investment in PV terms and must be
greater than the payback period without discounting. This method ignores
terminal values.

What are NPV profiles? graph that show's a project's NPV for different discount rates; y‑axis=NPV
x‑axis=cost of capital/discount rate
*when profile touches x‑axis NPV = 0*

What is the crossover rate? *point where two project's NPV's are equal*. Usually need to find mystery
initial cash outflow for a project.
1) Find NPV for project w/all known cash flows. 2) set initial cash outflow for
unknown project to 0 and calculate NPV
3) subtract that value from other project's NPV
What is project sequencing? an investment in a project today that creates the opportunity to invest in
other projects in the future

What is capital rationing? The situation where a firm has more positive NPV projects than its available
budget can fund. It must choose a combination of those projects that
maximizes shareholder wealth.
What is the WACC formula? (Wd) [Kd (1‑t)] + (Wps)(Kps) + (Wce)(Kce)

Wd = % of debt in cap structure


Wps = % preferred stock in cap structure
Wce = % C/S in cap structure
What are the three methods of 1) *CAPM*: Kcs = RFR +β [E(Rm) ‑ RFR]
determining cost of equity? 2) *(Div / P0) + growth rate* (sometimes you will have to add growth to the
dividend if it's going to be paid in the future)
3) *Add‑on yield* method (bond yield + add‑on rate)
What is the CAPM formula? Kcs = RFR +β [E(Rm) ‑ RFR]
What is the CAPM with country risk Kce = RFR + β [E (Rmkt) ‑ (RFR + CRP)]
premium (CRP)?
What are the two dividend discount 1) Po = D1 / [Kce ‑ g]
model formulas? 2) Kce = (D1 / Po) + g

D1 = next year's dividend


Kce = required rate of return
g = expected constant growth rate
What is asset beta? D/E: % debt / (1 ‑ %debt)
t : marginal tax rate

What is project beta? measure of its systemic / market risk


D/E: % debt / (1 ‑ %debt)
t : marginal tax rate

What is the break point formula? amt of capital at which a component's cost of cap chgs
= ‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
weight of component in capital structure
What is the marginal cost of capital the WACC at different levels of capital investment. It is usually upward
schedule? sloping and is a function of a firm's capital structure and its cost of capital at
different levels of total capital investment.
What is business risk? risk associated with *operating income* and is result of *uncertainty about a
firms revenues and expenditures* necessary to produce those revenues; main
factors are *demand variability, sales price variability, input price variability,
ability to adjust output prices, and operating leverage*

What is operating risk? uncertainty about operating *EARNINGS* caused by *FIXED* operating costs.
What is a DOL (using price and
qty)?

What is a DOL (using sales and total [S ‑ TVC] / [S ‑ TVC ‑ TFC]


variable cost)?
What is a DOL formula (using EPS = [%∆EPS / %∆Sales] / [EBIT / (EBIT‑interest)]
and sales and knowing about the = DTL / DFL
firm's use of debt)?

What is the DFL formula? [S ‑ TVC ‑ TFC] / [S ‑ TVC ‑ TFC ‑ interest]


OR
EBIT / [EBIT ‑ interest]
What is the DTL formula? = DOL x DFL
What is an alternative DTL formula? = %∆EPS / %∆Sales
What is Qbe (break even quantity)? fixed operating costs + fixed financing costs
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
Price ‑ variable cost per unit
What is Qbe (operating breakeven fixed operating costs
quantity)? ‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
Price ‑ variable cost per unit
What is the proper dividend DEHP (Department of Environment and Heritage Protection)
sequence? 1) Declaration date
2) ex‑dividend date (occurs TWO business days before the holder‑of‑record
date)
3) holder‑of‑record date
4) payment date
BDY = ([face value ‑ price] / face value) x (360 / days)
MMY = HPY x (360 / days)
BEY = HPY x (365 / days)
most appropriate for comparing a company's investments in short‑term
securities
Good corporate governance 1) the board of directors protects shareholders interests
practices seek to ensure that? 2) the firm acts lawfully and ethically in dealings w/shareholders
3) the rights of shareholders are protected and shareholders have a voice in
governance
4) the board acts independently from management
5) proper procedures and controls cover management's day‑to‑day
operations.
6) the firm's financial, operating and governance activities are reporting to
shareholders in a fair, accurate and timely manner.
How do you calculate the margin P0 x (1 ‑ initial / 1 ‑ maintenance)
call price?
What are the 3 types of market QOB (Queen of Bobs)
structures? 1) *quote‑driven*: investors trade w/dealers
2) *order‑driven*: matches buyers and sellers based on price and time
precedence
3) *brokered markets*: investors use brokers
What is the price‑weighted index *= sum of stock prices / number of stocks in index*
formula? simple to calculate; downward bias; divisor is adjusted for stock splits and
changes in the composition of the index when securities are added or deleted
(reconstituted); higher priced stocks have greater impact than lower priced
stocks
What is the market capitalization‑ computed by adding up the collective market capitalizations of its members
weighted index formula? and dividing it by the number of securities in the index
What is the equal‑weighted index arithmetic average *of the returns* of each component in the index;
formula? disadvantage: period rebalancing (similar to price‑weighted); weights placed
on returns of the securities of smaller cap firms are greater than their
proportions of the overall market value of the index stocks
What is a total return index? uses both price return and interim cash flows to calculate return; *always
greater than price return index*
What is weak form market 1) prices fully reflect all currently available security mkt data
efficiency? 2) price chgs are *independent* from one period to the next.
3) *TA will not work.*
What is semi‑strong form market 1) prices fully reflect all publically available security mkt data
efficiency? 2) prices do include past security mkt info plus non‑mkt info available to the
public
3) timing of *news announcements are independent* of each other
4) large # of profit maximizing participants
5) *FA will not work*
What is strong‑form market 1) prices fully reflect all *public and private sources* (perfect market)
efficiency? 2) *all info is reflected, past, public and private (inside)*
3) no group has a monopoly on info
4) noone should be able to consistently achieve abnormal returns
5) assumes cost *free availability* of all information
What does market efficiency it does not assume that individual market participants correctly estimate
assume? asset prices, but does assume that their *estimates are unbiased*. That is,
some agents will over‑estimate and some will under‑estimate, but they will
be correct, on average
What are the 5 most important 1) *macro* ‑ cyclical or structural; interest rates; credit availability; inflation;
external factors influencing industry education leading to productivity
growth? 2) *technology* ‑ increases in productivity
3) *demographic* ‑ age distribution and size
4) *governments* ‑ taxes and regulation
5) *social influences* ‑ relate to how people work, play, spend money
What are the five phases of industry 1) *embryonic*: slow growth, high prices, large investment needed, high risk
life cycle? of failure
2) *growth*: rapid growth, limited competition, falling prices
3) *shakeout*: growth has slowed, intense competition, industry
overcapacity, declining profitability, cost cutting, increased failures
4) *mature*: slow growth, consolidation, high barriers to entry, stable
pricing, superior firms gain market share
5) *decline*: negative growth, declining prices, consolidation

What is the one‑year holding period value of stock *TODAY* is PV of any dividends during the year plus the PV of
DDM? the expected price of the stock at the end of the year (terminal value); *be
sure to use the expected dividend*

What is the multi‑period DDM? discount all dividends to present as well as a "perpetuity" value; don't forget
to discount the "perpetuity" value to the present as well. add dividends and
perp value together; *appropriate for rapidly growing companies*

What is the earnings multiplier = [D1 / E1] / (k ‑ g)


model (justified P/E formula)? = payout / (k ‑ g)
According to Markowitz, an investor's highest utility curve is tangent to the efficient frontier
investor's optimal portfolio is
determined where the?
What are the 3 steps in the portfolio 1) *Planning*: IPS
management process? 2) *Execution*: top‑down or bottom up analysis, security selection
3) *Feedback*: monitor changes with client and rebalance portfolio, evaluate
performance relative to benchmark portfolio identified in the IPS
How do you calculate covariance 1) put return data into calculator using 2nd data func to find mean
between two assets? 2) find difference between each period's value and each sets mean
3) take period A's difference and multiply it by period B's
4) sum all the values up
5) *divide by n ‑1*
What is the formula for correlation (Cov of A, B)
coefficient? ‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
(STD of A) x (STD of B)

be careful, sometimes the question will include the variance, which is the
standard deviation squared.
What is the formula for the standard
deviation of a portfolio of two risky
assets?
What is the efficient frontier? *plots expected return against standard deviation of returns for efficient
portfolios*; the set of portfolios that gives investors the highest return for a
given level of risk or the lowest risk for a given level of return; *the point at
which there are no more benefits to diversification*; the efficient frontier line
bends backwards due to less than perfect correlation between assets; a
*portfolio to the left of the efficient frontier is not attainable*

The portfolio on the efficient global minimum‑variance portfolio


frontier that has the least risk is the
...
What is the separation theorem? think budget constraints and indifference curves from economics; this
combines the CML (risk‑free rate and efficient frontier) with an investor's
indifference curve map; it separates out the decision to invest from what to
invest in. The investment selection process is simplified from stock picking to
efficient portfolio construction through diversification.
What is the capital allocation line A line created in a graph of all possible combinations of risky and risk‑free
(CAL)? assets. Also known as the "reward‑to‑variability ratio"; as you increase the
weight of the risky asset you get more risk but also a higher return

What is the capital markets line A line used in the capital asset pricing model to illustrate the rates of return
(CML)? for efficient portfolios depending on the risk‑free rate of return and the level
of risk (standard deviation) for a particular portfolio; represents all possible
combinations of the market portfolio with the risk‑free asset; *derived by
drawing a tangent line from the intercept point on the efficient frontier to the
point where the expected return equals the risk‑free rate of return.*;
considered to be superior to the efficient frontier since it takes into account
the inclusion of a risk‑free asset in the portfolio. The capital asset pricing
model (CAPM) demonstrates that the market portfolio is essentially the
efficient frontier.

What is the security market line positively sloped straight line showing relationship between expected return
(SML)? and beta (systemic risk)

Beta formula= =(COV stock,market) / (VAR mkt)


Alternate beta formula = =correlation x [Std Stock / Std Market]
What does it mean to move you are borrowing funds and owning more than 100% of the market portfolio
rightward of the mkt portfolio?
What does it mean to move leftward you are lending funds or *buying the risk‑free asset* (IE lending to someone
of the mkt portfolio? else for a return)
What are some assumptions of *All investors:*
Capital Asset Pricing Model 1) Aim to maximize economic utilities
(CAPM)? 2) Are *rational* and risk‑averse
3) Are broadly diversified across a range of investments
4) Are *price takers*; they cannot influence prices
5) Can *lend and borrow* unlimited amounts under the risk free rate of
interest
6) Trade *without transaction* or taxation costs
7) Deal with securities that are all *highly divisible* into small parcels
8) Assume *all information is available* at the same time to all investors
9) All investors have the *same one‑period time horizon*
10) All investors have the *same risk/return expectations*
What is the Sharpe ratio? calculated by subtracting the risk‑free rate ‑ such as that of the 10‑year U.S.
Treasury bond ‑ from the rate of return for a portfolio and dividing the result
by the standard deviation of the portfolio returns

What is Roy's Safety First Criteria? calculated by subtracting the minimum desired return from the expected
return of the portfolio and dividing the result by the standard deviation of
portfolio returns. The optimal portfolio will be the one that minimizes the
probability that the portfolio's return will fall below a threshold level.

If the RR < ER stock is underpriced; buy it


If the RR > ER stock is overpriced; short it
If a portfolio plots above the SML, undervalued (RR < ER)
the portfolio is ...
If a portfolio plots below the SML, overvalued (RR > ER)
the portfolio is ...
What are federally related 1) owned by the US govt and exempt from the SEC registration
institutions? 2) *backed by full faith and credit of US govt*
3) free from credit risk
EX: Government National Mortgage Association (Ginnie Mae), TVA (Tennessee
Valley Authority)
What are government sponsored 1) privately owned but publicly chartered organizations
enterprises? 2) created by US Congress
3) securities issued directly in the marketplace
4) expose investors to some credit risk
What are the four tools the Fed 1) discount rate
uses to control interest rates? 2) open market operations (most common)
3) bank reserve requirements
4) persuading banks to tighten or loosen their credit policies
Par bond coupon rate = current yield = yield to maturity
Discount bond coupon rate < current yield < yield to maturity
Premium bond coupon rate > current yield > yield to maturity
What are four characteristics of the 1) Z‑Spread is the credit spread that adjusts for the curvature of the spot rate
zero‑volatility spread measure? yld curve.
2) Z‑Spread is the constant spread which must be added to each rate on the
Treasury spot yield curve in order to make the present value of the risky
bond's cash flows equal to its market price.
3) The steeper the benchmark spot rate curve, the greater the difference
between the two spread measures.
4) The earlier bond principal is paid, the greater the difference between the
two spread measures.
When the spot yield curve is upward z‑spread > nominal spread
sloping ...
When the spot yield curve is z‑spread < nominal spread
downward sloping ...
How do you calculate a forward rate if given 3f3, this means you want to know the 3 year fwd rate, 3 years from
from spot rates? now. what you need to calculate this is:
1) 3‑year spot rate
2) 6‑year spot rate
3) formula:

= [ (1 + z6)⁶ / (1 + z3)³ ] ‑ 1
How do you calculate reinvestment EX: how much reinvestment income would so‑and‑so need to earn over X
income? years to achieve a compound rate of return of Y?

PV * (rate ^ periods)
‑ principal repayment
‑ [bond coupons x periods]
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
= reinvestment income
How do you calculate total interest (coupon payments x n periods) + bond FV ‑ bond PV
expense?
How do think about duration think sensitivity; when you get more cash now, the bond has less sensitivity
to interest rate moves; when you have to wait longer to get the final payout,
the bond has more sensitivity
What is the effective duration
formula?

How do you apply the effective ‑(effective duration) x Δ yield x original bond price
duration when given a change in
yield and the effective duration?
What is the combined = [‑duration x Δ y] + [convexity x (Δ y) ²] x 100
duration/convexity formula?
What is the PVBP formula? = duration x 0.0001 x bond value
What does r on your calculator correlation coefficient
when using the 2nd Data functions?
How do you calculate HPY from MMY x [t / 360]
MMY?
How do you calculate HPY from [1 + EAY] ^ (t / 365)
EAY?
How do you calculate the MMY from [360 × bank discount yield]
the BDY? ‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
[360 − (t × bank discount yield)]
How do you calculate the BEY from 2 x [[1+HPY] ^ (182.5 / t)]
the HPY?
What are the four measurement 1) *nominal*: no particular order
scales? 2) *ordinal*: ordered w/respect to a specific characteristic
3) *interval*: provides relative rankings; differences between the scale values
are equal
4) *ratio*: equal differences between scale values; also have true 0 as the
origin
What is the formula for determining =(n + 1) x [y / 100]
the position of an observation at a
given percentile?
What is Chebyshev's inequality? =[1 ‑ 1/k²]
What is the formula for the standard deviation of x / mean of x
coefficient of variation?

positive skewness mode < median < mean


negative skewness mean < median < mode
What are the 3 moments? Moment 2 = variance (squared)
Moment 3 = skew (cubed)
Moment 4 = kurtosis (4ths)
What is the multiplication rule of =P(AB) = P(A|B) x P(B)
probability?
What is the addition rule of =P(A or B) = P(A) + P(B) ‑ P(AB)
probability?
What is the total probability rule? =P(X | Y) = P(X).
What are the "odds for" something = P(E) / [1 ‑ P(E)] A probability of 20% would be "1 to 4"
happening?
What are the "odds against" = [1 ‑ P(E)] / P(E) A probability of 20% would be "4 to 1"
something happening?
What is a confidence interval?

How do you calculate continuous 1) input the given rate in decimal format (IE: 10% = .10)
compounding given a rate? 2) 2nd + LN
3) raise to power if doing for multiple periods
4) subtract 1 and multiply by 100
How do you calculate continuous 1) divide ending value by beginning value
compounding given a beginning and 2) Hit the LN button
ending value?
What is sampling error? sample mean ‑ population mean
What is the standard error of the
sample mean?

What is the general confidence point estimate + reliability factor + standard error
interval formula?
Normal distribution with known 1) small sample: z‑stat
variance? 2) large sample: z‑stat
Normal distribution with unknown 1) small sample: t‑stat
variance? 2) large sample: t‑stat or z‑stat
Non‑normal distribution with known 1) small sample: NA
variance? 2) large sample: z‑stat
Non‑normal distribution with 1) small sample: NA
unknown variance? 2) large sample: t‑stat
Type I & II Errors If null is true & fail to reject = Correct!
if null is true and reject = Type 1 error! significance level, α
‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑
If null is false & fail to reject = Type 2 error!
if null is false and reject = Correct! (1‑ P)

When is a pooled variance used? with the t‑test for testing the hypothesis that the *means of two normally
distributed populations are equal*, when the variances of the populations are
unknown but assumed to be equal
What is a paired comparisons test? a test of whether the average difference between monthly returns is
significantly different from zero, based on the standard error of the
differences in monthly terms
What is a chi‑squared test? used for hypothesis tests concerning the variance of a normally distributed
population
How do you calculate a test chi‑ (n‑1) / hypothesized value
squared statistic?
What is the F‑statistic? s₁² / s₂²; always put the larger variance in the numerator
concerned with the *equality of the variances of two populations*
What are parametric tests? rely on assumptions regarding distribution of population and are specific to
population parameters.
What are non‑parametric tests does not consider particular population parameter or have few assumptions
about population that is sampled. Used when concerned about quantities
other than the parameters of a distribution or when the assumptions of the
parametric tests can't be supported.
What are non‑parametric test 1) hypothesis test of mean value for a variable that comes from a distribution
situations? 2) when data are ranks (an ordinal measurement scale) rather than values
3) hypo not involve parameters of distribution, such as testing whether a
variable is normally distributed. Use run tests
Marginal cost = ∆ TC / ∆ in output
Breakeven points 1) perfect competition: AR = ATC
2) imperfect competition: TR = TC
Short‑run shutdown points 1) perfect competition: AR < AVC
2) imperfect competition: TR < TVC
Long‑run shutdown points TR < TC
P < AC
GDP deflator = [nominal GDP in year t / value of year t output at base year prices] x 100
GDP equation = C + I + G + (X ‑ M)
Growth in potential GDP = growth in technology + growth in labor + growth in capital
Money multiplier = 1 / reserve requirement
Equation of exchange = MV = PY (money supply x velocity = price x real output)
Fisher effect = nominal interest rate = real interest rate + *expected* inflation rate
What are the three categories of Ep > 1; demand is elastic
price elasticity? Ep = 1; demand is unitary elastic
Ep < 1; demand is inelastic
Is there a well‑defined supply no. why? bc all three face downward sloping demand curves; qty supplied is
function under monopolistic determined by the intersection of MC and MR; price charged is then
competition, oligopoly and determined by the demand curve. only perfect competition has a well‑
monopoly? defined supply curve.
What is the N‑firm concentration 1) measures the concentration of a market (usually in regards to determining
ratio? if a merger should be allowed).
2) sum of the percentage mkt shares of the N firms in a mkt. *does not
directly measure mkt power or elasticity of demand*.
3) *may be relatively insensitive to mergers of two firms w/large mkt shares.*
What is the Herfindahl‑Hirschman 1) measures concentration of a market (usually in regards to determining if a
Index? merger should be allowed).
2) *sum of the squares of the mkt shares of the largest firms in the mkt*.
3) *does not take possible entry into mkt into account; nor does it consider
elasticity of demand*
What is the source of differences in differences in labor productivity due to differences in technology
production costs in the Ricardian
model?
What are the two factors of capital and labor
production under the
Heckscher/Ohlin model?
What are the 5 kinds of trading 1) *Free Trade area*: all barriers to flow of goods are eliminated between
blocs? members
2) *Customs Union*: same as FTA & in addition creates a common trading
policy with non‑members
3) *Common Market*: same as customs union & allows free movement of
factors of production; removes all barriers to movement of labor and capital
among members
4) *Economic Union*: same as common market & coordination of economic
policy
5) *Monetary Union*: same as economic policy + adopt a common currency
What are the three accounts which 1) current account
constitute the BOP (balance of 2) capital account
payments)? 3) financial account
What is the current account? sum of the balance of trade (X ‑ M); both government and private payments
are included in the calculation; goods and services are generally consumed in
the current period.
What is the capital account? reflects net change in national ownership of assets. A surplus means money
is flowing into the country; deficit means money is flowing out the country,
but it also suggests the nation is increasing its claims on foreign assets.
What is the financial account of? 1) govt‑owned assets abroad
2) foreign owned financial assets with the reporting country
What is the equation representing X ‑ M = private savings + government savings ‑ investment
the relationship between trade X ‑ M = (T ‑ G) + (S ‑ I)
deficit, saving and domestic
investment?
How do you calculate ending ending inventory = beginning inventory + purchases ‑ COGS
inventory?
What is the base currency? currency in the denominator
What is the price currency? currency in the numerator
The foreign currency is the base direct quote (foreign currency in denominator)
currency for a?
The home currency is the base indirect quote (home currency in denominator)
currency for a?
What is the interest rate parity forward rate = spot rate x (1+domestic rate / 1+foreign rate)
formula?
If USD/EUR spot exchange rate is 1.3425, USD = forward premium, EUR = forward discount; in 6 months 1
1.3500 and 6‑month forward points Euro will only buy 1.3425 instead of 1.3500, so currently it is at a premium
are −75, the 6‑month forward
exchange rate is:
If RFR goes up puts: go down
calls: go up
If RFR goes down puts: go up
calls: go down
How are lease payments accounted whether a lease is an operating or a finance lease, both GAAP and IFRS
for? require disclosure of the minimum lease payments *for each of the next five
years and the sum of minimum lease payments more than five years in the
future*