ETHICAL AND PROFESSIONAL phy 1a) Keowee ofthe aw UB) Independence and Objectivi 1) Misepresenation UD) Misconduct Th Integrity of Cepia Markers HA) Meal Nopeblc Information. M(B) Markee Manipulation ML Dates o Clients NA) Loyal, Pradence, and Cae KB) Fir Dealing INC) Suitably IK) Peformance Presentation TINE) Preservation of Confidential IV. Daties to Employer Via) Loyal IV(B) Akltional Compensation Arangements IV(C) Responses of Supervisor. V- Investment Analysis, Recommenda and Actions Via). Diligence and Reasonable Bass YB) Communication with Chine ad Prospective Cents V(O) Record Retention. Vi Conic of Interest VI(A) Dislnare of Cons VI(B) Privy of rnsacons. VIC) Reel Fes. VIL” Responsibilities asa CEA Insite Member or CFA Candidate \iICA) Condit sPatcipanes in CFA Instate Progam ‘IIE Reference to CFA Innis, the CEA Designation, and the CEA Program. Global Investment Performance Standards (airs) * Comp tment “er ae of i trh the Global Invesment Peformance Srandands(GIPS)" Compliance mus be pplicd tn firm wide bss + Nine section fundamental of compliance, jp data, alelation methodology, compose contruction, ducloates,peenaton an ‘poring el eat, private egy and we FEueparely managed acount porflice, Pats ey ‘Tin Vl of Moncy Baie + uur value (FV): amount to which investment {grows after one or more compounding periods. ‘Furure value: EV = PV + IY) Proen salu (PV): cutent value of some future cash low PV = FV/(I + 1) Annuities sts oF equal cashflows that occur at ‘renly spaced intervals overtime, (Ondinary anny cash Row at en-otime petiod. Anna due: ech flow a beginning oF time period. + Pees nie wih insite is MT discount rate). weal Rate of Return ‘Components: 1. Real fee rate (RFR). 2 Expected inflaton rate premium (I). 5. Risk premium. EAR) = (14+ RFR oy) (1+ 1PVU4+RP)—1 Approximation formula fr nominal equited rate: E(R) =RER +1P-+ RP Means ‘Arithmetic mean: sum ofall observation values in ‘amplpopultion, divided by # of observations Geometric mean: wsed when calculating investment returns over muliple periods orto messite ‘compound groweh rats. Geometric mean rear Rox [04R)x.x(4 Rul} ‘Variance and Standard Deviation Variance: average of squared deviations fom mean, Sew? population vaance = = 5 D2 ost Standard detonate roto since Holding Period Return (HPR) oe RED, sample variance Cocficient of Variation Ceffcen of variation (CN): expresses how much lisprson exists relative to mean ofa distribution: allows fo dtee comparison of dispersion across lferene daa ses, CV i calculated by dividing ‘andar deviation of distribution bythe mean oF ‘expected value ofthe distribution: wv x Sharpe Ratio ‘Sharpe ri: measures exc return per unit of isk For bth tos lange i bee. Expected Return/Standard Deviation Expected return: E(X) = 7P(x,) x, E(X) = P(x) P(g Jag +t PCs) Probable aria 2 (X)=DPlxi)fx, -E(X)P toot Plein EOP ‘Standard deviation ake quae root of vata CCorrdation and Covariance Caration: covatiance divided by product ofthe ‘wo sandard deviations P(x, EC + P(e -E(XP ho? (Ra) +wio" (Rs) +2wawyo(Ra)o(Rp)e(RaRs) Normal Distributions ‘Normal distribution is completely described by its ‘mean and variance (68% of observations fl within ¢ 1a, a(R) 90% fill within + 1.650 95% fill within + 1.96 999% fill within + 2.580 Aistibution; represents # of standard deviations a ven observation i rom population mean. Binomial Models Binomial dcribution: assumes avaiable can ake lone of two values (succes/ilure) of, in the case of Astock, movements (up/down). A binomial model ‘an describe changes inthe value ofan asset of porto: can be used to compute ie expected value over several periods Sampling Distribution Sampling dcribution: peobabiinydsebution of all posable sample statistics computed from a ct of equals samples randomly drawn from the same population. The somplingdiribution ofthe mean is the distribution of extimates of the mean, Central Limit Theorem Conta ims theanem: when selecting simple random samples of sae» from popudetion with ‘mean and finite variance 0, the sampling dlistebution of sample mean approaches normal probability distribution wich mean and variance ‘qual ton asthe sample size becomes lags Standard Error Ssondard ero of the szple mean isthe standard deviation of distribution of che sample means known population variance: 05 ‘unknown population variance: Confidence Intervals Confidence interval gives range of values the mean value will be berween, with 2 given probability (say 909% oF 95%). With known variance, Formula for 2 confidence interval is Finn 1.645 for 90% confidence intervals (significance level 10%, 5% in each ai) y= 1.960 for 959 confidence interval (significance level 5%, 2.5% in each ei) yy" 2.575 for 99% confidence interval (significance level 1%, 0.5% in each ei)QUATTATE METHODS continue. [Nall and Alternative Hypotheses ‘Nl bypthess (H): hypothesis tha contains the gual sign (<2) the hypothesis that is acually ‘este the basis for selection ofthe test statisti. Alenative pothesis (Ha): onclde if ther is salient evidence to reject the nll hypothesis. Diflrence Between One- and Two-Tailed Tests Onesie et tes whether valu is greater than of Jes than a gven number. ‘Tooter: tess whether vale is eal 8 sven number + Onevled tet: He < 0 versus Hy > 0. + Thortled test: Ho: = 0 ves Hy #0. ‘ype Land Type Il Erzors + pe err tection of rl hypothesis when itis scualy ve. + Tipe ero: te ost nll hypothesis when ieisacrualy fase. ‘Types of Hypothesis Tests Use etait for est involving the population mean (location of mean, liference in means rd comparisons. Use c-square sari or wets ofa ingle population variance. Use Fait fore comparing wo population ‘Technical Analysis Reversal patterns bea and shoulders, verse H&S, doubletiple op or boro. ‘Continuation pater wiange, rectangles pennants Ags. Price based indicator moving averages, Bollinget bands, momentum oscillators (ate of chang, RSL stochastic, MACD). Sentiment indicator opiion pols, pull aio, ‘VIK, margin debe, shor interest ratio. Flow of nds indicators: TRIN, margin debt, ‘mutual fund cash poston, new equity isuance, secondary ofering, es Elasticity (Oum price elaicy = 34d. quantity demanded id price [absolute value > 1, demand is elas Wasolute value < 1, demand is inelastic: LF postive the good i normal good. negative, the god isan inferior good 368. quantity demanded Co pie ty = cof ated good 1 postive, elated good i subi, negative, related god ia complemen. Breakeven and Shutdown Breakeven al revenve = trl cos. (Operate in shore raf otal revene i greater than total variable cost but les than total cost. Shut dewn in short ran fal even is es than ‘orl variable cost. Market Structures Pfs competition: Many fems with no pricing power: very low or no bares oenty: homogeneous product. ‘Monpliic competition Many Sms some Pricing powers low barriers to entry: diferenited procs large advertsing expense Oligopoly: Few fms that may have significant pricing power: high baeiers to entry: products may be homogencous or differentiated, ‘Monepol: Single cm with signiicane pricing power high arrest entry advertising used to ‘compere with subtue products Ina makee structures, profits maximized at ‘he output quanity for which marginal venue = marginal cot. Gross Domestic Product Real GDP = consumption spending + investment + ‘government spending + net export. ‘Savings, Investment, Fiscal Balance, and Trade Balance cal budget deficit (G—) = aces of ving over 0sk pices eae are Value-weighte Index = ___Eleuren pies share) Tibase year price) ase year shares) ‘Types of Orders Exeaton inaction: bow to wade; eg, matket orders, limit orders. Validity introns: when to excuse. sp orders, day orders fil-orkll orders Clearing inercion: how to cleat and sete fo ell orders, specify shor sleor sale of owned security ‘Markee Structures Quoredriven marks: investors wade with dealers (Onder driven marker: buyers and scllrs matched by rues Brokered marke brokers ind counterparties, Forms of EMH 1 Weak form. Cusent sock prices fly reflect uilabl security marke inf. Volume information/past price do not relate ro frre licecton of ecuity prices. Investor cannot achieve exes seems using tech analysis + Somi-strang form. Secutcy pices instantly adjust tw new public information. Investor cannot achieve ‘exces retutns using Fundamental analysis 1+ Shame form. Stock prices fly reflec all “information from public ana private ure. Assumes perfect markers in which al information ‘con fre and availble to everyone athe same time, Even with inside info, investor eannot achieve exes returns. EQUITY INVESTMENTS merece Saaainee peep ee Inport ase high io lr CGoulenpid pow aig pis linia competion, incre profs eee eee eg Ge eae aaa ‘Mati: do gow, conrliation, able rica, high bain tent Coe eens ame Bre Compatve Fores 1 nlyassey tegen 2 Thee fea sree eee net ees sees One Pesid Valuation Model Lares | Ok) ORD Be srt we expected dvidend Dn cain. Infinite Peiod Dividend Discount Models ‘Soprsamal poe mod (rama) DDN D pio oe et Tr) Gn ot ase value Ye % where: Py (kee) Contane grt model Dut+e)_ Dy (Cetcal relationship between k and g: ‘+ Acdfference between hand g widen, value of stock fall, + -Asdiference narrows, value of stock ret. ‘+ Small changes in difference berween F and g, ‘aus large changes in stock val. (Cave sumption: of infinite period DDM: + Stock pays dividends, constant growth ate, ‘+ Consant grow rate never changes. + must be greater than g (or math will not wor). ates Basic Features of Bonds oer. Soveteign,non-sverign qusi-government, ‘supranational corporat, SPE. ‘Masur, Money matke (one yea les); capital rmatkt (cate than one ye) ‘Per elue Bonds principal ae (ee value) Coupon. Anal percent of pa; aed or Hating Divide by peiadiciy wo get periodic rat. Gurren Single, dua, carency option. Indenture. ABioaive ad negative covenanes Price, Yield, Coupon Relationships Bond prices and yields are invenely cate Increase in yield decreases price: decrease in yield increases price ‘Coupon «yield: Discount to pa vale. ‘Goupon > yield: Premium to pat value. Constante price sector Price approaches ‘paras bond nears maturity from amortization of dlscounts and premiums. Capital gains and loses ar calculated relative to this trajectory ‘Cash Flow Structures Balle Al pica repaid at maar. ‘Fly amrtzing? Equal pesiodc payments include ‘bod interest and principal Partially emortzing Besiodic payments include incre and principal, balloon payment at matriy repays remaining principal Sinking fond: Sched oe ely redemption. “Foating-rate: Coupon payments based on reference sae pls margin. Bond Pricing “Ther ar wo equivalent ways to price a bond + Constant discount ate applied tall ah flows (OTM) to find PV. This a bond’ flr price (does ‘ot include accrued interes). + Discount cach cash low using appropriate spor sat for ach This isa bonds nearbirae price ‘ul prie includes accrued interes. Government ‘bonds use actual day counts corporate bonds use 30/360 method fil pie - PV at as coupon date (1+ ¥TM)"™ cried interest = coupon payment (/T) where: ays rom most recent coupon payment tae seulement days in coupon payment ptiod Matrix pricing origi bons, ilo bonds ‘with same cei quality to ema yeast for maui erences wth near inerpolation. Bond Markets [National bond markt includes domestic bonds and foreign bonds + "Dometic bons. Domesicauce and carey + Foreign bonds Foreign ace domestic currency Eurlond marker uid any oe county, with ‘bonds denominated in currencies cher han those ‘of countries in which bonds at sold. (Global bond ead in bot national ond matkee and the eurobond mark. Bond Issuance Underriten offering: aves banks buy cate isu, cll to publi. Ber efoto Investment hanks ata broke ‘Shel ination Register ei se with "egulators but all vera period of ime. Embedded Options alee: suc ay repay principal ey. ceases yield and decreases duration. Puede Bondblder may sll bod back vo suet Decreases yield and duration. CConverble Bondholt may exchange bond for inser common sock Embeded warns: Bandolier may buy issuers ‘common stock at exerci rice. Yield Measures _Efsive yield Spends on pid. TM = cfcie yield for anal pay bonds. Somianal bond basis YIM.» 2 seminal dicount re Curent ld» annul coupon price. Simple id= cue yield» smorraton. Yield calls based on cll ate and cll prc. Yield to wore lowes ofa bonds YICs YIM. Mone markt ier may be ona discon ora ‘on bss and may ie 2360-0 365day eat ‘Bondequvoent yields an snavalized addon yield based om 2 365-day year Forward and Spot Rates Forward ste erate for loan that gins at 3 future date. "Iy3y"» 3-year forward rate 1 year from today. Example of spr forward rations: (eS)= (+ Stl + yl) Yield Spreads (pred: Basi pots above government yi pred: Bass pints above sap rte Ziprad: Aecouns for shape of yield cue. Oprion-ajed spread: Adjusts spread for ccs of embedded options, Tacerest Rate Risk Inter ate kaso components soem and market pric ri ron YTM changes. Thee sl Ive opposing fc on an investor orzo yi. + "Bond investor with shor horizons are more concerned with math price isle + Bond investors with long horizons are more concerned with reinvestnee rik. +The orion at which market pice rk and reinvestment ri ju offi ica bonds Maselay ‘aration. Thins the weighted average of times tnt a ond cash Hows are scheduled vo be paidRED INCOME ative. ‘Modified durations the approximate change in a onal price given 1% change in is YTME __ Macy dria (V-)=(V) ae Bala) Aftive durations requived ia bond has ‘embedded options. /-)=(V+) 2Vo (Aicurve) Price change estimates based on duration only are Improved by adjusting for comvesi: odNprice -deration (Ay) + eonveniy(Ay)? Asset Backed Securities ‘Residential MBS: home mortgages ar collateral. ‘Agency RMBS include only conforming loans: ‘nonagency RMBS may include nonconforming Tans and need credic enhancement. Prpayment rick contraction ik rom faster repayments: extension risk from slower repayments, (CMOs pass-through MBS are collateral. May have Credit card ABS: creditcard receivables ae collateral (CDOs Bonds, bank loans, MBS, ABS, o other (CDOrare collateral. Collateral and Credit Enhancement ‘Secured bonds ate backed by speci colateral and ‘senior to unsecured bonds. ‘Unsecured bonds are general claims to issuers cash flows and acer Internal redit nancement: Excess spread, ‘overcollateralzation, waterfall sructare Esra credit enhancement Surety bonds, ewer of ceedit, bank guarantees. Credit Analysis JInvesment grade: Bas3/BBB_or above "Now neerment grade: Bal BBs or below ‘Corporate family rating (CFR): issuer rating ‘Corporate credit rating (CCR): security ating. “Four Cs" capacity, collate, covenants, character. spr pie. ‘Baclwonaton fetes price «spt pice Sours ovement: + Cole yl: eu on ils posted as margin * Prise ret du to change in spr price. * Rallye postive Fr bacvardaton, negative for contnge. Faures price ~ pot price « R) + storage cons ~conveninee yield Infartructare Longlved ses for plc we, ncading ceansprtatio, wit commuicatons, seca BunfeldExiinginfrseruce Grenfel nies abe bl