Mind Map Cfa Exam Prep 2017 1

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Mind map CFA exam prep 2017-1
Finance (Kedge Business School)
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WAY TO FINANCE SUCCESS
MIND MAP
CFA®
LEVEL 1
EXAM PRE
2017
MIND MAPS
For learning CFA® Exam
Website: http://waytofinancesuccess.com
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CFA® MIND MAPSTM 2017 LEVEL 1 BOOK

© WAY TO FINANCE SUCCESS – All rights reserved
Published in Dec.,2016
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4 + 5 GI PS 1 . ETH I CS AN D TRU ST I N TH E
I N VESTM EN T PROFESSI ON
3 .7 St a nda r d V I I . RESPON SI BI LI TI ES
AS CFA M EM BER & CAN D I D ATE 2 . COD E OF ETH I CS & STAN D ARD S
OF PROFESSI ON AL CON D UCT
Et hica l &
3 .6 St a nda r d V I CON FLI CTS OF I N TEREST Pr of e ssiona l
St a nda r ds 3 .1 St a nda r d I . PROFESSI ON ALI SM
3 .5 St a nda r d V. I N V ESTM EN T AN ALYSI S,

RECOM M EN D ATI ON S & ACTI ON S 3 .2 St a nda r d I I . I N TEGRI TY OF CAPI TAL M ARKETS
3 .4 St a nda r d I V . D UTI ES TO EM PLOYERS 3 .3 St a nda r d I I I . D UTI ES TO CLI EN TS
Ethical & Professional Standards - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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= > Consider alt ernat ive act ions as w ell as short er- and
longer- t erm consequences from various perspect ives
= > Teach, pract ice, and reinforce A code of et hics int egrat ed int o a firm 's decision m ak ing process
= > Developing an et hical cult ure et hical decision m aking and t he support of senior m anagem ent for int egrat ing et hics
can be described as a set of shared beliefs about what is good or accept able behavior and what is bad or unaccept able behavior
ident ify t he im port ant issues involved Et h ics refers co t he st udy of good and bad behav ior.
Ex pla in Et hics
exam ine t hese issues from m ult iple perspect ives behavior char follows m oral principles and is consist ent wit h societ y's et hical expect at ions.
develop t he necessary j udgm ent and decision m aking skills required The im port ance of using a fram ew ork Et h ica l con du ct conduce char im proves out com es for st akeholders
Fra m ew ork for Et h ica l D ecision M a k ing
avoid unant icipat ed et hical consequences
Relevant fact s, st akeholders and dut ies owed, et hical principles, conflict s of int erest . A code of e t h ics is a w r it t e n se t of m or a l pr in ciple s t h a t ca n gu ide
I dent ify be h a vior by de scr ibin g w h a t is con side r e d a cce pt a ble be h a vior
t o com m unicat e t he values, principles, and expect at ions of an organizat ion or ocher group of people
Sit uat ional influences, addit ional guidance, alt ernat ive act ions
Consider
Et hical decision- m aking fram ework Role t o prov ide a general guide t o w hat const it ut es accept able behav ior
Decide and act ( For CFA Lev el 1)
The Role of a Code of Et hics refers t o a g roup of people wit h specialized skills and knowledge who
Was t he out com e as ant icipat ed? Why or w hy not ? Reflect serve ochers and agree t o behave in accordance wit h a code of et hics
A pr ofe ssion
1 . ETH I CS AN D TRU ST I N TH E A pr ofe ssion a l code of e t h ics is a w a y for a pr ofe ssion t o com m u n ica t e t o t h e pu blic t h a t it s
Not all unet hical act ions are illegal, and not all illegal act ions are unet hical m e m be r s
I N V ESTM EN T PROFESSI ON w ill u se t h e ir k n ow le dge a n d sk ills t o se r ve t h e ir clie n t s in a n h on e st a n d e t h ica l m a n n e r
et hical decisions require m ore j udgm ent and Dist ing uish b et w ee n Et hica l
considerat ion com pared t o legal decisions a nd Le ga l St a nd a r d s
Et hical principles oft en set a higher st andard
of behavior t han laws and regulat ions overrat e t he et hical qualit y of t heir behavior on a relat ive basis
I ndividuals t end t o overem phasize t he im port ance of t heir own personal
I nt ernal ( personal) t rait s
t rait s in det erm ining t he et hical qualit y of t heir behavior
I nvest m ent professionals have a responsibilit y t o prot ect and grow client asset s
Trust in invest m ent professionals t akes on a great er im port ance t han in m any ot her
Ch a lle n ge s Loyalt y t o an em ployer, supervisor,
businesses because invest m ent adv ice and m anagem ent are int angible produces
Social pressure from ochers organizat ion, or co- w orkers
Failure t o act in a highly et hical m anner can dam age not only client wealt h Cha lle ng es t o Et h ica l Be ha v ior Ext ernal t rait s ( sit uat ion influences)
but also im pede t he success of invest m ent firm s and invest m ent professionals
The prospect of acquiring m ore m oney or great er prest ige
reduce t he funds ent rust ed t o t hem and increase che cost
of raising capit al for business inv est m ent and grow t h Th e Ne e d for H igh Et h ica l St a n da r ds so focused on adhering t o com pliance rules t hat
Fir m s w it h st r ict r u le s- ba se d com plia n ce individuals only ask t hem selves what t hey can do
reduce t he am ount s invest ed and increase t he
pr oce du r e s r u n t h e r isk of fost e r in g a
ret urns required t o at t ract invest or capit al anot her lay er of risk cu lt u r e
Unet hical behavior by financial services professionals
can hav e negat ive effect s for societ y
reduces t he growt h of an econom y
and t he w ell- being of it s people Misallocat ion of capit al
1. ETHICS AND TRUST IN THE INVESTMENT PROFESSION - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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All CFA I nst it ut e m em ber s and candidat es ar e

r equir ed t o com ply wit h t he Code and St andar ds
The CFA I nst it ut e Bylaw s
Basic st ruct ure for en for cing
Based on t w o Fair process t o m em ber and candidat e
t he Code and St andards
prim ary principles
Rules of Pr ocedure Confident ialit y of proceedings
Maint ains ov ersight and responsibilit y

The CFA I n st it ut e I s r espon sible for t he
Board of Governors enfor cem ent of t he
Thr ough t he Discip linary
Professional Conduct Review Com m it t ee ( DRC) Code and St andards
program ( PCP)
St r uctur e of t he CFA The CFA Designat ed Conduct s pr ofessional
I n st it ut e Pr ofessional Officer Direct s pr ofessional conduct st aff conduct inquiries
Conduct Pr ogr am
Selfdisclosure
Writ t en com plaint s
An in q uiry can b e p r om pt ed
Ev idence of m isconduct
by sev er al circum st ances
Report by a CFA ex am pr oct or
Analysis of exam m at erials and m onit or ing
a. of social m edia by CFA I nsit ut e
Request ing a w rit t en ex planat ion

The Pr ofessional from t he m em ber or candidat e
Conduct st aff conduct s
The m em ber or candidat e
an in v est ig at ion t hat
m ay include I nt erv iewing Com plaining part ies
Thir d part ies
Collect ing docum ent s and records in support of it s inv est igat ion
2 . Code Of Et hics And Conclude t he inquir y w it h no disciplinary sanct ion

St a nda r ds Of I ssue a caut ionary let t er
Wh en an
Profe ssion a l Con du ct inq uir y is I f fin d ing t hat a v iolat ion of
Pr ocess for t he enfor cem ent Up on r ev iewing t he t he Cod e and St and ards
init iat ed
of t he Code and Standar ds m at er ial ob t ained d u r ing occur r ed, t he Designat ed Accept ed by m em ber
t he invest igat ion, t he Officer p r op oses a
Designat ed Officer m ay The m at t er is refer red t o a
disciplinar y sanct ion hearing by a panel of CFA
Cont inue proceedings I nst it ut e m em bers
Rej ect ed by m em ber
t o discipline t he
m em ber or candidat e
condem nat ion by t he m em ber's peers
I f sanct ion is im posed suspension of candidat e's cont inued
part icipant in t he CFA program
Act w it h in t egrit y , com p et ence, d ilig ence,

respect and in an et hical m anner
I n t egrit y of inv est m ent pr ofession &
int erest of client s above per sonal int erest
Six com ponent s of Care & j udgm ent

t he Code of Et hics Pract ice et hics & encour age ot hers t o pr act ice
I nt egrit y & v iabilit y of t he global capit al m arket s
Professional com pet ence
b,c.
Professionalism
I nt egrit y of Capit al m ar ket s
Dut ies of Client s
Dut ies t o Em ployers
Seven St an dar ds of
Pr ofessional Conduct I nv est m ent analysis, Recom m endat ions & Act ions
Conflict of int erest
Resp on sib ilit ies as a CFA I nst it ut e
m em ber or CFA Candidat e
2. Code Of Ethics And Standards Of Professional Conduct - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Understand and com ply w ith
applicable law s and regulations
Code and Standards vs. Local law Follow stricter law and regulation
Responsible for violations in w hich they

know ingly participate or assist
D isso ciate fr o m illeg al,
unet hical activities Leave em ployers ( in ext rem e case)
At t em p t t o stop t he b eh av ior b y b r in g ing it t o t he at t en t io n o f

Guid a nce em ployer through a supervisor or com pliance departm ent
Participation or association
May consider directly confronting
w ith violations by others
t he involved individuals
I nt erm ediat e st eps
I f n o t su ccessful,- - > st ep aw ay an d Rem oving t heir nam e from w ritt en report s
dissociate from the activity by
Asking for a different assignm ent
A. Know ledge I naction w ith continued association m ay be construed as know ing participation
of t h e law Not required reporting violations to governm ent, CFAI ,
but advisable in som e cases or required by law s in others
Stay inform ed
Review procedures
Mem ber s an d Maintain current files
candidat es
When in d o ubt, seek ad v ice o f
com pliance personnel or legal counsel
W h en d isso ciating fr o m v io lat ions, - - > D o cu m ent
Re com m e nd ed any violations and urge firm s to stop them
p r o ce du re s f or
co m plia nce ( RPC) Develop and/ or adopt a code of ethics
Make available t o em ployees info t hat
Firm s highlights applicable law s and regulations
Establish w ritten procedures for reporting suspected
violation of law s, regulations or com pany policies
Ap plica t ion
Maint ain independence and

objectivity in professional activities
Gifts, I nvitations to lavish
fu nct ions, Tick ets, Fav ors, Job r efer r als,
By benefits Allocation of shares in oversubscribed I POs. ..
Ex t er n al
pressures
From public com panies To issue favorable reports
Fr o m Bu y side clients May t r y t o p r essure sellside analysts
Fr o m t h eir e. g. to issue favorable research reports/

ow n firm s recom m endat ions for cert ain com panies
I n t er n al
pressures t o issue f av o r able r esearch o n cu r r ent o r
I n v est m ent b an k in g p r o sp ective in v est m en tb an k in g clients
How t o cope w ith external an d
relationships
internal pressures Conflicts of interest
Modest gifts and ent ert ainm ent are

accept able but special care m ust be t aken m ust disclose to em ployers
Best practice: rej ect any offer of gifts,

t hreatening independence and obj ect ivity
Guidance
convey true opinions
--> free of bias from pressures
Recom m endations m ust
be stated in clear
B. I n d e p e n d e n ce and unam biguous language
an d obj ect ivit y Portfolio m anagers m ust respect and
fo ster ho nesty o f sellside research
I s fraught w ith conflicts

3 .1 St a n d a r d I Must engage in thorough,
PROFESSI ON ALI SM independent , and unbiased analysis
Must fully disclose potential conflicts,
including the nature of com pensation
I ssuer paid research Must strictly lim it the type of com pensation
Analyst s they accept for conducting research
Accept only flat fee for their
w ork prior to w riting the report
Best practice Without regard to conclusions
or recom m endations
Protect integrity of opinions

Create a restricted list
Restrict special cost arrangem ents
Lim it gifts
Equity I POs
RPC Rest rict em ployee invest m ent s
Privat e placem ent s
Review procedures
Wr it t en p o licies o n in d ep end ence
and obj ectivity of research
D ef in it ion o f any untrue statem ent or om ission of a fact

"Misrepresent ation"
or any false or m isleading st at em ent
Mu st n o t k n o w in gly m ak e
oral represent ations, advert ising
m isr ep r esen t ation o r g iv e
false im pression in electronic com m unications
w rit ten m aterials
qualifications or credentials, services

perform ance record
Mu st n o t m isr ep r esent Without regard to conclusions or
Guid a nce any aspect of practice, including recom m endat ions
characteristics of an investm ent
any m isrepresent at ion relating t o
C. Misre pre se n t at ion m em ber's professional act ivit ies
Must not guarantee clients specific return
on investm ents that are inherently volatile
St an d ar d I ( C) p r o h ibits p lagiar ism in p r ep ar at ion
o f m at er ial for distribution t o em p lo y ers, asso ciates,
clients, prospects, general publish
Writ ten list of available services, description of firm 's qualification

Designate em ployees to speak on behalf of firm
Prepare sum m ary of qualifications and experience,
list of services capable of perform ing
RPC
Maintain copies
To avoid plagiarism Attribute quotations
At tribut e sum m aries
Address conduct related to professional life

An y act in v o lv ing ly in g, ch eat ing, st ealing, o t h er d ish o nest co n duct t h at
reflect s adversely on m em ber's professional act ivit ies w ould be violat ion
Conduct dam aging trustw orthiness or com petence ( include behaviour m ay
not be illegal but negat ively affect a m em ber t o perform responsibility such
Guid a nce as abusing alcohol during lunch hours)
Violations
D . Miscon du ct Abuse of the CFA I nstitute Professional Conduct Program
I nvolved in personal bankruptcy is not autom at ically assum ed t o be in violation but
bankruptcy involve fraudulent or deceit ful business conduct m ay be a violation
Develop and/ or adopt a code of ethics

Dissem inate to all em ployee a list of potential violations
RPC
Check references of pot ent ial em ployees
3.1 Standard I PROFESSIONALISM - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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it s significant im pact t o t he pr ice

of secur it y if it is disclosed
Reasonable invest or s w ould like
Definit ion of " Mat erial Mat er ial infor m at ion
t o know for m aking decision
nonpublic inform at ion"
The r eliabilit y of t he infor m at ion
dissem inat ed t o t he m ar ket place and

Non- public unt il
effficient t im e for invest or s t o r eact
Mu st be par t icular ly aw ar e of in fo
Guidance select ively disclosed by cor por at ions
Analysis of Public info + nonm at erial
nonpub lic info - - > I nv est m ent conclusion
Mosaic Analyst s ar e free t o act on t his collect ion
Theor y of info w it hout r isking violat ion
Analyst s should save and
A. M a t e r ia l n on - pu blic docum ent all t heir r esear ch
in for m a t ion ( M N I )
Mak e r easonable ef fort s t o achiev e
public dissem inat ion of m at er ial info
Must com m unicat e t he info only t o t he designat ed
I f pu blic dissem in at ion super visor y and com pliance per sonnel w it hin t he fir m
is not possible,
Must not t ake invest m ent act ion on t he basis of t he info
Must not k now ingly engage in cond uct
3 . 2 St a n d a r d I I inducing insider s t o pr ivat ely disclose MNI
I N T EGRI TY O F RPC adopt com pliance pr ocedur es
CAPI TAL M ARKETS pr event ing m isuse of MNI
dev elop & follow disclosur e policies
Encour age fir m s t o
t o ensur e pr oper dissem inat ion
use "fir ew all"
Pr ohibit ion of all pr opr iet ar y t r ading w h ile f ir m
is in possession of MNI m ay be inappr opr iat e
Dist or t pr ices or ar t ificially inflat e t r ading volum e

wit h t he int ent t o m islead m arket part icipant s
Definit ion
Tr an sact ions t hat ar t if icially
dist or t pr ices or volum e
t r ansact ions t hat deceive
m ar ket par t icipant s Secur ing a cont r olling, dom inant posit ion in a
financial inst r um ent t o ex ploit and m anipulat e
B. M a r k e t pr ice of a r elat ed der ivat ive/ or under lying asset
m a n ipu la t ion can be relat ed t o
dissem inat ion of false includ ing spr eading false r um or s
or m isleading info t o induce t r ading by ot her s
pr ohibit legit im at e t r ading st r at egies

St andar d I I ( B) not m eant t o pr ohibit t r ansact ions done for t ax pur poses
The int ent of act ion is crit ical t o det erm ining
whet her it is a violat ion of t his St andard
3.2 Standard II INTEGRITY OF CAPITAL MARKETS - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Prudence requi re act wit h care, sk ill, and diligence

dut y t o ex er cise caut ions and discr et ion follow t he invest m ent param et ers set fort h
reasonable care by client s & balancing risk & ret urn
Un der st and & adhere Det erm ine ident it y of " client "
t o fiduciary dut ies Must be aw ar e of whet her t hey hav e
" cust ody" or effect ive cont rol of cl ient asset s
Responsibilit y Manage pool of asset s i n accordance w i t h t erm s of governi ng docum ent s
t o a client includes
Put t heir obligat ion t o client first in all dealings
dut y of l oyal t y Av oid all real or pot ent ial conflict s of int erest
Guidance
A. Loya lt y, For go usi ng oppor t uni t ies for t heir own benefi t at t he expense of cl ient
p r u d e n ce , Follow any guidel ines set out by client for t he m anagem ent of asset s
a n d ca r e Judge i nvest m ent decisi ons i n cont ex t of t ot al port folio
Vot e proxies in an i nform ed & responsible m anner
Gi ft s i n t he form of r e se a rch sup p or t is any t hing t hat hel p t o m ake

( research report is one t ype of research support ) inv est m ent deci si ons
" Soft dollars"
Subm it t o client s at l east quart erl y it em i zed st at em ent s

Separ at e asset s
Rev iew inv est m ent s periodically
RPC
Est ablish polici es & procedures w it h respect t o proxy v ot ing and t he use of cl ient brokerage
Encourage fi rm s t o address som e t opics ( p. )
Do not discrim inat e against any client s

New issues and secondary offerings shoul d be
pro- rat ed t o all subscri bers on a round- lot basi s
Fairy t o all client s
and pr ospect iv e cl ient s can different i at e servi ces t o cl ient s but m ust not
" Fairly" v s " equal ly" disadvant age or negat ivel y affect cl ient s and
t he differences m ust be disclosed and avai lable
im possible t o t reat e q u a lly due t o each cl ient 's unique needs and obj ect iv es
St an dar d I I I ( B) addr esses t he m anner of

dissem inat ing inv est m ent r ecom m endat ions or
changes i n pr ior r ecom m endat ions t o client s
Ensure fai r opport uni t y t o act on
En courage firm s t o design equit able sy st em t o
pr ev ent select iv e, discr im inat ory disclosur e
Guidance part icularly clients m ay hav e act ed on
I nv est m ent recom m endat ions Mat er ial ch anges should be
com m unicat ed t o all cur r ent cl ient s or been affect ed by earlier advi se
should be adv i sed of t he ch anged

Cl ient s w ho don't k now ch anges and t h er efor e r ecom m endat ion befor e t he or der
place orders cont rary t o a current recom m endat ion is accept ed
B. Fa ir de a ling
Tr eat all clients fairly in light of t heir
inv est m ent obj ect iv es & ci r cum st ances
Disclose t o clients & dut y of fairness and loy alt y t o clients can
I nv est m ent act ions prospect s wri t t en nev er be ov err idden by cl ient consent t o
al locat ion procedures pat ent ly unfair allocat ion pr ocedur es
Shoul d not t ake advant age of t heir posit ion in t he indust r y t o t he det r im ent of client s
Li m it t he num ber of people aw are t hat a change i n recom m endat ion w ill be m ade
3 .3 St a n d a r d I I I
Short en t he t im e bet ween deci si on and dissem inat ion
D UTI ES TO CLI EN TS
Publish personnel guidelines for pre- dissem inat ion
Sim ult aneously dissem inat e recom m endat ions t o all client s who
hav e ex pressed an i nt erest or for w hom an i nvest m ent is sui t able.
RPC Maint ain list of client s and holdings

Dev el op w rit t en t rade allocat ion pr ocedur es
Disclose t r ade allocat ion pr ocedures
Est ablish sy st em at ic account r ev iew
Disclose av ailable lev el of serv ice
Be sure t o gat her client info in t he f orm of an I PS and m ak e suit ability

analy sis prior t o m ak ing recom m endat ion/ t ak ing inv est m ent act ion
I nqui r y shoul d be r epeat ed at least annual ly/ prior t o m at er ial changes
I n inv est m ent I f client s Suit abilit y analy sis m ust be done
adv isory relat ionships w it hhold info based on info prov ided
Risk analy sis

Guidance Be sure inv est m ent s are consist ent wi t h t he st at ed m andat e
C. Suit a bilit y Fund m anager s
Refrai n from m aking t rade or seek

I n case of unsolicit ed t r ade affirm at ive st at em ent from cl ient
r equest s unsuit able for cl ient t hat suit abilit y is not a considerat ion
Wr it t en I PS
I nv est ors' obj ect iv es and const raint s should be m aint ained and r ev i ew ed
RPC
periodically t o reflect any changes in client s' ci r cum st ances
St an dar d I I I ( D) pr ohi bit s m i sr epr esen t at ions of past

per form ance or r easonably ex pect ed per form ance
Provide credible perform ance i nfo
Should not st at e or im ply t hat client s will obt ain
or benefit from rat e of ret urn generat ed in t he past
D . Pe r for m a nce pr e se nt a t ion Guidance Research analy st s pr om ot ing t he success ensur e t hat t heir claim s ar e
of accur acy of t hei r r ecom m endat ions fair, accurat e, and com plet e
I f t he present at ion is brief, m ust m ake av ailable t o

cl ient s an d prospect s t he det ailed info upon request
GI PS
RPC
on t he basis of t heir special ability t o conduct a

St an dard I I I ( E) is applicable port ion of cl ient s' busi ness or personal affai rs
w hen m em ber s recei v e i nfo arising f r om or is r elev ant t o t hat port ion of client s' business
t hat is t he subj ect of special or confident i al rel at ionshi p
Com ply wit h applicable laws
Guidance consult wit h com pliance depart m ent / out side counsel befor e discl osing
When i n doubt
E. Pr e se rv a t ion of confide nt ia lit y
St andard I I I ( E) does not pr ev ent cooperat i ng
w it h an invest igat ion by CFAI PCP
Avoid disclosi ng inform at ion received from a cl ient ex cept

t o aut hori zed cowork ers al so work ing for t he cl ient
Follow firm procedures for st orage of el ect ronic dat a
RPC
Recom m end adopt ion if not in place
3.3 Standard III DUTIES TO CLIENTS - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Som eone is in t he ser v ice of anot her

Definit ion
Em p loy e e Writ t en cont ract m ay or m ay not exist bet ween em ployer and em ployee
Act ual receipt of m onet ary com pensat ion is not required for em ployer- em ployee relat ionship
I n m at t er s r elat ed t o t heir em p loy m ent , m em ber s and

can didat es m ust not engage in conduct t hat h arm s t he
int erest s of t he em ploy er
Com ply w it h p olicies and p r ocedures est ablished by
Em ploy er em ploy ee em p loyers t hat g ov ern em ploy er em ploy ee relat ionship
relat ionship St andard I V( A) d oes not r equire t o p lace em ploy er
int erest s ahead of personal int erest s in all m at t ers
The r elat ionship im p oses d ut ies and r esp onsibilit ies
on bot h part ies
Abst ain f rom in dependent com pet it ive act ivit y

t hat could conflict wit h em ploy er's int erest s
I ndependent pract ice Provide n ot ificat ion t o em ploy er, obt ain consent
fr om em ploy er in adv ance
A. Loy a lt y
Guidance
Planning t o leav e, m ust cont inue t o act in em ployer's best int erest
Must Firm r ecords or w ork p erform ed on behalf of f irm st ored on a
hom e com put er should be er ased or r et urned t o em ploy er
engage in act ivit ies conflict ing wit h dut y unt il resignat ion effect ive
Leav ing an em ploy er
Must not cont act ex ist ing client s/ pot ent ial client s prior t o leav ing for solicit ing
t ak e records of files t o a new em ployer wit hout writ t en perm ission
Free t o m ak e arrangem ent s/ preparat ions prov ided t hat not breaching dut y of loyalt y
Ap plicable non com pet e agreem ent
Whist le blowing
Nat ure of em ploy m ent
3 .4 St a n d a rd I V Obt ain writ t en consent from em ploy er before accept ing

DUTI ES TO EM PLOYERS com pensat ion or ot her benefit s from t hird part ies...
B. Ad dit ion a l Guidance
co m pe n sa t ion
Should m ake an im m ediat e
arrangem ents
writ t en report t o t heir em ploy ers
RPC
Must hav e in dept h k n owledge of t he Code & St andards

Apply k nowledge in discharging superv isory responsibilit ies
Supervisors t ak e posit ive
Delegat ion of su p erv isory d ut ies d oes not st eps t o prom ot e com pliance
reliev e m em bers of superv isory responsibilit y I n st ruct su b ordinat es m et hods
t o prevent and det ect v iolat ions
Focus on t ak ing posit iv e st eps t o
prom ot e com pliance
Mak e reasonable effort s t o prev ent & det ect v iolat ion of laws, rules, regulat ions, and Code & St andards
Must underst and what const it ut es an adequat e com pliance syst em
Guidance Mak e r easonable effort s t o see t hat appropriat e com pliance
p r ocedures are est ablished, docum ent ed, com m unicat ed
C. Re sp on sib ilit ie s t o covered personnel and followed
of su p e r v isor s Bring an in adequat e com p liance sy st em t o senior
Est ablish and im plem ent ing
m anagers's at t ent ion & recom m end correct iv e act ion
Com pliance pr ocedures
I f clearly cannot discharge
r esp onsibilit ies cos of ab sence d ecline in w r it ing t o
of com pliance sy st em , accept responsibilit ies
prom pt ly init iat e inv est igat ion

I n case of em ployee's violat ion
t ak e st eps t o ensure no repet it ion
Recom m end em ploy er t o adopt a code of et hics

Respond prom pt ly
I f t here is
Conduct a t horough invest igat ion
RPC a v iolat ion
I n crease su p erv ision or p lace ap propriat e lim it at ions on
t he wrongdoer pending t he out com e of t he inv est igat ion
3.4 Standard IV DUTIES TO EMPLOYERS - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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inv est m ent philosophy followed

Th e ap p licat ion of r ole of m em ber in t he inv est m ent
St andard V( A) depends on d ecision m ak ing process
support and resources
pr ov ided by em ploy er
Must m ak e reasonable effor t s t o cov er all pert inent
issues when arriving at recom m endat ion
Prov ide or offer t o provide support ing info t o client s when
m aking recom m endat ions/ changing recom m endat ions
Guidance Using secon dary or m u st m ak e r easonable &d iligent ef fort s t o
t hird p art y research det erm ine whet her 2nd/ 3rd part y research is sound
Not n ecessarily h av e t o decline t o be

A. D i lige n ce a n d id ent ified if believ ing consensus op inion
I f m em ber does not agree w it h
r e a son a ble ba sis t he independent and obj ect iv e has reasonable & adequat e basis
Gr oup r esearch and
view of t he group Sh ould d ocu m ent m em b er's
decision m aking
difference of opinion wit h group
Hav e a policy requiring t hat research report s and recom m endat ions
have a basis t hat can be subst ant iat ed as reasonable and adequat e.
Hav e det ailed, w rit t en guidance for pr oper research and due diligence.
Hav e m easurable cr it eria for Judging t he qualit y of r esearch,
and base analy st com pensat ion on such crit eria.
RPC Hav e writ t en procedures t hat prov ide a m inim um accept able lev el of scenario t est ing
Hav e a policy for ev aluat ing out side prov ider s of infor m at ion
Adopt a set of st andards t hat provides crit eria for evaluat ing ex t ernal adv isers
and st at es how oft en a rev iew of ex t ernal adv isers w ill be per for m ed.
St andard V( B) ad d r esses conduct w it h

respect t o com m unicat ing wit h client s
Com m u n icat ion is n ot con fined t o w r it t en
form but v ia any m eans of com m unicat ion
Dev eloping and m ain t aining clear, f r equent , and
t horough com m unicat ion pract ices is crit ical
3 .5 St a n da r d V : dist inguish clearly bet ween fact s & opinions
I N V ESTM EN T AN ALYSI S, present basic charact erist ics of t he analy zed
RECOM M EN D ATI ON S securit y in preparing research report
& ACTI ON S k eep t h em in f orm ed w it h r espect t o ch anges
t o t he chosen inv est m ent process
Must use reasonable j udgem ent in ident ifying im port ant fact ors t o t he analy sis,
recom m endat ions or act ions and include t hem when com m unicat ing
adequat ely illust rat e t o client s & prospect iv e
client s t he m an ner of con d u ct ing in v est m ent
d ecisionm ak ing process
B. Com m u n ica t ion Guidance include a requir em ent t o address r isk s and
w it h clie n t s a n d lim it at ions as part of t he inv est m ent process
pr ospe ct iv e clie n t s m u st be su p p ort ed by b ack ground
Brief com m unicat ions report or dat a on request
sh ould n ot ify client s t hat ad dit ional

Cap sule f or m info and an aly ses are av ailable f r om
recom m endat ions t he producer of t he report
m u st be su p p ort ed by r eadily
I n v est m ent ad vice available r eference m at er ial
based on quant it at ive
research and analysis in a m an ner con sist ent w it h
prev iously applied m et hodology
or wit h changes highlight ed
Should out line known lim it at ions, consider principal
risk s in inv est m ent analy sis, report
m aint ain r ecords indicat ing t he nat ur e of t he research

be able t o supply addit ional inform at ion if it is request ed
RPC
by t he client and ot her users of t he report .
I n hard copy or elect ric form
Fu lfilling r eg u lat ory r eq u ir em ent s m ay Mu st ex p licit ly d et erm ine

sat isfy t he requir em ent s of t his St andard whet her it does
Guidance
C. Re cord re t e n t ion
Absence of regulat ory guidance CFAI r ecom m ends m aint aining r ecords for at least 7 y r s
The record- k eeping r equir em ent generally is t he firm 's r esponsibilit y .

RPC
3.5 Standard V. INVESTMENT ANALYSIS, RECOMMENDATIONS & ACTIONS - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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is a crit ical part of w or king in invest m ent indust ry

Man aging
conflict s can t ake Best pr act ice is t o avoid conflict s of int er est w hen possible
m any form s
I f not , disclosure is necessar y
prom inent
Di sclosur es
m ust be m ade in plain language
in a m anner t o effect iv ely com m unicat e t he info t o client s
bet w een m em ber or t heir fir m and issuer

Relat ionships invest m ent banking
underw rit ing and financial relat ionships
Br ok er / dealer m ar ket m ak ing act iv it ies
Mat erial beneficial ow nership of st ock
All m at t er s b et ween dut ies t o client s and t o
m ay im pair shar eholder s of t he com pany
p oses
obj ect ivit y conflict s m ay r eceive opt ion t o
I n v est m ent of int er est p u rchase securit ies of t he
p ersonnel com pany as com pensat ion
Di sclosur e also serves MNI
t o client s as a dir ect or
Guidance
m em bers providing invest m ent
ser vices also ser ving as d ir ect or s
should be i solat ed f rom t hose
A. D isclosu r e of con flict s m aking invest m ent decisions by firew alls
Sell- side should disclose m at er ial beneficial ow nership

m em bers int erest in securit ies/ inv est m ent r ecom m ended
Buy - side should disclose p r ocedur es for r eport ing

m em bers requirem ent s for personal t ransact ions
Sam e cir cum st ances w it h client s

What ?
Any pot ent ial conflict sit uat ion
Di sclosur e of conflict s How ? Enough info

t o em ployers
Must com ply w it h em ployer's r est rict ions regar ding conflict of int er est
Ot her requirem ent s Must t ak e r easonable st eps t o avoid conflict s
I f conflict s occur inadv er t ent ly , m ust repor t t hem pr om pt ly
Should disclose special com pensat ion arr angem ent s

w it h em ployer t hat m ight conflict w it h client int erest
Docum ent request & m ay consider dissociat ing fr om t he act iv it y if fir m
3 .6 St a n da r d V I does not per m it disclosure of special com pensat ion ar r angem ent s
CON FLI CTS OF RPC Disclose t o client s info t hat fee based on a shar e of capit al gains
I N TEREST Disclose as a foot not e t o r esear ch r epor t published if m em bers hav e
out st anding agent opt ions t o buy st ock s as a part of com pensat ion pack age
Client s & em ployer s' t r ansact ions have pr ior it y

p ersonal i n v est m ent posit ions or t r ansact ions
Co- invest m ent should never adv er sely affect client invest m ent s
m ay occur
client is not disadvant aged by t he t r ade
invest m ent professional does
Conflict s of int er est s n ot b enefit p er sonally f r om
m ake sure t rades under t aken for client s
i n v est m ent p r ofessional
Guidance com plies w it h applicable
regulat ory requirem ent s
B. Pr io r it y o f Having k n owledge of p ending t r ansact ions,

t r a n sa ct ion s assess t o info dur ing nor m al pr epar at ion of
research recom m endat ions Must not convey such info
May u n d ert ake p ersonal t r ansact ions aft er client s & em p loyers
have had adequat e opport unit y t o act on recom m endat ion
Fam ily account s ( t hat should be t r eat ed like ot her account s
are client account s) m ay st ill be subj ect t o pr e clear ance or repor t ing requir em ent s
if m em ber has beneficial ow nership
Lim it ed par t icipat ion in equit y I PQs.

Rest r ict ions on pr i vate placem ent s.
Est ablish black out / r est r ict ed periods.
RPC
Report in g r equirem ent s.
Disclosure of policies.
em ployer
w hom client
prospect ive client
com pensat ion

consider at ion
C. Re fe r r a l fe e s I nform w hat
benefit
r eceiv ed fr om , or paid t o, ot hers
befor e ent ry int o any for m al agreem ent

how
nat ur e of t he consider at ion or benefit
3.6 Standard VI CONFLICTS OF INTEREST - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Cheat ing on CFA exam or any exam
Not following r ules an d E.g. calculat or, per sonal

policies of t he CFA pr ogram belongings, candidat e pledge
Giving con fident ial info on t he CFA

Program t o candidat es or t he public
A. Conduct a s Pr ohibit ing any conduct t hat under m ines Revealing anyt hing about eit her broad or specific
m e m be r s a n d ca n dida t e s t he int egrit y of t he CFA chart er t opics t est ed, cont ent of exam quest ions, or
form ulas required or not required on the exam .
in t h e CFA pr ogr a m
I m pr operly using t he designat ion t o
further person al and pr ofessional goa ls
Misrepresenting inform at ion on t he Professional Conduct St atem ent
( PCS) or t he CFA I nst it ut e Professional Developm ent Program .
Not pr ecluded fr om ex pr essing opinion
regarding t he CFA Program or CFAI
Over pr om ise t he
com pet ence of an individual
Prevent ing prom ot ional effort s
Over pr om ise fu t ure
t hat m ak e prom ises or guar an t ees
invest m ent result s
3 .7 St a n da r d V I I : t ied t o t he CFA designat ion
RESPON SI BI LI TI ES Applies t o any form of com m unicat ion
AS CFA M EM BER/ CAN D I D ATE Rem it an n ually t o CFAI a com plet ed
Professional Conduct St at em ent
Pay applicable CFAI m em ber ship dues
To m aint ain CFAI m em bership
on an annual basis
Should be used as an adj ective and never a noun,

i.e. a 'CFA chart er holder', not a CFA
B. Re fe r e n ce t o CFA Using t he CFA designat ion Should not be used as par t of a fir m 's nam e
I n st it u t e , t h e CFA D e sign a t ion
a n d t h e CFA pr ogra m Must be enrolled for next scheduled exam
t o say t hat t hey ar e candidat es
I f not r egist ed, m ay say " I passed level
[ 1] of t he CFA Program m e in [ year] ."
May st at e t hat have passed one or m ore levels
Referencing candidacy in t he CFA program but cannot hold par t ial designat ion, e.g. CFA I I
Wit hout exper ience who passed level I I I m ay say " I
have passed all t hr ee levels of t he exam and will be
eligible for the CFA Char t er upon t he com pletion of
t he r equir ed w or k exper ience."
Only the m ar k CFA or t he wor ds Char t er ed Financial

Analyst should appear aft er the char t er holder 's nam e
Pr op er using of t he CFA m ar k s
3.7 Standard VII. RESPONSIBILITIES AS CFA MEMBER.CANDIDATE - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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The financial m ar ket s and

invest m ent m anagem ent indust r y
ar e becom ing incr easingly global
a1. Why w ere t he GI PS St andar ds cr eat ed?
Only invest m ent m anagem ent firm s
t hat act ually m anage asset s
a2. Who can claim com pliance?
N ot e : GI PS st a nd a rds a re p rint ed in t he ir Prospect client s and invest m ent
ent iret y in t he rea ding s, but t he Lev el I m anagem ent firm s
ca ndid a t e is req uired only t o k now t he a3. Who benefit fr om Com pliance?
Fundam ent als and Com pliance m a t e ria l t hrough t he end of Sect ion I I .0
Consistency of input data is critical to " Funda m ent a l of Com plia nce ." A com posit e is an aggr egat ion of discr et ionar y
effective com pliance w ith GI PS and por t folios int o a single gr oup t hat r epr esent s a
establish a foundation for full, fair and par t icular invest m ent obj ect ives or st r at egy
com parable perform ance present at ions
I nput dat a A com posit e m ust include all act ual, f ee- paying
discr et ionar y p or t folios m anaged in accor dance
Uniform ity in m ethods used to wit h t he sam e invest m ent obj ect ive or st r at egy
calculate returns to achieve
com parability am ong firm s I n t r odu ct ion t o Glo b a l Com posit es m ust include new por t folios on a
Calculat ion m et hodology I n v e st m e n t Pe rfor m a n ce t im ely and consist ent basis aft er t he por t folio
b. Const r uct ion & pur pose of Com posit es com es under m anagem ent
com posite return is the St a n da rds ( GI PS)
a sse t - w e igh t e d average of all the Fir m s m ay set m inim um asset lev els for inclusion in
portfolios' perform ance results a por t folio, but changes t o a com posit e- specific
Com posit e const r uct ion m inim um asset level ar e not per m it t ed r et r oact ively.
allow firm s to elaborate on the raw Ter m inat ed por t folios m ust be included in t he
num bers and give the end user the hist or ical r et ur ns of appr opr iat e com posit es
proper context to understand
No "negat ive assurance" is needed I ncrease t he level of confidence t hat a firm claim ing
Disclosures M a j o r se ct ion s of
for non- applicable disclosures GI PS com pliance did adher e t o GI PS
Present at ion and r epor t ing
GI PS st a n da rds I m pr ove a fir m 's int er nal policies and pr ocedur es wit h
Real est at e r egar d t o all aspect s of com plying wit h t he GI PS st andar ds.
Refers t o invest m ents in nonpublic Fir m s ar e e n cou ra ge d but not require d
com panies that are in various stages of t o under t ake t he ver ificat ion pr ocess
developm ent and vent ure invest ing, c. Verificat ion
A single v er ificat ion r epor t is issued for t he ent ir e f ir m .
buyout invest ing and m ezzanie financing
Privat e equit y V erifica t ion ca nno t be ca rried out for a single co m po sit e
Firm s t hat have been verified are encouraged t o add a disclosure t o com posite present at ions or
Wrap fees are a type of bundle fee and are
advert isem ent s st ating t hey have been verified: "[ nam e of firm ] has been verified for t he periods
specific to a particular investm ent product [ insert dates] by [ nam e of verifier] . A copy of the verification report is available upon request."
is charged by a w rap fee sponsor for investm ent
m anagem ent services and included trading
expenses t hat cannot be separat ely ident ified To obt ain global accept ance of calculat ion and pr esent at ion
st andar ds in a fair , com par able f or m at wit h f ull disclosur e
can be all- inclusive, asset- based fees and m ay include Wr ap Fee/ Separ at ely Managed
a com bination of invest m ent m anagem ent fees, t rading To ensure consist ence, accur at e invest m ent per form ance dat a
Account ( SMA) por t folios.
expenses, cust ody fees and/ or adm inist rat ion fees
4 + 5 GI PS GI PS Obj ect ives To pr om ot e fair com pet it ion am ong invest m ent m anagem ent f irm s
A w rap fee portfolio is som etim es
referred t o as a " separat ely m anaged To pr om ot e global "self r egulat ion"
account ( SMA) or " m anaged account"
To claim GI PS, invest m ent m anagem ent
fir m s m ust define it s "fir m "
Com ply wit h local law or
Require Firm s to include all a ct ua l fee pa y ing ,
r egulat ion conf lict s w it h GI PS discr e t ion a r y portfolios in com posites defined
H ow a r e GI PS st a n d a r d s according to sim ila r st r a t e gy / inve st m e n t obj e ct ive s
Make f ull disclosur e of t he conflict
im p le m e n t e d in co u n t r ie s
N ot e : t h is diffe r s fr om St a n da r ds of I f local/ count r y specific law or Rely on int e grit y of inpu t d a t a
Pr ofe ssiona l Conduct in w hich t h e
w it h e x ist in g st a n d a r d s Key char act erist ics
r egulat ion conflict s w it h GI PS I f an investm ent firm applies GI PS in a perform ance situation that is
st r ict er of loca l la w s or St a nd a r ds of for pe r for m a n ce r epor t in g not addressed specifically by GI PS/ is open to interpretation,
Professiona l Conduct pre v a ils disclosures other than those required by GI PS m ay be necessary
GI PS do not address every aspect of perform ance
m easurem ent, valuation, attribution or cover all asset classes
Fir m s fr om any count r y m ay com e int o com pliance wit h GI PS
Com pliance cannot be achieved on a
GI PS m ust be applied on the fir m - w ide basis. Firm m ust be defined as an invest m ent
single pr oduct , por t folio, or com posit e
firm , subsidiary, or division held out to clients as a dist inct bu sine ss e n t it y Firm s m ust m eet full
Total firm assets m ust be the aggregate of the m a r k e t va lue of I nv est m ent fir m definit ion com p lia nce t o claim GI PS
all discretionary and non- discretionary assets under m anagem ent. Ke y f e at u r e s of t h e The effective date of the revised Standards is 1 Jan 2011.
This includes bot h fee- paying and non- fee- paying asset s GI PS st a n d a r d s & Present ations t hat include perform ance results for periods after 31
Firm s m ust initially show GI PS com pliant history for a m inim um of 5 y ea rs, or f u n d a m e n t a ls of Dec. 2005 m ust m eet all t he requirem ent s of t he revised GI PS.
Perform ance present at ions t hat include results through 31 Dec. 2005
since ince pt ion if the firm has been in existence for le ss t ha n 5 ye a r s. com plian ce m aybe prepared in com pliance w ith the 1999 version of GI PS.
Aft er 5- year com pliant hist ory has been achieved, firm s m ust Effect iv e dat e
add an additional year of perform ance each year until Th e scope of t h e GI PS
10- year perform ance record is est ablished, at a m inim um Firm s m ust docum ent, in w riting, their polices and
procedures used in est ablishing and m aint aining
only GI PS com pliant perform ance is
com pliance with all requirem ents of GI PS
present ed for periods after 1 Jan. 2000;
A firm m ay link non- GI PS Docum ent s policies and pr ocedur es
and
com pliant perform ance to its Hist or ical per for m ance r ecor d
Firm discloses non- com pliance period Once a firm has m eet a ll t he r e qu ir e d r e qu ir e m e n t s of GI PS , use this
com pliant history as long as
and explain how it is not in com pliance st atem ent t o declare: "[ I nsert nam e of firm ] has prepared and present ed t his
w ith GI PS report in com pliance w it h t he Global I nvest m ent Perform ance St andards ( GI PS) ."
Firm s previously claim ing com pliance w it h an I nvest m ent Perform ance I f not m eet all the requirem ents, cannot state: " ...in com pliance w ith GI PS except for..."
Council- endorsed Count ry Version of GI PS are grant ed reciprocity t o Statem ents referring to the calculation m ethodology used in a com posite
claim com pliance w ith GI PS for historical periods prior to 1 Jan. 2006 presentation as being " in accordance [ or com pliance] w ith the Global
Claim s of com pliance I nvestm ent Perform ance Standards" are pr oh ibit e d .
St at em ent s referring t o t he perform ance of a single, exist ing client as being "calculated in
accordance w ith the Global I nvestm ent Perform ance Standards" are pr oh ibit e d except w hen a
GI PS com plaint firm reports the perform ance of an individual account to the existing client
pr ovide a com pliant pr esent at ion t o all pr ospect client s, cannot

choose t o whom t hey want t o pr esent com pliant per form ance
m ust list discontinued com posites on
Firm fundam ent al the firm s' list of com posites for at
pr ovide a com plet e list and descr ipt ion of all of t he fir m s'
responsibilit ies com posit es t o any client t hat m akes such a r equest least 5 years after discontinuation
4+5 GIPS - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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6 . TI M E VALUE OF M ON EY
1 3 . TECH N I CAL AN ALYSI S
7 . D I SCOUN TED CASH

1 2 . H YPOTH ESI S TESTI N G
FLOW APPLI CATI ON S
Qua nt it a t ive
1 1 . SAM PLI N G & ESTI M ATI ON M e t h ods 8 . STATI STI CAL CON CEPTS
AN D M ARKET RERURN S
1 0 . COM M ON PROBABI LI TY
D I STRI BUTI ON S 9 . PROBABI LI TY CON CEPTS
Quantitative Methods - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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t o solve m any t y pes of t im e

v alue of m oney problem s
equilibr ium int er est rat e for a
Find PMT
par t icular invest m ent
Find N Required rat e of ret urn
Loan paym ent a . I n t e r e st r at e ,
Find I / Y and Am ort izat ion for calculat ing t he pr esent v alue of
con side r e d a s
Am ort izat ion t able fut ure cash flow s
Discount rat e
Rat e of com pound growt h f1 . Use t im e lin e Opport unit y cost
Num ber of per iods for specific gr ow t h
Ot her applicat ions
Funding a fut ure obligat ion r eal r isk- f r ee r at e is a t heor et ical
rat e on a single- per iod loan when
t he sum of t he pr esent values of t he cash Rows is t he pr esent value of t he t here is no expect at ion of inflat ion.
ser ies. The sum of t he fut ur e values (at som e fut ur e t im e = n) of a ser ies of Nom inal r isk - free rat e = real r isk - free rat e
cash flows is t he fut ur e value of t hat ser ies of cash flows. + ex pect ed inflat ion rat e
The ca sh flow a dd it iv it y pr inciple r efer s t o t he fact t hat pr esent value of any Connect ion bet ween a borr ower will not m ake t he pr om ised
st r eam of cash flows equals t he sum of t he pr esent values of t he cash flows PV, FV & series of CF default r isk paym ent s in t im ely m anner
b. I n t e r e st r at e
r eceiving less t han fair value if an
6 . TI M E VALUE liquidit y r isk invest m ent m ust be sold f or cash quickly
Fut ure value Sev er al r isk s of securit ies
OF M ON EY
Lo nge r- t e rm bonds have m ore r isk
Present value m at ur it y r isk t han short e r- t e rm bonds
a series of equal cash flow s t hat occur s - - > The re quir ed ra t e of re t urn on a securit y = r ea l risk - fre e r a t e + ex pe ct ed infla t ion ra t e
at ev enly spaced int er vals over t im e. + def a ult risk pr em ium + liquidit y pr em ium + m a t urit y risk pr em ium
occur at the en d of each tim e period . Or dinary Annuit y
represent s t he annual rat e of ret urn act ually being ear ned aft er
FV of Annuit y Due = FV of Or dinar y adj ust m ent s hav e been m ade for different com pounding per iods
Annuit y x ( 1+ I / Y) Annuit y e. CF ca lcu la t ion s
Where:
PV of Annuit y Due = PV of Or dinar y occur at the beginning of each t im e per iod. Annuit y Due Periodic rat e = st at ed annual rat e/ m
Annuit y x ( 1+ I / Y) m = t he num ber of com pounding per iods per y ear
c,d. EAR
divide t he st at ed annual int er est rat e by t he num ber of com pounding
per iods per y ear, m , and m ult iply t he num ber of years by t he num ber
PV of a Perpet uit y of com pounding periods per y ear
Non- annual t im e value of
m oney problem s
Discount each individual cash flows
Use CF funct ion in Calculat or Uneven CF
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t he PV of the cash flows less t he initial ( tim e = 0) out lay

w h ere:
CFt = the expect ed net cash flow at tim e t
N = t he est im at ed life of t he invest m ent
r = t he discount rare ( opport unit y cosr of capit al)
NPV
Acce pt pr oj ec t s w it h a posi t ive NPV
Conve r t a m ong t he se yie lds Rej ect proj ect s with a negat ive NPV
Decision r ules
Tw o m ut ually ex clusive pr oj ect s:
accept higher posit ive NPV
is the discount r at e t hat m ake t he

NPV of a proj ect equal to zer o
1. Based on face value, not price Different proj ect size: t he sm aller proj ect s m ay have
Ca lcu lat e ,
2. Use 360- day higher I RR but t heir contr ibut ion t o t he fir m value
Not m uch m eaningful I nt erp ret , Conflict wit h m ay be sm aller com pared t o t he larger pr oj ect s
3. Use sim ple int er est, ignor e D e cision rule NPV due to
r einvest m ent of int er est Differen t im ing of cash flows
Mult iple I RR or No I RR When CFA pat t er n is unconvent ional

Pr oblem s
I RR I RR m et hod: proj ect cash flows are
Bank discount yield
Wh er e: assum ed to rein vest at I RR while wit h NPV
r BD = t he annualized yield on a bank discount basis it is assum ed to rein vest at m arket rat e
D = t he dollar discoun t , which is equal t o t he difference
7 . D I SCOUN TED Unr ealistic assum pt ions
- -> at t he bott om lines: use NPV
bet w een t he face value of t he bill and t he pur chase pr ice CASH FLOW
F = t he face value ( par value) of t he bill Accept proj ect s with an I RR > t he firm 's
APPLI CATI ON S
t = num ber of days r em aining unt il m at ur it y ( investor 's) r equir ed r at e of r et ur n.
360 = bank convent ion of nu m ber of days in a year Decision r ules Rej ect proj ect s with an I RR < t he firm 's
( investor 's) r equir ed r at e of r et ur n.
Yie lds of T- b ills For single proj ect , I RR and NPV
lead t o exact ly t he sam e decision
Wh er e:
Po = init ial pr ice of t he t he instr um ent Holding period yield is t he percent age change in an
P1 = pr ice r eceived for instr um ent at m at ur it y H PR invest m ent over t he period of holding
D 1 = int er est paym ent ( distr ibut ion)
defined as t he I RR
Mor e appr opr iat e if m anager has
Effect ive annual yield Money Weight ed
com plet e contr ol over cash in/ out
r MM = HPY x ( 360/ t ) m easur es com pound gr ow th

Money m arket yield
Por t f olio Not affect ed by cash in/ out
BEY = 2 x sem i annual discount rat e r a t e of r e t ur n Pr efer r ed m et hod
Bond equivalent yield Value t he invest m ent im m ediat ely aft er
Tim e weight ed
( chain- link) any wit hdrawals or deposit s, divide t he
overall invest m ent horizon into subperiods
3 st eps Calculat e HPR for each subpediod
Com put e t he geom et ric m ean
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St at ist ics is used t o r efer t o

dat a an d t o t h e m et h ods we
use t o an alyze dat e
t o sum m ar ized t he im por t ant
Descr ipt ive st at ist ics char act er ist ics of lar ge dat a set s
St at ist ical m et hods

per t ain t o t he pr ocedur es used t o
m ake for ecast s, est im at es, or
I nfer ent ial st at ist ics j u dgem ent about a lar ge set of dat a
A populat ion is defined as t h e set of all

possible m em ber s of a st at ed gr oup Populat ion par am et er s
Sam ple st at ist ics

A sam ple is defined as a subset of m ean (m easur es of cent r al t endency )
Populat ion vs. Sam ple t he populat ions of int er est w hich addr esses r et ur n
a.
The m ost fr equen t ly concer ned Var ( m easur es of v ar iat ion ar ound
Excess ku r t osis = sam ple k ur t osis - 3 Calculat e cent er ) w hich addr esses r isk
Lept oku r t ic: m or e peak ed, fat t er t ails

l. Kur t osis Classify or count obser v at ions w it h no
( excess ku r t osis > 0) - - > m or e r isk Nom in al scales par t icular or r ank ing
Plat y ku r t ic: less peak ed ( excess ku r t osis < 0) Com pared w it h

Specified char acter istics ar e used t o
Mesokur t ic: ident ical ( excess ku r t osis = 0) norm al dist ribut ion
cat egor ize obser v at ions band inv olv e r ank ing
Or dinal scales
no infor m at ion on t he differ ence am ong cat egor ies
Lik e or dinal scales + t he differ ences

Types of m easurem ent scales bet w een scale v alues ar e equal - > scale
v alues can be added and subt r act ed
I nt er val scales cannot build m eaningful r at ios
No t rue zer o point
Pr ov ide r ank ing, equal differ ences

Sym m et rical bet w een scale v alues and t r ue zer o point
Rat io scales
m ean= m edian= m ode

A par am et er is a m easur e used t o
t he fr equency of exper iencing
descr ibe a char act er ist ic of a populat ion
losses and gains ar e t h e sam e
Param et er vs. Sam ple st at ist ic A sam ple st at ist ic is used t o
m easur e a char act er ist ic of a sam ple
A t abular pr esent at ion of st at ist ical dat a

b. t h at aids t h e analysis of lar ge dat a set s
Defin it ion
j ,k . Sha pe of dist r ibut ion
1. Define int er v al
Frequency dist ribut ion Con st r uct ion of a
3 st eps 2. Tally t he obser v at ions
fr equ en cy dist r ibu t ion
3. Count t he obser v at ions and t hen calculat e
Non sy m m et rical ( Skewness) Absolut e frequency

Posit ively skewed ( Sk> 0) Types
( because of out liers) calculat ed by dividing t he absolut e
fr equency of each r et u r n int er val by
t he t ot al num ber of obser vat ions.
Relat ive frequency
c. sum m ing t he absolut e fr equencies st ar t ing at t he

Cum ulat ive absolut e lowest int er v al and pr ogr essing t hr ough t he highest .
frequency
Negat ively skewed ( Sk< 0)
- - > m or e r isk sum m ing t he r elat iv e fr equencies st ar t ing at t he
8 . St a t ist ica l Con ce p t s
lowest int er v al and pr ogr essing t hr ough t he highest .
a n d M a r k e t Re t u r n s Cum ulat ive relat iv e frequency
bar char t
Hist ogram
CV ( Coefficient of Variat ion) d.
line char t
i. Rela t iv e d isper sion Frequency polygon
Negat iv e Shar pe r at io
Lim it at ion s Sharpe Rat io / Reward- t o- Variabilit y rat io
Not suit able w it h asy m m et r ic r et ur n dist r ibut ion
Populat ion m ean
For any dist r ibut ion wit h finit e v ar iance, t he

per cent age of obser vat ions lie wit h in k st andar d
deviat ion of t he m ean is at least 1- 1/ ( k^ 2)
Sam ple m ean
36% : + / - 1.25k
56% : + / - 1.50k h. Che by she v 's ine q ua lit y t he m easur e of cent r al t endency
for w hich the sum of t he dev iat ions
75% : + / - 2k fr om the m ean is zer o
89% : + / - 3k Ar it hm et ic m ean
94% : + / - 4k
Weight ed m ean
Mean ( por t folio r et ur n)
Easy t o com put e
affect ed by ex t r em e value (com pound gr ow t h)
Range = Max - Min Geom et r ic m ean
no info on h ow dat a is dist r ibut ed
e . M e a su r e s of ( r et ur n dat a set )
bet t er t han r ange
ce n t r a l t e n de n cy Use of arit hm et ic or geom et r ic m ean
less sophist icat ed t han Var and Sd when det er m ining inv est m ent r et ur ns
g. Disp er sion Har m onic m ean

Populat ion ( cost of shar es)
( m e a su r e of r isk)
Variance & St andard deviat ion Har m onic < geom et r ic < ar it h m et ic
value of m iddle it em in a set of sort ed it em s
Sam ple Median not affect ed by ex t r em e value but

m or e difficult t o find out
No m ode
Unim odal, bim odal, t r im odal
Sem iv ariance and
- - > t h e only m easur e can be
sem ideviat ion used wit h nom inal scale
Mode
Model in t er val - - >
for cont inuous dist r ibut ion
value at or below which a por t ion of t h e dat a dist r ibut ion lies
int o quar t er s
Quart iles
int o fift hs
f. Qua nt ile Quint ile
int o t ent hs
Decile
Ly = ( n+ 1) x y / 100
Percent ile ( 100)
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Fact orial
w ays t o assign k differ ent labels t o n an uncert ain quant it y/ num ber
it em s, w here ni is t he num ber of Random variable
it em s w it h t he label i
an observ ed value of r andom variable
Out com e
Labeling o. Cou n t in g m e t h ods a single out com e or set of out com es
a. Event
Com binat ion
( or der does not m at t er ) event s t hat cannot happen at t he sam e t im e
Mut ually ex clusive event s
t hose t hat include all possible out com e
Exhaust ive event s
Per m ut at ion
( or der m at t er s)
2 defining propert ies sum of all P( E) = 1, if set of event s is

of probabilit y m ut ually ex clusive & exhaust ive
hist orical dat a

Based on t he b. Em pirical
ev ent O's occurrence n . Ba ye s' form u la
Pr ior i form al reasoning and inspect ion process
Det erm ine probabilit ies
Subj ect iv e per sonal j udgm ent
m . Ca lcu la te cova r ia n ce give n Giv en odds for E of "a t o b"- - > t he

a j oin t pr oba bilit y fu n ct ion c. Odds for vs. odds a ga in st t he e ve n t im plied probabilit y of E is a/ ( a+ b)
and odds against E is "b t o a"
Pr obabilit y of an ev ent r egar dless of t he

past or fut ur e occur rence of ot her event s
Ex pect ed v alue Uncondit ional probabilit ies
d. t he occurrence of one ev ent
affect s anot her event 's probabilit y
9 . PROBABI LI TY
t he probabilit y of A giv en t he
CON CEPTS Condit ional probabilit ies
occurr ence of B: P( A/ B)
l. Port folio
Variance and st andard deviat ion
P( AB) = P( A/ B) x P( B)
P( AB) = P( A) x P( B)
Mult iplicat ion rule
( if 2 independent ev ent s)
P( A or B) = P( A) + P( B) - P( AB)
e. Proba bilit y ru les P( A or B) = P( A) + P( B)
Addit ion rule
( I f 2 m ut ually exclusiv e event s)
Two- asset port folio
P( A) = P( A/ B 1 ) P( B 1 ) + P( A/ B2 ) P( B 2 ) + . .. + P( A/ B N) P( B N)
B 1 , B 2, . . . B N is a m ut ually ex clusive
Tot al probabilit y rule
and ex haust ive set of out com es
Covariance m easure how t wo

asset s m ove t oget her Of 2 event s P( AB) = P( A/ B) x P( B) or P( A/ B) = P( AB) / P( B)
k . Cova r ia n ce a n d Corr ela t ion Of any num ber of also apply t he m ult iplicat ion r ule but t o
Joint Probabilit y
m or e t han t wo independent event s
f. Ca lcula t e independent event s
Correlat ion is a st andardized
p= 1: perfect ly posit ive m easure of associat ion bet ween
p= - 1: per fect ly negat iv e t he addit ion rule
t wo random variables & ranges Probabilit y of at least
p= 0: no linear relat ionship one event will occur
from - 1 t o 1
I ndependent event : t he P( A/ B) = P( A) or P( B/ A) = P( B)
occurrence of t he event
g. D e pe n de n t e ve n t s has no influence on ot hers'
vs. I n de pe n de n t e ve n t s Dependent ev ent : r everse
t o independent event
j . Tre e dia gr a m
h . Tot a l proba bilit y ru le t o use t he t ot al probabilit y rule

calcu la t e a n u n con dit ion a l
pr oba bilit y Ex pect ed v alue
For ecast s of ex pect ed values for a i. Use of con dit ion a l e x pe ct a t ion
st ock's ret urn, ear nings, and dividends
in in vest m e n t a pplica t ion s
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Discret e random Uniform

variables
Binom ial
Probabilit y dist ribut ion: discribes Uniform

Continuous random
t he probabilit ies of all t he possible
variables Norm al
out com es for a random vari able
Lognor m al
uses r an dom ly generat ed values for risk fact or s, based on t heir
assu m ed dist ribut ions, t o produce a distribut ion of possible securit y a ,b. t he num ber of possible ou t com es can be count ed
v alues. I t s lim it at ions ar e t hat it is fair ly com plex and w ill prov ide an d t here is a m easurable, posit iv e probabilit y for
answ er s t hat are no bet t er t han t he assum pt ions used. each possible out com e
Discret e
Value com plex securit ies
Random var i ables
t he num ber of possible ou t com es is infinit e,
Sim ulat e t he profit s/ losses fr om a t rading st rat egy
Continuous ev en if low er and upper bounds ex ist
Calculat e est im at es of VAR I s used t o Mont e Carlo sim ulat ion
q ,r. Sim ula t ion Discr et e dist r ibut ion v s.
Sim ulat e pension fund assets and liabilit ies over t im e
cont inuous dist r ibut ion
Value por t folios of asset s t hat hav e non- nor m al r et ur ns dist r ibut ions
uses r andom ly select ed past changes in r isk fact or s t o gener at e a dist r ibut ion of
for discrete variable
possible secu r it y v alues, in cont r ast t o Mont e Car lo sim u lat ion, w hich u ses r andom ly
Probabilit y funct ion p( x )
gener at ed v alues. A lim it at ion of hist or ical sim ulat ion is t h at it cannot consider t h e
effect s of significan t ev en t s t hat did n ot occur in t he sam ple per iod
Hist orical sim ulat ion
t he com pound returns we are fam iliar wit h, given

som e discret e com pounding period, such as
sem iannual or quart erly
Di scr et ely com pounded
c,d. Funct ions PDF- Probabilit y densit y funct ion f( x)
p. Com pound e d r a t e of re t ur n
For a holding period ret urn ( HPR) over

any per iod, t he equivalent continuously Cont inuously com pounded
com pounded rat e over t he period is ln( l + HPR)
gener at ed by t he funct ion e^ x ,

where x is norm ally dist ribut ed
CDF- Cum ulat iv e dist r ibut ion funct ion F( x ) = P( X< = x )
t he probabilit ies for all possible

out com es for a discrete random
variable are equal
Discr et e unifor m
o. Log norm a l d ist rib ut ion
1 0 . COM MON
PRO BABI LI TY
D I STRI BUTI ON S
Skew ed t o t he right
bounded from bel ow by zero so useful for m odel ing
asset pr ices w hich nev er t ak e negat iv e v al ues e ,f,g . D iscr e t e
ra ndom va ria ble s
Binom ial
Short fall risk = Probabilit y t hat ( ret urn < t hreshold)
t he num ber of " successes" in a given
num ber of t rials, whereby t he outcom e
can be either "success" or "failure."
n. Roy's sa fe t y- first crit e rion E( X) = np

SF Rat io u t ilizes t he ex cess r et urn ov er t h e t hreshold ret urn , RL , Variance of X = np( 1 - p)
w her e t he Shar pe r at io uses t he ex cess r et ur n ov er t he r isk -fr ee
r at e, R1. When t he t hr eshold lev el is t he r isk -free r at e of r et ur n,
t he SF Rat io is also t he Shar pe r at io.
Com pare t o Sharpe A binom ial random variable for
which the num ber of t rials is 1
Bernoulli
is a nor m al dist r ibut ion t hat has
been st andar dized, i.e N~ ( 0,1)
t he difference bet ween t he t ot al ret urn on a port folio and t he t ot al
m . St a n da rd n orm a l h. Tra ck ing e rror ret urn on the benchm ark against which it s perform ance is m easured
dist ribu t ion a n d st a nda rdiz e int erchangeable wit h " t rack ing risk "
Using Z- t able, denot ed by F( z) = P( Z< z) defined over a range t hat spans bet ween som e lower lim it , a, and
som e upper lim it , b, which serve as t he param et ers of t he dist ribution
a r ange w it hin w hich w e hav e i. Cont inuous uniform d ist rib ut ion
a giv en lev el of confidence of
finding a point est im at e
1 - - > 68%
1.65 - - > 90% Com plet ely descr ibed by it s m ean and var iance
For any norm ally dist ribut ed
1.96 or 2 - - > 95% l. Confid e nce int e rva ls Sk ewn ess = 0 - - > sy m m et rical, m ean = m edian = m ode
r andom var i able
( for norm a l d ist rib ut ion) Kurt osis = 3
2.58 - - > 99%
Norm al dist ribut ion A linear com binat ion of nor m ally dist r ibut ed
r andom var iables is also nor m ally dist r ibut ed
The t ails get v ery t hin but ex t end infinit ely
t w o t im es [ 1 - t he cum ulat iv e left - hand t ail pr obabilit y , F( - A) ] , or t w o probabilit y t hat a norm ally
t im es { 1 - t he r igh t - hand t ail pr obabilit y , [ 1 - F( A) ] } , w her e F( A) is
dist r ibut ed random v ariable X j ,k . N orm a l d ist rib ut ion Univariat e dist ribut ion: t he dist ribut ion
t he cum ulat ive st andar d nor m al pr obabilit y of A
of a single random variable
2 discr et e r andom var iables: use j oint pr obabilit y
Mult ivariat e: for t wo or m ore cont inuous r andom v ariables: use

Univ ariat e dist ribut ion v s. m ult iv ar iat e nor m al dist r ibut ion
random and dependent var iables
Mult iv ariat e dist ribut ion ( t he role of correlat ion) Cor relat ion: t he relat ion bet ween t he
ou t com es of it s v ar iables r elat iv e t o
t heir ex pect ed v alues
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Possi ble m ist ake: Observat ions from a

different popul at ion m ay be i ncl uded
Higher Cost Sam ple size n ( larger is bet ter) , but
occur s when analyst r epeat edly use t he
A m et hod of sel ect i ng a sam ple i n such a w ay t hat
sam e dat abase t o sear ch for pat t er ns
unt il t he one t hat "wor ks" is discover ed each i t em in t he popul at ion bei ng st udied has
Dat a m ini ng bias
equal opport u nit y of being included in t h e sam pl e
Sim ple random sam pling
occur s when som e dat a is syst em at ically
excluded fr om t he analysis, usually t he difference bet w een a sam ple st at ist i c and
because of t he lack of availabilit y Sam ple select ion bias a ,b. Sa m plin g con ce pt s it s corresponding populat i on param et er
Sam pling error
t he m ost com m on for m of sam ple select ion bias Surv iv orship bias
k . Sele ct ion of sa m ple siz e
a probabilit y dist ribut ion of all possible sam ple
st at ist i cs com put ed from a set of equal - si ze sam ples
occur s when a st udy t est s a r elat ionship
Bias t hat w ere random ly draw n from t he sam e popul at ion
using sam ple dat a t hat was not available
Sam pling dist ribut ion
on t he t est dat e Look- ahead bias
Too shor t : r esear ch r esult s m ay r eflect a m et hod of sel ect i ng a sam ple i n such a w ay t hat
phenom ena specified t o t hat t im e per iod each i t em in t he popul at ion bei ng st udied has Usi ng r andom num ber s
or per haps even dat a m ining equal opport u nit y of being included in t h e sam pl e
occur s when t im e span of dat a in t he Sy st em at ic sam ple
Too long: t he fundam ent al econom ic sam ple is eit her t oo shor t or t oo long Tim e- period bias Sim ple random sam pling
r elat ionship t hat under lie t he r esult m ay
c. Sa m plin g m e t h ods
have changed uses a classificat ion sy st em t o separat e t he populat ion int o sm aller
gr oups based on one or m ore dist inguishing charact erist ics. Fr om
each subgroup or st rat um , a random sam ple i s t aken proport ionally
Not av ailable t o it s w eight in t he popul at ion and t he r esul t s ar e pooled
Non - Norm al AND n< 30 St rat ified random sam pling
Know n var iance - - > z t est j . Ca lcu la t e con fiden ce in t e rva l

Observat ions over a peri od of t im e at equal int erval s
if n > = 30 - - > t approach z - - > bot h are ok Unk now n var iance - - > t t est Ot her sit uations Tim e- series
1 1 . SAM PLI N G &
Obser v at i ons t ak en at a point i n t i m e
ESTI M ATI ON Cross- sect ional
Sm all sam ples ( n< 30) , d. Se t of da t a
unk now n v ar iance Longit udinal dat a: obs over t im e of
Norm al ( or approxi m at ely m ult iple feat ures of one ent i t y
Used when
norm al) dist ribut ion Pooled dat a: pooling t im e- series and Panel dat a: obs over t im e of sam e
i. St u de n t ' s t - dist ribu t ion cross- sect ional in 2 different ways feat ur e of m ult iple ent it ies
Sy m m et r ical
Degrees of freedom df= n- 1
n> = 30 - - > the sam ple m ean will
Less peaked, fat t er t ails t han norm al Propert ies
approxim at ely follow norm al dist ribut ion
Higher n - - > appr oach z e. Ce n t ra l lim it t h eorem The im port ance of t his t heorem : No m at t er w hat dist ribut ion is t he
popul at ion, as long as t he sam ple size i s l arge t hen specific i nference
about populat ion can be m ade usi ng norm al dist r ibut ion assum pt ion
si ngle ( sam ple) v alues used t o

est im at e populat ion par am et ers is t he st andard deviat ion of t he
Point est im at ion dist ribut ion of t he sam ple m eans
h . Est im a t e a popu la t ion pa r a m e t e r
a r ange of val ues i n w hich t he
populat ion param et er is ex pect ed t o lie
Confidence int erval est im at ion
f. St a n da rd e rr or of t h e sa m ple m e a n Known populat ion variance
t he ex pect ed v alue of t he est im at or is equal
t o t h e corresponding populat i on param et er
Unbiased
unbiased est im at or wit h t he sm allest v ariance
of sam pling dist ribut ion or st andard error g. Desira ble prope rt ie s of a n est im a t or Unknown populat ion variance
Efficient
est im at or wi t h probabilit y of est im at es close t o
populat ion par am et er as sam ple si ze i ncr eases
Consistent
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is a statem ent about the value of a

population param eter developed for the
purpose of testing a theory or belief
Designated Ho, is the hypothesis
t hat t he resear cher want s t o rej ect ,
the null hyphothesis always include
Null hypothesis "= "
St at em ent about
populat ion param et er
Designated Ha, is what is concluded if there is sufficient
evidence to rej ect the null hypothesis. I t 's usually the
alt ernat ive hypot hesis t hat you are t r ying t o assess
like the t- test, F- test, and chi- square test, m ake assum ptions regarding Alt ernat ive hypot hesis
the distribution of the population fr om which sam ple are drawn Can be one- sided or t wo- sided
Param et ri c t est Hypot hesis
Upper t ail: rej ect if t est
eit her do not consider a part icular populat ion param et er j. st at ist ic> crit ical value
or have few assum ptions about t he sam pled population A one- sided test is refer red to as a one- taled test Lower tail: rej ect if test
used w hen the assum ptions of param etric a. One- t ailed and t wo- t ailed st at ist ic < crit ical value
tests can't be supported or w hen the data Nonparam et ri c t est tests of hypotheses
are not suitable for param etric tests Rej ect Ho if t est st at ist ic > upper crit ical
value or t est st at ist ic < lower cr it ical value
A t wo- sided t est is referred t o as a t wo- t ailed t est Not rej ect Ho if ( - crit ical value) <
sam ple st at ist ic < crit ical value
1. State the hypothesis

Single populat ion 2. I dent ify t he t est st at ist ic
& probabilit y dist ribut ion
Chi- square t est
i. Te st va ria nce 3. Specifying significance level
Hy pot hesis 4. St at e decision rule
t est ing st eps
5. Collect dat a and calculat e t est st at ist ic
Tw o independent populat ions 6. Make st at ist ical decision

F- test
7. Make econom ic/ invest m ent decision
known variance ( review b) = ( sam ple st at ist ic - hypothesized value) / ( standard error of t he sam ple st at ist ic)
f. Mean of a norm ally
unknown variance ( review b)
dist ribut ed popul at ion w it h
1 2 . H YPOTH ESI S
TESTI N G
Test
st at ist ic
equal assum ed variances
g. The equalit y of m eans of 2 norm ally di st ri but ed

populations, based on independent random sam ples wit h b. Errors
Te st m e a ns
( alpha) rej ect null when it 's true

Type I
unequal assum ed variances
( bet a) do not rej ect null when it 's false
Type I I
the probability of m aking a Type I error ( rej ecting the
null w hen it is true) and is designated by the Greek letter alpha
Significance level significance level m ust be specified to
h. The m ean difference of 2 norm ally dist ribut ed and crit ical value identify the critical value
Values out side t he crit ical t - values lead t o rej ect qualit y
popul at ions ( pai red com parisons t est )
t he power of a t est : probabilit y of
P- value is the probability of obtaining a crit ical value that would lead to a rej ect ing t he null when it is false:
rej ection of the null hypothesis, assum ing the null hypothesis is true - - > the 1- P( t ype I I error )
sm allest level of significance for w hich the null hypothesis can be rej ected
Either reject the null hypothesis or fail to
One tailed tests: probability lies above the com puted test statistic for e . H ow t o use p - va lue c. D e cision rule , t he p ow e r of a reject the null hypothesis
upper tail tests or below the test statistic for low er tail tests
based on the distribution of the test
Tw o tailed tests: probability lies above the positive value of the test statistic t e st , re la t ion b e t w e e n confid e nce
statistic - - > calculate critical value
plus the probability that lies below the negative value of the test statistic int e rva ls a nd hyp ot he sis t e st s c. Decision rule
if the test statistic is ( greater, less than)
the value X, rej ect the null
A hypothesis about a population param eter is rej ected w hen
the sam ple statistic lies outside a confidence interval around
the hypothesized value for the chosen level of significance.
Stat ist ical significance does not

necessarily im ply econom ic significance
d. A st a t ist ica l re su lt a nd a n
Even though a test statistic is significant statistically, the size of the gains
e conom ica lly m e a ning ful re sult
to a strategy to exploit a statistically significant result m ay be absolutely
sm all or sim ply not great enough to outw eigh transactions costs.
12. HYPOTHESIS TESTING - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Technical analysis is t he st udy of

collect ive m arket sent im ent
Prices are det erm ined by t he
Pr inciples
int eract ion of Supply & Dem and
m ake invest m ent decision

St udy past pat t erns t o predict fut ure
Applicat ions suit able wit h short t im e fram e
a . Tech nica l a na lysis Widely applied t o t he price of com m odit y
Market p rice reflect s bot h rat ional &

irrat ional invest or behavior ( Efficient
m arket hypot hesis does not hold)
Trends & Pat t erns exist & t end t o
Assum pt ions
repeat , can be used t o forecast
Can be cont rast ed wit h fundam ent al
analysis( use int rinsic value)
Line char t
Closing prices as a
cont inuous line
Bar chart
1 3 . TECH N I CAL
AN ALYSI S ( pa r t 1 )
Candlest ick chart

b. Cha rt s
X: increases
Point & figur e chart Plot only price rever sals
O: decr eases
Scale
Volum e chart
An incr easing t r end: t he asset is

out per for m ing t he benchm ar k
( posit ive r elat ive str engt h)
calculat e t he rat ios of an asset 's
closing prices t o benchm ark values A decr easing t r end: t he asset is
Relat iv e st rengt h analy sis under per for m ing t he benchm ar k
( negat ive r elat ive str engt h)
13. TECHNICAL ANALYSIS (part 1) - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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prices are consist ent ly r eaching higher

highs and ret racing t o higher lows
dem and is increasing relat ive supply
Upt rend Line is dr aw n below t he prices on a chart
by connect ing t he increasing lows wit h a
st raight line
prices are consist ent ly declining t o lower

c. The use s of t r e nd, lows and ret racing t o lower highs.
suppor t , r e sist a nce line s, suggest s supply ( i.e., selling pressure)
a nd change in pola r it y. is increasing relat ive t o dem and
Dow nt r end Line is dr aw n abov e t he pr ices on a
chart by connect ing t he decreasing
highs wit h a st raight line
Support and resist ance are prices levels at which buying or selling pressure
is expect ed t o lim it price m ovem ent . Com m only ident ified support and
resist ance levels include t rendlines and previous high and low prices.
The change in polarit y pr inciple is t he idea t hat br eached resist ance levels
becom e support levels and breached support levels becom e resist ance levels.
Definit ion: a t r end approaches a range of prices but

fails t o cont inue beyond t hat r ange and t hen reverse
Head &
shoulders
Head & Shoulders
Reversal pat t erns
I nverse head
& shoulders
1 3 . TECH N I CAL
AN ALYSI S ( pa rt 2 )
Double t ops & bot t om s

d. Ch ar t
pa t t e r ns Definit ion: a pause in a t rend
rat her t han a rev er sal
Tr iangles
Cont inuat ion pat t er ns
Rect angle
Flags & Pennant s
are rect angle and t riangle

pat t erns in short t erm
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t o sm oot h fluct uat ions t rends ar e easier t o see

= m ean of t he last
n closing prices
( n= 20; 250...) __ ( sm oot her/ less sm oot h) line
lar ger n if ov erly long n - -> m ay
obscur e pr ice t r end ( obscur e = hide)
abov e golden cross --> _________ (buy/sell) signal

Mov ing av er age lines ST av er age line cr osses
LT aver age line
Price- based below dead cross --> _________ (buy/sell) signal
SMA ( Sim ple Mov ing Av er age) v s. EMA ( Ex pone ntial)

( place m or e w eigt s on r ecen t dat a)
e.g.: bollinger band ( 20,2) m eans 2 st andar d dev iat ions

abov e an d below t h e 20- day m ovin g av erage line
Bollinger bands view ed as cont r ar ian indicat or : if pr ice at or above upper band - - >
ov er ___ (bought / sold) m ark et - - > we should ____ ( buy / sell)
closing price t oday & n day s ear lier

Mom en t um oscillat or ( or --> oscillate around 0
( t oday - past day ) x 100
Rat e of Chan ge oscillat or )
2 for m ulas
t oday / past day --> oscillate around 100
RSI = ( 1 - 1/ ( 1 + RS) ) x 100 RS = Tot al price incr eases / Tot al price decreases
Relat iv e st r engt h index bet w een 0 & 100

com pare t o 3 0 an d 70
MACD lin e ( e.g.: MACD ( 26,12) :

Ex pMA(26) - Ex pMA(12)
Moving aver age Signal line: Ex pMA( 9) of MACD
Oscillat ors conv er gence/ div er gence oscillat or
MACD line cr ossin g abov e Signal line
( or diver gen ce histogram crosses up)
- - > buy signal
% K line: ( lat est price - recent low) / ( recent high - recent low)
e . Com m on Lines
% D line: 3- per iod av erage of % K line
t echnica l a na ly sis
indica t ors If %K line crosses up %D line --> buy signal
St och ast ic oscillat or Fast % K = % K basic calculat ion

Fast st ochast ic oscillat or
Fast % D = 3 - per iod SMA of Fast % K
Slow % K = Fast % K sm oot hed wit h 3- period SMA

Slow st ochast ic oscillat or
Slow % D = 3 - per iod SMA of Slow % K
Opinion polls (survey)

= put v ol / call v ol
Put / Call r at io v iew ed as cont r ar ian indicat or: if v er y high -- > __________ ( bearish/ bullish)
Calculat ed inv est or sent im ent - - > ov er _______ ( bought / sold) m ar k et
st at ist ical indices
= v olat ilit y of opt ions on S&P 5 00
Sentim ent CBOE Volat ilit y I ndex ( VI X) if high --> investors ____ (bearish/bullish) --> we should
indicat or s be______ (bearish/bullish)
if increase --> investors are ________ (bearish/bullish) --> prices are

Mar gin debt __________ (increasing/decreasing)
shor t int erest = num ber of shar es t h at

= shor t int er est / aver age daily t r ading volum e inv est or s have bor r ow ed and sold shor t
Sh ort int erest rat io
cont r ar ian indicat or of follow t he sm ar t m oney indicat or ?
Non- pr ice- based indicat or s
= (num ber of adv ancing issues/ num ber of declining issues) /
v olum e of advancing issues / v olum e of declining issues)
Ar m s index or TRI N
Com par e t o 1:
( sh or t - t er m TRading I Ndex )
Spik es upw ar d = daily ____ ( gain/ loss)
Spik es downw ard = daily ______ ( gain/ loss)
1 3 . TECH N I CAL
AN ALYSI S ( pa rt 3 ) Mar gin debt if increase --> investors _________ (buy/sell) more
Flow of funds indicat ors
= m ut ual fund cash / t ot al asset s
Mut ual fund cash posit ion
view ed as cont r ar ian indicat or
New equit y issuan ce ( I PO) = m ar k et _________ ( peak / t r ough) because I ssuers sell new shar es
and Secondar y offer ings wh en st ock prices ar e t hou ght t o be _ ____ ( high/ low)
Kondr at ieff Wave

( 54 year s)
f. Cy cle s 18-y ear cy cle
Decennial ( 10- year) pat t er n
4- year Pr esident ial cycle
Maj or asset classes: st ock s, bonds,

com m odit ies, cur rencies
h. I nt erm a rk e t a na ly sis Equity sect or s/ indust ries
int er r elat ionships ( r elat ive st r engt h r at ios) am ong
I n t er nat ional m ar ket s
Upw ar d m ov es: 5 w av es ( 1,3,5= im pulses; 2,4= corr ect iv e; 2= pullback

Dow nw ar d m oves: 3 w av es (A,B,C) ( A= bullt r ap)
Upt r end
g. Elliot t W a v e The ory
Downt r end: downwar d m ov es (5

wav es) ; upwar d m oves (3 wav es)
Fibonacci 0,1,1,2,3,5,8,13,21...
num bers
Golden r at io: 1.618 or 0.618
Size of waves cor r espond wit h Fibonacci r at ios Pr ice t ar get can be 1.61 8
of t h e prev ious high
Gr and The cy cle periods r an ge fr om a

Su per cy cle few m inut es ( a " subm inuet t e"
( cen t uries) cy cle) t o cent ur ies
Different waves
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1 4 . Top ics I n D e m a n d An d Supply An a lysis

2 0 . Cu r r e ncy Ex ch a n ge Rat e s
1 5 . Th e Fir m An d M ar k e t St r u ct u r e s
1 9 . I n t e r n a t ion a l Tr ade
And Ca pit a l Flow s Ex ch a nge Ra t e s ECON OM I CS
1 6 . Aggr e ga t e Ou t pu t , Pr ice ,
An d Econ om ic Gr ow t h
1 8 . M one t a r y And Fisca l Policy

1 7 . Un de r st a n din g Bu sine ss Cycle s
ECONOMICS - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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is a m easure of t he responsiveness of t he quant it y dem anded t o a change i n price

W hen quant it y dem anded is very
responsive t o a change in price = > dem and is elast ic
W hen quant it y dem anded is not very

responsive t o a change in price = > demand is inelast ic
Ea ch point a long t he cur ve r e pr e se nt s t he m inim um AT C f or a give n pla nt siz e or sca le of ope r a t ions
= % QD/ % P
Few or no good subst it ut es for a good = > inelast ic.
One or m ore goods are very good subst it ut es for t he good = > elast ic
The larger t he proport ion of incom e,

Port ion of incom e spent on a good t he more elast ic an individual's demand
H ow Econom ies of sca le a n d Ow n- Pr ice Ela st icit y of De m a nd Ot her fact ors affect dem and elast icit y in addit ion
Diseconom ies of Sca le Af f ect Cost s t o t he qualit y and availabilit y of subst it ut es
Elast icit y of dem and t ends t o be great er t he
longer t he t im e period since t he price change
Tim e
Elast icit y is not slope for dem and curves Slope is dependent on t he unit s chat price and quant it y are m easured in
Ave r a ge cor a l cost s f ir st de cr e a se w it h la r ge r sca le a nd e ve nt ua lly incr e a se
The l owest point on t he LRATC corresponds t o t he scale or plant size at which t he average t ot al cost of product ion is at a m inim um
Under perfect compet it ion, firm s m ust operat e at m inim um efficient scale in long- run equilibrium , and LRATC will equal t he m arket price T he m inim um e f f icie nt sca le
Price, I n com e, a n d Cr oss Price Ela st icit ies of
result from fact ors such as labor specializat ion, mass product ion, and invest m ent in m ore efficient equipm ent and t echnology, lower input prices D e m a n d a nd Fa ct or s t ha t Af f e ct e a ch M e a sur e
T he dow nw a r d- sloping se gme nt : e conom ie s of
A firm operat ing wit h economies of scale can increase it s compet it iveness by expanding product ion and reducing cost s sca le ( incr e a sing r e t ur ns t o sca le )
result as t he increasing bureaucracy of larger firm s leads co inefficiency, problem s wit h

m ot ivat ing a larger workforce, and great er barriers t o innovat ion and ent repreneurial act ivit y
A firm operat ing under diseconomies of scale will want t o decrease out put and m ove back t oward t he m inim um efficient scale T he upw a rd- sloping se gm e nt: dise conom ie s of sca le
Cost s are const ant for t he various plane sizes T he r e m a y be a r e la tive ly Ra e por tion a t the
bottom of the LR AT C cur ve tha t e x hibits consta nt
r e tur ns t o sca le
The t im e period over which som e fact ors of product ion are fixed
Shor t r un
All fact ors of product ion ( cost s) are variable

Long r un Price Elast icit y Along a Linear Dem and Curve
pr ice = m ar ginal r ev enue= av er age r ev enue

The sensit ivit y of quant it y dem anded co a change in income
For m ost goods, t he sign of incom e elast icit y is posit ive Norm al goods
I n com e Ela st icit y of De m a n d = % QD/ % I

For some goods, an increase in income
leads t o a decrease in quant it y dem anded I nferior goods.
is lhe rat io of t he percent age change in t he quant it y dem anded of

a good t o t he percent age change in t he price of a relat ed good
Subst it ut es An increase in t he price of a relat ed good = > increase dem and for anot her good
Cr oss Price Ela st icit y of De m a n d
Complem ent s An increase in t he price of a relat ed good = > decrease dem and for anot her good
Shutdow n a nd Br e a ke ve n
Unde r Pe r f e ct Com pe t it ion
I f AR> = ATC, t he firm should st ay in t he m arket in bot h t he short and long run
I f AR > = AVC but AR< ATC, t he firm should st ay in t he m arket Ca lcu la t in g Ela st icit ies
in t he short run but will exit t he m arket in t he long run
I f AR < AVC, t he firm should shut down in t he shore run and exit t he m arket in t he long run
T he subst it ut ion e f f e ct a lw a ys a ct s t o incr e a se t he consum pt ion of a good t ha t ha s f a lle n in pr ice
if average revenue is less t han average variable cost in t he short run, t he firm should shut down Short - run shut down point T he incom e e f f e ct ca n e ithe r incr e a se or de cr e a se consum pt ion of a good tha t ha s f a lle n in pr ice
1 4 . TOPI CS I N D EM AN D The subst it ut ion effect is posit ive, and
I f average revenue is great er t han average variable cost in t he short run, t he firm should cont inue t o operat e, even if i t has losses Br e a k ev e n a n d Sh u t dow n Poin t s t he incom e effect is also posit ive Consum pt ion of Good X will increase
I n t he l ong run, t he firm should shut down if average revenue i s less t han average t ot al cost of Pr od u ct ion AN D SUPPLY AN ALYSI S
Long- run shut down point
The subst it ut ion ef f ect is posit ive, and t he income ef f ect
Out com e s of a is negat ive but sm aller t han t he subst it ut ion effect Consum pt ion of Good X will increase
I f average revenue is j ust equal t o average t ot al cost , t ot al revenue is j ust equal t o t ot al ( economic) cost Breakeven point de cr e a se in t he pr ice
of Good X The subst it ut ion ef f ect is posit ive, and t he income ef f ect
is negat ive and larger t han t he subst it ut ion ef f ect Consum pt ion of Good X will decrease.
TR= TC: break even

I f t he ent ire TC curve exceeds TR, t he firm will want t o minim ize t he economic loss in t he short Shutdow n a nd Br e a ke ve n
TC > TR> TVC: firm should cont inue t o operat e
run by operat ing at t he quant it y corresponding t o t he sm allest ( negat ive) value of TR - TC Unde r I m pe r f e ct Com pe t it ion
in t he short run but shut down in t he long run
Com pa r e Su bst it u t ion a n d
TR < TVC: firm should shut down in t he short run and t he long run I ncom e Ef f e ct s
Land
Labor
Capit al Fa ct or s of pr oduct ion
Mat erials
Consider t wo input s: capit al and labor t o calculcat e t he quant it y of out put

The increase in product ion t hat will result as increasing
one labor em ployed given a fixed amount of capit al
Pr odu ct ion Fu n ct ion
Adding one m ore worker will increase t ot al product Marginal product
by less t han rhe addit ion of t he previous worker
I ncom e a nd Substitution Ef f e cts
W hen we reach t he quant it y of labor for which t he addit ional out put for each addit ional worker begins t o decline
Beyond t his quant it y of labor, t he addit ional out put from each addit ional worker cont inues t o decline
There is some quant it y for labor for which t he m arginal product of labor is act ually negat ive
Th e Ph e n om en on of D im in ish in g
M ar gin al Ret u r n s
Dim inishing m a r gina l pr oduct ivit y or

dim inishing m a r gina l r e tur ns
A spe cific good m a y be a n infe r ior good f or som e r a nge s of incom e a nd a nor m a l good
for ot he r r a nge s of incom e
is an inferior good for which t he negat ive incom e effect out weighs t he posit ive subst it ut ion effect when price falls
At lower prices, a sm aller quant it y would be dem anded as a result
A Giff e n good of t he dominance of t he income ef f ect over t he subst it ut i on ef f ect
The exist ence is not ruled out by t he axiom s of t he t heory of consum er choi ce
N or m a l Good s a n d I n f e r ior Good s
The consum er get s ut ilit y from being seen t o consum e a good chat has high st at us
and t hat a higher price for che good conveys m ore st at us and increases it s ut ilit y
is one for which a higher price
m akes t he good m ore desirable The subst it ut ion and income effect s of a price
increase are t o decrease consum pt ion of t he good
A Ve ble n good Not an inferior good
The exist ence does violat e t he t heory of consum er choice
14. TOPICS IN DEMAND AND SUPPLY ANALYSIS - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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M a ny f ir m s p r od u ce id e nt ica l p r od u ct s, a nd com p e t it ion f or ce s t he m a ll t o se ll a t t he m a r k e t p r ice
Pe r fe ct ly e la st ic ( h or izon t a l) d e m a n d cu rve s a t t he p r ice d e t e rm in e d in t he m a rk e t
None Pr icin g p ow e r
Firm s com pet e for sales only t he basis of price. N a t u re of com p e t it ion
A fir m w ill con t in ue t o e x p a nd p r od u ct ion u nt il M R = M C
Very good subst it ut es N a t ur e of sub st it ut e s

p r od u ct s
very low Ba r r ie r s t o e n t r y
Many firm s N um b e r of se lle r s
I n p ur e com p e t it ion , A p r of it
An increase in m arket dem and will increase m a x im izin g fir m w ill p r od u ce t he
bot h equilibrium price and quantit y & vice versa q u a n t it y, Q* , w h e n M C = M R.
Change in equilibrium price - - > change the ( horizontal) dem and curve
faced by each individual firm & t he profit - m axim izing out put of a firm
I n short - run
Shor t r un : e con om ic p r of it is m a x im ize d a t Q w h ich

M R = M C. Pr ofit m a x im iz a t ion a lso occu r s w h e n
Ch a n g e s in De m a nd , En t r y TR > TC b y t he m a x im um a m ou nt .
1 5 . Th e Fir m An d
a nd Ex it , a nd Ch a n g e s in
Pla n t Siz e M a r k e t St r u ct u r e s
An adj ustm ent to a shift in industry dem and and the result ing change in price
m ay be eit her t o alt er t he size of it s plant or leave t he m arket ent irely I n long- run - Pa r t 1 - Per fect
Com pet it ion
On any unit which MR < MC. At any out put above t he quant it y where MR = MC
- > generat e losses on MP & m axim ize profit s by reducing out put t o where MR = MC
I f P = AVC: operat ing at shut down point .
A perm anent change in dem and - - > t he entry
of fir m s t o, or exit of firm s from , an indust ry. I f P < AVC: by cont inuing t o operat e - - > losses > fixed cost s - - >
t he firm will shut down ( zero out put) and lay off it s workers.
An e con om ic loss occu rs

I n short run: when P < ATC
Th e lon g - r u n e q u ilib r iu m ou t p u t le ve l is w h e r e M R = M C = ATC ( ATC is a t

a m inim u m ) - - > Econ om ic p r of it is z e r o & on ly a nor m a l r e t u rn is r e a liz e d
Sh or t - Ru n Su p ply Cu r ve s
The MC line above t he AVC

The short - run m arket supply curve, which is t he horizont al sum ( add up t he quant it ies
from all firm s at each price) of t he MC curves for all firm s in a given indust ry.
I n shor t - r un e q uilib r ium ,
Slope upward t o the right because firm s will supply m ore unit s at higher prices e a ch fir m p rod u ce s a t M R =
M C = ATC
15. The Firm And Market Structures - Part 1 - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Each fi rm different i at es i t s product ( s) from t hose of ot her firm s t hrough som e

com binat ion of differ ences in pr oduct qual it y, pr oduct feat ur es, and m ar ket ing
The dem and curv es are hi ghl y elast i c because com pet ing
The dem and cur ve is dow nw ard sl oping; w hile pr oduct s are perceiv ed by consum ers as close subst it ut es
dem and is elast ic, it is not perfect ly elast ic.
Many firm s
Num ber of sel lers
Low
Barriers t o ent ry The ent r y of new fir m s shi ft s t he dem and cur v e faced by each i ndivi dual fir m dow n t o t he
point w here price equal s av erage t ot al cost ( P* = ATC* ) , such t hat econom ic profit is zero.
Nat ure of subst i t ut es product s Good subst i t ut es but different i at ed
The differ ences bet w een l ong- r un equi libr ium

in m arket s w i t h m onopolist i c com pet it ion and Monopolist i c com pet it ion: P> MC, ATC is not at a m ini m um for
m arket s w it h perfect com pet it ion. t he quant it y pr oduced or an ineffi ci ent scal e of pr oduct i on,
M ON OPOLI STI C and price is slight ly hi gher t han under perfect com pet it ion
COM PETI TI ON Perfect com pet it ion is charact eri zed by no product different i at ion
Price
Nat ure of com pet i t ion
The fi r m cont inues t o pr oduce at Q w her e MR = MC

but no l onger earns posi t ive econom ic profit s.
1 5 . The Firm An d Cont i nual ly l ook for innovat ive product feat ures t hat w ill m ake
M a rk e t St ru ct u re s - t hei r product s rel at ively m ore desirable t o som e consum ers
Pa rt 2 t han t hose of t he com pet it ion.
The cost s of pr oduct i nnovat ion m ust be w ei ghed
Product i nnovat ion against t he ext ra revenue t hat it produces
A fir m is consi der ed t o be spending t he opt im al am ount on innovat ion w hen MC of
( addit ional) innovat ion j ust equals t he MR ( m arginal benefit ) of addit ional innovat ion
Hi gh
Adv er t isi ng ex penses To infor m about t he uni que feat ur es of t hei r pr oduct s and t o cr eat e or incr ease
a percept ion of differences bet w een product s t hat are act ual ly quit e si m ilar.
som e
Pricing power
An indicat or of m arket pow er.
Use N- fir m concent r at ion r at io, w hich i s calcul at ed as t he su m or t he

percent age m arket shares of t he l argest N firm s i n a m arket
This problem is reduced by using an al t ernat ive m easure of

f. Con ce n t ra t ion m e a su r e s May be rel at ively i nsensi t ive t o m ergers of t w o m ar k et concent r at ion, t he Herfindahl- Hir schm an I ndex ( HHI )
firm s wit h large m arket shares. The HHI is calcul at ed as t he sum of t he squares of
t he m arket shares of t he largest firm s i n t he m arket .
Lim it at ions
Applies t o bot h of our si m ple concent rat ion m easures is
t hat barriers t o ent ry are n ot consi dered in ei t her case
g. I de n t ify t ype of
m a rk e t st ru ct u re
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A few fir m s com pet ing. Each fir m m ust consider t h e act ions and
r espon ses of ot her fir m s in set t ing pr ice and business st r at egy
- - > int er dependent .
Kin k e d d em a n d cu rv e m odel
Char act er ized by a single seller of a pr oduct w it h no close subst it ut es.
Shor t com ing: in spit e of it s int uit iv e appeal, it is incom plet e because w hat det er m ines
t he m ar k et pr ice ( w her e t he k ink is locat ed) is out side t he scope of t he m odel.
Fir m s det er m ine t heir quant it ies sim ult aneously each per iod and, under t he assum pt ions
of t he Cour not m odel, t hese quant it ies w ill change each per iod unt il t hey ar e equal.
When each fir m select s t he sam e quant it y , t her e is no longer any addit ional
pr ofit t o be gained by changing quant it y - - > a st able equilibr ium
The Cour n ot m od el
The r esult ing m ar k et pr ice is less t han t he pr ofit m ax im izing pr ice t hat a m onopolist w ould
The pr ofit m ax im izing output for char ge, but higher t han m ar ginal cost , t he pr ice t hat w ould r esult fr om per fect com pet it ion
a m onopolist is w her e MR = MC.
To ensur e a pr ofit, the dem and cur v e m ust lie
abov e the fir m 's av er age total cost ( ATC) cur v e at
the opt im al quantity so that pr ice > ATC.
The m ar k et dem and cur v e is a dow nw ar d- sloping. The fir m has
The pr ofit m ax im izing output is Q* , w ith a pr ice of P* , t he pow er t o choose t he pr ice at w hich it sells its pr oduct .
and an econom ic pr ofit equal to ( P* - ATC* ) x Q* .
Monopolists ar e pr ice sear cher s and hav e im per fect in
for m ation r egar ding m ar k et dem and. They m ust
ex per im ent w ith differ ent pr ices to find the one that
m ax im izes profit
Single firm
Num ber of seller s
One sour ce of m onopoly pow er is the pr ot ect ion offer ed by copy r ight s and pat ent s
Anot her possible sour ce of m onopoly pow er is cont r ol ov er a r esour ce specifically needed
t o pr oduce t he pr oduct . Most fr equent ly , m onopoly pow er is suppor t ed by gov er nm ent
A nat ur al m onopoly r efer s t o a sit uat ion w her e t he av er age cost of pr oduct ion is falling ov er Ver y high
t he r elev ant r ange of consum er dem and. I n t his case, hav ing t w o (or m or e) pr oducer s w ould Bar r ier s t o ent r y
r esult in a significant ly higher cost of pr oduct ion and be det r im ent al t o consum er s.
N a sh eq u ilib riu m
Som et im es m ar k et pow er is t he r esult of net w or k effect s or sy ner gies t hat m ak e it v er y is r eached w hen the choices of all fir m s ar e such that
difficult t o com pet e w it h a com pany once it has r eached a cr it ical lev el of m ar k et penet r at ion ther e is no ot her choice that m ak es any fir m bett er off
OLI GOPOLY ( incr eases pr ofits or decr eases losses) . Ther e ar e few er fir m s.
No good subst it ut es Pr oduct s ar e m or e sim ilar ( less differ entiated) .
Nat ur e of subst it ut es pr oduct s
Cost st r uctur es ar e m or e sim ilar
Adv er t ising I ncr ease pr ice in an oligopoly m ar k et w ill be m or e
1 5 . Th e Firm An d successful (hav e less cheat ing) w hen: Pur chases ar e r elativ ely sm all and fr equent.
Nat ure of com pet it ion
M a rk e t St ru ct u re s - Retaliation by other fir m s for cheating
Single- price
Pa rt 3 is m or e cer tain and m or e sev er e.
Pr ice discr im inat ion is descr ibed in m or e det ail aft er w e addr ess single- pr ice pr ofit m ax im izat ion. Ther e is less actual or potential
Face a dow nw ar d- sloping dem and cur v e. com petition fr om fir m s outside the car tel.
Hav e at least tw o identifiable gr oups of custom er s w ith For pr ice discr im ination to w or k , M ON OPOLY
differ ent pr ice elasticities of dem and for the pr oduct . t he seller m ust
Be able t o pr ev ent the custom er s pay ing the low er pr ice fr om
r eselling t he pr oduct t o t he cust om er s pay ing t he higher pr ice.
Consum er sur plus is r educed not only by t he

decr ease in quantit y but also by t he incr ease
in pr ice r elativ e to per fect com petition
Pr ice- discrim inat ion Pr icing st rat egies
The quant it y pr oduced by a m onopolist r educes t he sum A pr ice decr ease by one of t he com pet it iv e fir m s, w hich incr eases QCF in
of consum er and pr oducer sur plus by an am ount t he shor t r un, w ill lead t o a decr ease in pr ice by t he dom inant fir m , and
r epr esent ed by t he t r iangle labeled deadw eight loss ( DWL) com pet it iv e fir m s w ill decr ease out put and/ or ex it t he indust r y in t he long r un.
The long- r un r esult of such a pr ice decr ease by com pet it or s below P* w ould t hen be to decr ease
t he ov er all m ar k et shar e of com pet it or fir m s and incr ease t he m ar k et shar e of t he dom inant fir m .
The av er age cost of pr oduct ion for a single fir m is falling

t hr oughout t he r elev ant r ange of consum er dem and
A single price m onopolist will m ax im ize profit s by producing
w her e MR = MC, pr oducing quant it y Qu and char ging Pu St a ck e lb er g d om ina n t f irm m od el
I ncr ease out put

and decr ease pr ice.
Monopolists hav e to r educe pr ice to
I ncr ease social w elfar e w her e the fir m 's ATC inter sects
( allocat ive efficiency ) . the m ar k et dem and cur v e. Av er age cost pr icing is the m ost N ATU RAL MON OPOLY Ther e is a single fir m t hat has a significant ly lar ge m ar k et shar e because of it s gr eat er scale and low er cost st r uct ur e- t he dom inant fir m ( DF) . I n such
com m on for m of r egulation.
Ensur e t he m onopolist a nor m al a m odel, t he m ar k et pr ice is essent ially det er m ined by t he dom inant fir m , and t he ot her com pet it iv e fir m s ( CF) t ak e this m ar k et pr ice as giv en.
pr ofit because pr ice = ATC.
Few fir m s
Num ber of seller s
I ncr eases output and r educes pr ice, Monopolists hav e to r educe pr ice to
but causes the m onopolist t o incur a the point w her e the fir m 's MC cur v e High Oft en because econom ies of scale in pr oduct ion or m ar k et ing lead t o v er y lar ge fir m s.
loss because pr ice is below ATC Mar ginal cost pr icing is also
inter sects t he m ar k et dem and cur v e Bar r ier s t o ent r y
r efer r ed t o as efficient r egulation
Ver y good subst it ut es but differ ent iat ed
The gov er nm ent t o sell the Nat ur e of subst it ut es pr oduct s
m onopoly r ight to the highest bidder
Pr ice, m ar k et ing, feat ur es
Nat u r e of com pet it ion
Som e t o Significant
Pr icing power
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G D P = C + I + G + ( X - M)
w here:
The number of people ov er t he age of 16 w ho are eit her C = c onsumpt ion spending
w orking or av ailable f or w ork but c urrent ly unemploy ed
Labor supply GDP is c alc ulat ed by summing t he amount s spent on I = business inv est ment ( c apit al
I t is af f ec t ed by populat ion grow t h, net Ex pendit ur e approach goods and serv ic es produc ed during t he period equipment , inv ent ories)
immigrat ion, and t he labor f orc e part ic ipat ion rat e G = gov ernment purchases
X = export s
Workers w ho are skilled and w ell- educ at ed ( possess more human c apit al) are a. Calculat e GDP using M = import s
more produc t iv e and bet t er able t o t ake adv ant age of adv anc es in Human c apit al
t ec hnology , inv est ment in human c apit al leads t o great er ec onomic grow t h.
GDP is c alc ulat ed by summing t he amount s earned by GDP = nat ional inc ome + c apit al
households and c ompanies during t he period, inc luding c onsumpt ion allow anc e + st at ist ic al
A high rat e of inv est ment inc reases a c ount ry 's st oc k of phy sic al c apit al Incom e approach
Phy sic al c apit al st oc k Sources w age inc ome, int erest inc ome, and business prof it s disc repanc y
A larger c apit al st oc k inc reases labor produc t iv it y and pot ent ial GDP
improv ement s in t ec hnology inc rease produc t iv it y and pot ent ial GDP. Tec hnology GDP is c alc ulat ed by summing t he addit ions t o v alue
Sum- of- value- added m et hod c reat ed at eac h st age of produc t ion and dist ribut ion.
Raw mat erial input s, suc h as oil and land, m.
are nec essary t o produc e ec onomic out put .
b. Com pare
GDP is c alc ulat ed by summing t he v alues of all f inal
These resourc es may be renew able or nonrenew able Nat ural resourc es Value- of- final- out put met hod goods and serv ic es produc ed during t he period
Count ries w it h large amount s of produc t iv e nat ural

resourc es c an ac hiev e great er rat es of ec onomic grow t h . Nominal GDP GDP v alues goods and serv ic es at t heir c urrent pric es.
Co mpare
Pot ent ial GDP = aggregat e hours w orked x labor produc t iv it y
Measurement Real GDP Real GOP measures c urrent y ear out put using pric es f rom a base y ear.
Grow t h in pot ent ial GDP = grow t h in labor f orc e + grow t h in labor produc t iv it y c.
GD P The GDP def lat or is a pric e index t hat c an be used t o c onv ert nominal
Can be est imat ed by est imat ing t he grow t h rat e of labor
GDP deflat or GDP int o real GDP by remov ing t he ef f ec t s of c hanges in pric es
produc t iv it y and t he grow t h rat e of t he labor f orc e
I s import ant bec ause long- t erm equit y ret urns are highly
Sust ainabilit y Econom ic g row t h
dependent on ec onomic grow t h ov er t ime The f our c omponent s of gross domest ic produc t are c onsumpt ion
GDP spending, business inv est ment , gov ernment spending, and net export s.
A c ount ry 's sust ainable rat e of ec onomic grow t h is t he
rat e of inc rease in t he ec onomy 's produc t iv e c apac it y
= c ompensat ion of employ ees ( w ages and benef it s)
The relat ionship bet w een out put and labor, t he c apit al st oc k, and produc t iv it y . + c orporat e and gov ernment ent erprise prof it s bef ore t axes
+ int erest inc ome
Ec onomic out put f unc t ion: Y = A xf ( L, K) The inc ome rec eiv ed by all f ac t ors of produc t ion + uninc orporat ed business net inc ome ( business ow ners' inc omes)
w here: Nat ional income used in t he c reat ion of f inal out put . + rent
Y = aggregat e ec onomic out put + indirec t business t axes - subsidies ( t axes and subsidies t hat are
L = size of labor f orc e inc luded in f inal pric es)
K = amount of c apit al av ailable
A = t ot al f ac t or produc t iv it y
n. Product ion funct ion approach d. Com pare
The produc t ion f unc t ion c an be st at ed on a per- w orker basis by = nat ional inc ome
div iding by L: Y/ L = Ax f ( K/ L) + t ransf er pay ment s t o households
w here: The pret ax inc ome rec eiv ed by households. - indirec t business t axes
Y/ L = out put per w orker ( labor produc t iv it y ) Person al income - c orporat e inc ome t axes
K/ L = phy sic al c apit al per w orker - undist ribut ed c orporat e prof it s
Labor produc t iv it y c an be inc reased by eit her improv ing
t ec hnology or inc reasing phy sic al c apit al per w orker.
Personal inc ome af t er t axes. PDI measures t he amount t hat households hav e
Grow t h in pot ent ial GDP = grow t h in t ec hnology + Wl( grow t h in labor) + Wc ( grow t h in c apit al) av ailable t o eit her sav e or spend on goods and serv ic es and is an import ant
WL and Wc are labor's perc ent age share of nat ional inc ome Inp ut g rowt h Personal disposable income ec onomic indic at or of t he abilit y of c onsumers t o spend and sav e.
and c apit al's perc ent age share of nat ional inc ome. Personal disposable inc ome = personal inc ome - personal t axes
Driv en by improv ement s in t ec hnology . Somet imes, t he relat ionship bet w een pot ent ial o. Com ponent s of econom ic growt h
GDP, t ec hnology improv ement s, and c apit al grow t h is w rit t en on a per- c apit a basis Growt h of t ot al S (household and b usiness savings)
Grow t h in per- c apit a pot ent ial GDP = grow t h in fact or p rod uct ivit y Saving
t ec hnology + Wc ( grow t h in t he c apit al- t o- labor rat io) S = I+ (G - T) + (X- M)
I nvest m ent
a posit iv e v alue is a gov ernment budget def ic it
(G - T)
a negat iv e v alue is a budget surplus
e . Funda m ent a l The difference bet ween government spending and t ax receipt s.
oc c urs w hen real GDP is less t han pot ent ial real GOP, Fiscal balance
c ausing dow nw ard pressure on input pric es
relat ion ship am ong a gov ernment def ic it ( G - T > 0) must be f inanc ed
by some c ombinat ion of a t rade def ic it ( X - M < 0)
(G - T) = (S - I) - (X - M)
an exc ess of priv at e sav ing ov er
priv at e inv est ment ( S - I > 0) .
Adj ust m ent t o a Decrease
in Aggregat e Dem and a posit iv e v alue is a t rade surplus
(X - M)
I nc rease inv est ment in def ensiv e c ompanies and dec rease Trade balance a negat iv e v alue is a t rade def ic it
inv est ment in c y c lic al c ompanies
Net ex p ort s
I nc rease inv est ment in inv est ment - grade and
An inv est or expec t ing a dec rease in
gov ernment fixed inc ome sec urit ies and dec rease
aggregat e demand t hat w ill result in
inv est ment in low er- qualit y f ixed inc ome sec urit ies (S - I) = (G - T) + (X - M)
a rec essionary gap should:
I nc rease inv est ment in long- mat urit y f ixed inc ome The negat iv e relat ionship bet w een t he real int erest rat e and lev els of aggregat e
sec urit ies bec ause t heir pric es reac t more t o f alling inc ome t hat are equal t o planned expendit ures at eac h real int erest rat e.
int erest rat es t han do short er- mat urit y sec urit ies.
An inc rease in t he money w age and ot her resourc e pric es means

t hat business w ill be w illing t o supply less real goods and serv ic es at I S cur ve
eac h pric e lev el ( pric es of f inal goods and serv ic es) .
t he IS cur ve is an inver se r elat ionship
I t is t he inc rease in resourc e pric es t hat c auses Adj ust m ent t o an I ncrease bet ween t he real int erest rat e and income
SRAS t o dec rease ( shif t t o t he lef t ) in Aggregat e Dem and
An inf lat ionary gap oc c urs w hen real GDP is

great er t han pot ent ial real GOP, c ausing upw ard
pressure on input pric es.
l. I 2 : Analyze th e ef fect of com b in ed
ch an g es in ag g r eg ate su p p ly an d
d em an d on th e econ om y.
1 6 . Aggr e gat e I S & LM The LM c urv e show s t he c ombinat ions of GDP or real inc ome
Cur ve ( Y) and real int erest rat e ( r) t hat keep t he quant it y of real money
Out put , Pr ice, And LM cur ve
demanded equal t o t he quant it y of real money supplied
Econ om ic Gr ow t h
is simult aneous high inf lat ion and w eak ec onomic grow t h, w hic h
The point s at w hic h t he I S c urv e int ersec t s LM c urv es f or dif f erent
c an result f rom a sudden dec rease in short - run aggregat e supply
lev els of t he real money supply f orm t he aggregat e demand c urv e
Show s t he negat iv e relat ionship bet w een GDP ( real out put demanded)
and t he pric e lev el, w hen ot her f ac t ors are held c onst ant .
St agflat ion
A dec line in aggregat e supply is represent ed in Figure
13 as a shif t f rom SRAS0 t o SRAS1 . Ag g r eg ate d em an d cu rve The AD Curv e show s t he relat ionship bet w een t he quant it y of real
out put demanded ( w hic h equals real inc ome) and t he pric e lev el.
Equilibrium GOP dec reases f rom GDP* t o GDP1' Slopes dow nw ard bec ause higher pric e lev els reduc e real w ealt h,
inc rease real int erest rat es, and make domest ic ally produc ed
goods more expensiv e c ompared t o goods produc ed abroad.
I nf lat ion rises as t he pric e lev el inc reases f rom P0 t o P1
Dif f ic ult f or gov ernment polic y makers t o address bec ause polic y c hanges t o reduc e inf lat ion t end t o
make unemploy ment w orse, w hile polic y c hanges t o f ight rec ession t end t o make inf lat ion w orse
Dec rease inv est ment in f ixed inc ome sec urit ies in
The posit ive relat ionship bet ween real GDP supplied and t he
ant ic ipat ion of higher inf lat ion and nominal int erest rat es.
SR price level, when ot her fact ors are held const ant
Dec rease inv est ment in equit ies as rev enue
An inv est or ant ic ipat ing st agf lat ion should
and prof it margins w ill dec rease.
Perfect ly inelast ic (vert ical)
I nc rease inv est ment relat ed t o c ommodit ies in
ant ic ipat ion of higher c ommodit y pric es. LR Long- run aggregat e supply represent s pot ent ial GDP,
t he full employment level of economic out put .
Real GDP = full employment (pot ent ial) GDP Long- r un full employment
AD incr eases - - > GDP of shor t - r un equilibr ium> full- employment GDP Short - run recessionary gap Aggre ga t e
j . Distin gu ish be tw een th e fo llo w in g supply cur ve in
typ es o f m acr o eco n o m ic eq u ilib r ia
AD decr eases - - > GDP of shor t - r un equilibr ium< full- employment GDP Shor t - r un inflat ionar y gap
AS decreases - - > GDP < full- employment GDP but wit h an crease in price level Short - r un st ag flat ion
The AS curve describes t he relat ionship bet ween t he price level and t he
quant it y of real GDP supplied, when all ot her fact ors are kept const ant
Caused by changes in household wealt h, business and consumer ex pect at ions, capacit y ut ilizat ion,
fiscal policy, monet ary policy, currency ex change rat es, and global economic growt h rat es.
Long- Run Equilibr ium Real Out put

There is exc ess supply ; t he quant it y of real goods and
Businesses w ill see a build- up of serv ic es supplied exc eeds t he ( aggregat e) demand for real
inv ent ories and w ill dec rease bot h goods and serv ic es.
produc t ion and pric es in response This somet imes ref ers t o A rec essionary gap. There w ill be
dow nw ard pressure on pric es.
Businesses w ill experienc e unint ended Shift s in t he shor t - r un aggr egat e supply cur ve
dec reases in inv ent ories and respond by There is exc ess demand f or real goods and serv ic es.
inc reasing out put and pric es. This is somet imes ref erred t o as an inf lat ionary gap.
The short - run aggregat e supply ( SRAS) c urv e ref lec t s t he relat ionship bet w een
out put and t he pric e lev el w hen w ages and ot her input pric es are held c onst ant .
I n Panel ( a) , short - run equilibrium real GDP, GDP1, is less t han c aused by c hanges in nominal w ages or ot her input pric es, expec t at ions of f ut ure pric es,
f ull- employ ment GDP ( along t he LRAS c urv e) and w e w ould int erpret business t axes, business subsidies, and c urrenc y exc hange rat es
t his as a rec ession, or below f ull- employ ment equilibrium. i. Flu ctu ation s in ag g r eg ate D & S
- - > SR ch an g es in econ & b iz cycle The long- run aggregat e supply ( LRAS) c urv e is v ert ic al ( perf ec t ly
Dif f erenc e bet w een real GDP and f ull- employ ment GDP is c alled a
inelast ic ) at t he pot ent ial ( f ull- employ ment ) lev el of real GDP.
rec essionary gap or out put gap - - > dow nw ard pressure on money w ages
and resourc e pric es - - > dec rease t he equilibrium pric e lev el f rom P1 t o P* h. Shif ts a nd I nc rease in t he supply and qualit y of labor
m o v e m e nt s
a long D & S cur ve s I nc rease in t he supply of nat ural resourc es
Shift s in t he long- r un aggr egat e supply cur ve Changes in f ac t ors t hat af f ec t t he real I nc rease in t he st oc k of phy sic al c apit al:
out put t hat an ec onomy c an produc e at
Shor t - r un Equilibr ium Real Out put Tec hnology
f ull employ ment w ill shif t t he LRAS c urv e.
Dec reases in labor qualit y , labor supply , t he supply of nat ural resourc es, or t he
st oc k of phy sic al c apit al w ill all dec rease LRAS. Tec hnology does not really ret reat ,
but a law prohibit ing t he use of an improv ed t ec hnology c ould dec rease LRAS.
An ec onomic expansion w here aggregat e demand has
I nc rease in c onsumers' w ealt h
grow n f ast er t han LRAS.
Business expec t at ions
The result w ill be upw ard pressure on pric es - - >
inf lat ion as t he general pric e lev el inc reases f rom P1 t o P* Consumer expec t at ions of f ut ure inc ome
A number of f ac t ors c an af f ec t t his lev el of High c apac it y ut ilizat ion

expendit ures and c ause t he AD c urv e t o shif t . Expansionary monet ary polic y
Shift s in t he Aggr egat e Demand Cur ve
Expansionary f isc al polic y
Changes in t he money supply - - > changes in aggregat e demand. An increase Exc hange rat es
in t he money supply - - > decrease real int erest rat es and increase aggregat e Global ec onomic grow t h
demand t hr ough incr easing consumpt ion ex pendit ur es on dur able goods
Not e t hat a c hange in t he pric e lev el is represent ed as a
A decrease in t he money supply will have t he opposit e effect , increasing mov ement along t he AD c urv e, not a shif t in t he AD c urv e.
t he r eal int er est r at e and r educing consumpt ion and invest ment spending. Movem ent s along t hese curves reflect t he impact of a change in t he price level on t he quant it y demanded
and t he quant it y supplied. Changes in t he price level alone do not cause shift s in t he AD and AS curves
16. Aggregate Output, Price, And Economic Growth - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
lOMoARcPSD|6909307

Charact erized by fluct uat ions i n econom ic act ivit y

Biz Cycle Real gross GDP
2 key variables
Rat e of unem ploym ent
Expansion real GDP is increasing
have t urni ng point s t hat t end t o real GDP st ops increasing

precede those of t he business cycle Leading i ndi cat ors Peak and begins decreasing
a. Describe
have t urni ng point s t hat t end t o coincide Phases of Biz Cycle real GDP is
w it h t hose of t he business cycle Coincident indicat ors Types of indicat ors Cont ract ion or recession decreasing
have t urni ng point s t hat t end t o occur i. Describe econom ic indicat ors real GDP stops decreasing
after those of t he business cycle Lagging indicators Econ om i c Trough and begins increasing
indica t or s
Uses I nvent ory- sales rat io
I nventory levels
relationships w it h the business cycle are inexact and can vary over t im e Resource use
Lim it at ions
fluct uat ion Labor
Past biz cycle Physical capit al ut ilizat ion levels
Current biz cycle Mort gage rat e
j . I dent ify Housing
Expect ed fut ure biz cycle sector Housing cost s relative t o incom e
b. Econom y m oving act ivit y
t hrough biz Cycle - - > Specul at ive act ivit y
persist ent increase in t he price level over t im e I nflat ion Busine ss cycle Dem ographic fact ors
a decrease in t he inflation rat e over t im e Dom est ic im port s

Disinflat ion Ext ernal t rade sect or act i vit y
e. Explain Dom est ic export s
a persist ent decrease in t he price level Deflat ion business cycles are t em porary and
driven by changes in t echnology
m easures t he cost of a specific basket of goods and Neoclasscial school rapid adj ust m ents of wages and ot her input prices cause
services relat ive t o it s cost in a prior ( base) period Price index t he econom y t o m ove t o fu ll- em ploym ent equilibrium
Keynesian school
based on t he purchasing pat t erns
of a typical household Consum er price index ( CPI ) 1 7 . Un d e rst a n din g excessive opt im ism or pessim ism am ong
business m anagers causes business cycle
Bu sin e ss Cycle s
Price index for personal consum pt ion expendi t ures cont ract ions can persist because
f. I ndices u sed t o New Keynesian school wages are slow t o m ove downward
GDP deflat or m easure inflation New Keynesians believe input prices other
Producer price index ( PPI ) t han wages are also slow t o m ove downward
c. Theories of Biz Cycle
Wholesale price index ( WPI )
inappropriat e changes in t he rat e of m oney
Core inflat ion supply growt h cause business cycles
Monet arist school m oney supply growt h should be m aint ained
Headline inflat ion
at a m oderat e and predict able rat e
I nfla t ion
Uses a const ant basket of goods and services
business cycles are init iated by governm ent intervent ion
New goods Aust rian school t hat drives interest rat es t o art ificially low levels
3 elem ent s cause bi ased
Qualit y im provem ent s Laspeyres
upward t o Laspeyres index Real biz cycle t heory ( RBC)
Consum ers' subst it ut ion of low er- priced Lim it at ions New classical school
goods for higher- priced goods over tim e
g. I nflat ion m easures result s from t he t im e it takes for em ployers looking t o fi ll

uses current consum pt ion weight s for t he basket of goods and services for bot h periods j obs and em ployees seeking t hose j obs t o find each ot her
Paasche index Frict ional unem ploym ent
reduces subst it ut ion bias
The geom et ric m ean of a Laspeyres and a Paasche index result s from long- t erm econom ic changes t hat require
Fisher index w orkers t o learn new skills t o fill available j obs
Types St ruct ural unem ploym ent
Hedonic pricing
posit ive ( negat ive) w hen the econom y is producing less
result s from a decrease in aggregat e supply caused by an increase in ( m ore) t han it s pot ent ial real GDP.
Cyclical unem ploym ent
t he real price of an im port ant fact or of product ion, such as labor or energy Cost - push inflat ion
d. U ne m p loym e nt Unem ploym ent rat e = Unem ploym ent / labor force
result s from persist ent increases in aggregat e dem and t hat h. Fact ors t hat
increase t he price level and t em porarily increase econom ic affect price levels
includes all people w ho are eit her
out put above it s pot ent ial or full- em ploym ent level. Dem and- pull inflat ion
Labor force em ployed or unem ployed
Volunt arily unem ployed

Measures
Underem pl oyed
Part icipat i on rat io = Labor force/ Population working age
Discouraged w orker
17. Understanding Business Cycles - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Defin it ion a gener ally accept ed m edium of exchange.
Medium of exchange m eans of paym ent
Funct ions of m oney in an econom y Unit of accoun t
b. St or e of value
t he am ount of not es ( cur r ency ) and coins in cir culat ion

in an econom y plus balances in check able bank deposit s
Nar r ow m oney
Money
includes nar r ow m oney plus any am ount av ailable in
Br oad m oney liquid asset s, w hich can be used t o m ak e pur chases
Concept s Money m ult iplier = 1/ ( reserve r equir em ent )
c. Money cr eat ion pr ocess m oney supply x velocit y

Quant it y t heor y of m oney = pr ice x r eal out put ( MV = PY)
The am ount of w ealt h that households and fir m s in

Defin it ion an econom y choose t o hold in the for m of m oney
Expansion ar y ( accom m odat ive or easy)
Ty pe
Cont r act ionar y ( r est r ict ive or t ight ) Monet ary policy Tr ansact ion dem and
Dem and for m oney
a . Com pa r e for unfor eseen
budget deficit Reasons for holding m oney Pr ecaut ionar y dem and fut ur e needs
Fiscal policy d. Theories of

budget sur plus
Speculat ive dem and
det er m ined by t he cent r al bank

( t he Fed in t he Unit ed St at es)
Supply of m oney
independent of t he int er est r at e
R ( Nom ) = R( r eal) + E( I )
e. Fisher effect
1. Sole supplier of cur r ency
2. Bank er t o t he gov er nm ent and ot her bank s
3. Regulat or and super visor of paym ent syst em
Roles
4. Lender of last r esor t
1.Expansionary fiscal and m onet ary policy 5. Holder of gold and for eign exchange r eser ves
2. Cont ract ionary fiscal and m onet ary policy 6. Conduct or of m onet ar y policy
t . I n t e r a ct ion of
3. Expansionary fiscal policy + cont ract ionary m onet ary policy f. Cent ral banks
m one t a ry a nd fisca l p olicy Pr im ar y obj ect ive con t r ol in flat ion so as t o pr om ot e pr ice st abilit y
4. Cont ract ionary fiscal policy + expansion m onet ary policy
I nt eract ion of m onet ary and fiscal policies St abilit y in ex change r at es wit h for eign cur r encies
Obj ect ives Full em ploym ent
use of spending and t ax at ion t o Ot her goals
Sust ainable posit ive econom ic gr owt h
m eet m acr oeconom ic goals Roles
Moder at e long- t er m int er est r at es
I n flu en cin g t h e lev el of econ om ic act iv it y High inflat ion, even when
o. Describe people r educe cash balance
Redist r ibu t in g wealt h or in com e Obj ect ives it is per fect ly ant icipat ed
Allocat in g r esou r ces am on g in du st r ies r educes t he infor m at ion

unex pect ed inflat ion v alue of pr ice changes
Tran sfer paym ent s
Cur r ent spending ( goods and ser vices used by gover nm ent ) Spending t ools g. Cost s of expect ed and unexpect ed
Uncer t aint y about t he decr ease business
Capit al spending ( invest m ent pr oj ect s funded by gover nm ent ) fut u r e r at e of inflat ion incr eases r isk inv est m ent
Dir ect and indir ect t axat ion Revenue t ools

M onet a r y policy called t he discount r at e in t he Unit ed St at es,
t he r efinancing r at e by t he ECB, and t he
I n dir ect t ax es can be u sed t o qu ick ly im plem en t social policies
Policy r at e 2- w eek r epo r ate in t he Unit ed Kingdom
and can also be used t o quickly r aise r ev enues at a low cost Advant ages
Pr os and cons Tools Reser ve r equir em ent s
Tim e lags for im plem ent ing changes in dir ect t axes 1 8 . M on e t a r y h. I m plem ent at ion of m onet ary policy
Disadvan t ages Buy ing and selling of
Tim e lags for capit al spending changes t o hav e an im pact And Fisca l Policy Open m ar ket oper at ions secur it ies by t he cent r al bank
Det er m ines t he pot ent ial incr ease in aggr egat e dem and
r esult ing fr om an incr ease in gov er nm ent spending p. Tools of fiscal policy Shor t - t er m bank lending r at es
Changes in t he cent r al bank 's
Fiscal Mu lt iplier Asset pr ices
policy r at e t hr ough prices and
inflat ion include one or m or e Expect at ion s for econ om ic act ivit y
and fut u r e policy r at e changes
A m easur e of t he change in aggr egat e product ion caused i. Monet ar y t r ansm ission m echanism
by equal changes in gover nm ent pur chases and t ax es Ex change r at es wit h for eign cur r ency
Balan ced Budget Mu lt iplier The centr al bank is fr ee

I ndependence from polit ical int er fer ence.
Fisca l p olicy
Tax pay er s r educe cur r ent consum pt ion and incr ease cur r ent The centr al bank follow s thr ough
sav ing by j ust enough to r epay t he pr incipal and inter est on Cr edibilit y on it s st at ed policy int ent ions
t he debt t he gov er nm ent issued to fu nd t he incr eased deficit j . Qualit ies of effect ive cent ral banks
Ricar dian Equ ivalen ce
The centr al bank m ak es it clear w hat econom ic indicat or s
Higher futur e tax es lead t o disincentiv es to w or k , it uses and r epor t s on the stat e of t hose indicat or s
Tr anspar ency
negat iv ely affect ing long- t er m econom ic gr ow t h.
Fiscal deficits m ay not be financed by econom ic gr owt h
t he m ar k et w hen debt lev els ar e high Ar gum ent s for
in flat ion
Cr ow ding- out effect as gov er nm ent bor r ow ing incr eases
int er est r at es and decr eases pr iv at e sect or inv est m ent incr ease aggr egat e dem and
incr ease inv est m ent dem and
Debt m ay be financed by dom estic citizens
q. Being concerned wit h Low er int er est r at e cur r ency depr eciat ion
Deficit s for capit al spending can boost k. Relat ionships bet ween
Size of a fiscal debt int er est w ith low r eal int er est r at e
t he pr oduct iv e capacit y of t he econom y m onet ary policy and
Fiscal deficits m ay pr om pt needed t ax r efor m
Ar gum ent s against
Ricar dian equiv alence m ay prev ail: priv at e sav ings rise in m ay pur chase or sell secur it ies
anticipat ion of the need t o r epay pr incipal on gov er nm ent debt
When t he econom y is oper at ing below full em ploy m ent , exchange r at e
deficit s do not cr ow d out pr iv at e inv estm ent
The m oney supply is used
Most cent r al banks set t ar get t o adj ust econom ic act iv it y
i m plem en t at ion
gover nm ent al changes in t ax ing and spending policies & t hen affect t o inflation
of fiscal policy inflat ion r at es, t ypically 2 % t o 3%
Recognit ion lag: Policy m ak er s m ay not im m ediat ely l. Cont rast t he use of inflat ion, int erest rat e, Dev eloping econom ies som et im es t ar get
a stable ex change r at e for t heir cur r ency Use for eign r eser v es to adj ust
r ecognize w hen fiscal policy changes ar e needed. Delay s in r ealizin g exchange rat e t arget ing by cent ral bank
difficu lt ies of r. Explain r elativ e to that of a dev eloped econom y Must follow a m onetar y policy that
Act ion lag: Gov er nm ent s t ak e t im e t o enact needed fiscal policy changes t he effect s caused by
im plem en t at ion suppor t s t he t ar get ex change r at e
I m pact lag: Fiscal policy changes t ak e t im e t o affect econom ic act iv it y .
Expansionar y
m onet ar y policy The policy r at e is below t he neut r al r at e
Decr ease in a gover nm ent budget sur plus or incr ease in a gover nm ent budget deficit Expansion ar y fiscal policy
m. Cont r act ionar y

I ncr ease in a gover nm ent budget sur plus or decr ease in a gover nm ent budget deficit s. m onet ar y policy The policy r at e is above t h e neut r al r at e
Con t r act ion ar y fiscal policy
May affect inflation ex pectations due to long- t er m inter est

r at es m ov e opposit e t o shor t - t er m int er est r at es
I ndiv iduals m ay be w illing t o hold gr eat er cash balances
w it hout a change in shor t t er m rat es (liquidit y t r ap)
Bank s m ay be unw illing t o lend gr eat er am ounts,
ev en w hen t hey hav e incr eased ex cess r eser v es
n. Lim it at ions of m onet ary policy
Shor t - t er m r at es cannot be r educed below zer o
undev eloped financial m ar k et s, r apid financial innov at ion,
Unique challenges of dev eloping
econom ies t o ut ilize m onet ar y policy and lack of cr edibility of the m onetar y author ity
18. Monetary And Fiscal Policy - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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a vit al source of financial and t echnical assist ance

t o developing count ries around t he world
The I nt ernat ional Bank for
Reconst ruct ion and Developm ent ( I BRD) m ade up of t wo u nique WB
developm ent inst it ut ions
The I nt ernat ional Developm ent Associat ion ( I DA)
prom ot ing int ernat ional m onet ary cooperat ion

facilit at ing t he ex pansion and balanced grow t h of int ernat ional t rade
prom ot ing exchange st abilit y
Goals
assist ing in t he est ablishm ent of a m ult ilat eral syst em of paym ent s I MF j . Fu n ct ion s an d obje ct ives of
m aking resources available ( wit h adequat e safeguards) t o in t er n at ion al or gan iz at ion s
m em bers experiencing balance of paym ent s difficult ies
The on ly int ernat ional organizat ion dealing

w it h t he global rules of t rade bet w een nat ions
Funct ion: ensure t hat t rade flow s as sm oot hly , predict ably and freely as possible
Trade frict ion
The WTO's agr eem ent s, negot iat ed and signed W TO
by a lar ge m aj or it y of t he wor ld's t r ading
nat ions, and r at ified in t h eir par liam ent s The m ult ilat eral t rading syst em
A coun t r y m ust buy t he cur r encies of t h e for eign coun t r ies in or der t o accom plish t r ansact ions
such as paym ent for t h eir pur chases of for eign goods, ser vices, and financial asset s
Description
I m por t s
Merchandise and services Ex por t s
I ncom e receipt s Current account Au t a r k y or close d e con om y
Unilat eral t ransfers Fr e e t r a de
Capit al t ransfers Tr a de pr ot e ct ion

Capit al account Com ponents W or ld pr ice
Sales and purchases of non- financial asset s h ,i. Balan ce of pay m en t s
W ar m - Up: I n t er n at ion al Tr ade D om e st ic pr ice
Governm ent - owned asset s abroad
Financial account N e t e x por t s
foreign- owned asset s in t he count ry Tr a de su r plu s
X - M = privat e sav ings + gov t sav ings + invest m ent Tr a de de ficit
Consum ers Te r m of t r a de
Firm s I nfluenced by FDI

M u lt in a t ion a l cor por a t ion
Governm ent
The t ot al value of goods and services

Reduce t he volat ilit y of dom est ic asset prices
produced wit hin a count ry's borders
Maint ain fixed exchange rat es g. Com m on ly cit e d GDP ( Gross Dom estic Product)
Keep dom est ic int erest rat e low and enable obje ct ives of capit al a. Com par e
The t ot al value of goods and serv ices produced
great er independence regarding m onet ary policy flow r est r ict ion s by t he labor and capit al of a count ry 's cit izens
Prot ect st rat egic indust ries from foreign ow nership GNP ( Gross National Product)
Trading blocs or regional trading agreem ent ( RTA) To im port ing count ries Lower- cost goods
barriers t o im port or ex port are rem ov ed Free t rade areas ( FTA)
increasing em ploym ent
= FTA Benefit
b. I n t er n at ion al t r ade To export ing count ries increasing wages
adopt ing a com m on set of t rade Cust om s union ( CU) profit s from ex port s
rest rict ions wit h non- m em bers
f. M ot iva t ion s for
& Adva n t a ge s of 1 9 . I nt er na t iona l Tr a de em ployees have t o ret rain
Types of agreem ents losing j obs
CM
Com m on m arket ( CM) And Ca pit a l Flow s Costs
com m on inst it ut ions and econ policy for t he union
Ex ch a nge Rat e s
EU Low er opport unit y cost
Monet ary union
a single currency Trading brings gains regardless
Com parative advantage
of absolut e advant age
I nfant indust ry. Low er cost

Absolute advantage
Nat ional securit y
Prot ect ing dom est ic j obs
Prot ect ing dom est ic indust ries Reasons
r et aliat ion for foreign t r ade r est r ict ions; gover nm ent
collect ion of t ar iffs; coun t er ing t h e effect s of gover nm ent c. D ist in gu ish
subsidies paid t o for eign pr oducer s; and pr event ing for eign
expor t s at less t han t heir cost of pr oduct ion ( dum ping) Ot hers
Tariffs
quot as
Export subsidies Ty pe
Min dom est ic cont ent
The product ion
Volunt ary export rest raint ( VER) possibility frontiers ( PPF)
Only one fact or of product ion - labor

Differences in labor product ivit y
Ricardian
Trade rest rict ions due t o differences in t echnology
Two fact ors of product ion capit al and labor

d. M ode ls of t r ade
Differences in t he relat ive am ount s
of each fact or t he count ries possess
Heckscher- Ohlin
Redist ribut ion of wealt h wit hin each count ry
e . Re st r ict ion s bet ween labor and t he ow ners of capit al
Effect of Tariffs and quot as
Reduce im port s
I ncrease price
To dom est ic count ry,
Decrease consum er surplus quot as,t ariffs and VERs all
I ncrease dom est ic quant it y supplied
I ncrease producer surplus
are t hought t o decrease econom ic w elfare

m ay n ot offset long- t er m cost s
( When excluded fr om int er nat ional Effect s
Helping developing count ries avoid t he im pact of
m ar ket s for financial capit al flows) great inflow s of foreign capit al ov er t he short t erm
prohibit ion of invest m ent

prohibit ion or t axes on t he incom e earned Capital restrictions
on foreign invest m ent by dom est ic cit izens
prohibit ion of foreign invest m ent Form of rest rict ions
in cert ain dom est ic indust ries
rest rict ions on repat riat ion of earnings of
foreign ent it ies operat ing in a count ry.
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Ela st icit ie s of export and im port dem and m ust m eet the
Marshall- Lerner condit ion for a depreciat ion of t he
dom est ic currency t o reduce an exist ing t rade deficit
t he price or cost of units of one

curr ency in term s of another
USD: price currency
Define an exchange rat e E.g. 1.25 USD/ EUR
EUR: base currency
j . I m p a ct of e x cha nge m easures the cost t o buy an unit
ra t e s on count rie s of currency at a point in tim e
Nom inal exchange rates
m easures changes in r elative

The J- Curve
a. purchasing power over t im e
Y= dom est ic product ion of goods an d ser v ices or nat ional incom e
Real exchange r ates
E= dom est ic absorpt ion of goods and ser v ices, wh ich is t ot al ex pen diture BT = Y - E
BT = balance of t r ade Dist inguish
national incom e m ust increase r elative t o national the currency exchange r ate for im m ediate
Absorption approach
expenditure in order to decrease a trade deficit Spot exchange r ates delivery, usually t wo days aft er t he t rade
or a requirem ent that national saving m ust increase r elative
to dom estic investm ent in order to decrease a trade deficit a currency exchange rat e for an
Forward exchange r ates exchange t o be done in t he fut ure
use other country's curr ency

Form al dollarizat ion
Do not have it s own m onet ary policy Count ries t hat do not serve com panies/ individuals t hat purchase or sell foreign
Be a m em ber of a m onet ary union have t heir ow n currency goods and services denom inated in foreign curr encies
t he l argest financial m arket in t erm s
m ay include capit al flows
an explicit com m it m ent t o exchange dom est ic currency of t he value of daily t ransact ions
for a specified for eign currency at a fixed exchange rat e Cur rency Board Agr eem ent large m ult inat ional banks ( t he sell side)
cor por at ions
direct int ervent ion
( m onet ary aut horit y) a count ry pegs it s currency wit hin m argins of ± 1% investm ent fund m anagers
versus another curr ency or a basket that includes the
indir ect intervention ( be currencies of it s m aj or t rading or financial part ners Conventional fixed b. FOREX m a r k e t hedge fund m anagers
const rained by t he peg's Part icipant s
peg arrangem ent 2 0 . Cu r r en cy invest ors
requir em ent s)
Ex ch a n ge Ra t e s governm ent s
the perm itt ed fluctuations in curr ency value relative cent ral banks ( t he buy side)
t o anot her currency or basket of currencies are wider hedger s: ent er int o t r ansact ions t hat
t he m onet ary authorit y has m ore policy Target zone i. Ex cha ng e ra t e re g im e s decr ease an ex ist ing for eign ex change r isk
discretion because the bands are wider speculat or s: ent er int o t r ansact ions t hat
H e dger s vs specu lat or s
incr ease t heir for eign ex change r isk
passive: adj ust for higher inflat ion Count ries t hat have
versus the currency used in the peg t heir ow n currency
the exchange r ate is adj usted per iodically Crawling peg appreciat ion ( price goes up)
active: a series of exchange r ate adj ustm ents
over tim e is announced and im plem ented change in an exchange rat e depreciat ion ( price goes down)
c. % cha nge in a
invert t he quote to the base currency and pr oceed
t he widt h of t he bands t hat identify perm issible cur re ncy r e la t ive t o
Managem ent of exchange
exchange r ates is increased over tim e a not he r cur re ncy an appr eciat ion of t he USD
rates within crawling bands
Calcul at e E.g. a decrease in the USD/ EUR exchange relat ive t o t he EUR of 1.41% :
rat e from 1.44 t o 1.42 ( USD: base currency) = ( 1 / 1 .42 ) / ( 1 / 1 .44 ) - 1
t he m onet ary author it y influences t he exchange rat e in r esponse t o specific
indicat or s such as t he balance of paym ent s, inflat ion r at es, or em ploym ent System of m anaged
w it hout any specific t ar get ex chan ge r at e or pr edet er m ined ex chan ge r at e pat h floating exchange r ates
is t he exchange rat e bet ween t w o currencies im plied
t he ex change r at e is m ar k et -det er m ined and for eign ex change m ar k et int er v en t ion by t heir exchange rat es wit h a com m on t hird currency
is used only t o slow t he r at e of change and r educe shor t - t er m fluct uat ions I ndependent ly floating d. Cu rre ncy cross- ra t e s - - > t he cr oss r at e of MXN/ EUR:
E.g. The MXN/ USD quot e is 12.1 12.1 x 1.42 = 17.18
and t he USD/ EUR quot e is 1.42
m ust m eet t he condition of
no- arbit rage opport unit y g. Ca lcu la t e a n d in t e rpre t
a forw a rd ra t e E.g. a forward quot e of + 25.3 & t he spot
exchange rat e is 1.4158 - > forward exchange
rat e = 1.4158 + 0.00253 = 1.41833
Point s in a foreign currency quot at ion are
e . Ex p re ssion in a p oint s
in unit s of t he last digit of t he quot at ion
when a forward exchange rate does not correctly reflect ba sis or in pe rce n t a ge
the differ ence bet ween t he interest rates for two currencies E.g. A forward exchange rat e quot e of + 1 .7 87 % ,t he spot exchange rat e is
1. borr owing one curr ency, convert ing 1.4158 - > t he forward exchange rat e is 1.4158 ( 1 + 0.01787) = 1.4411
it t o t he ot her currency at t he spot rat e Percent age
2. investing the proceeds for the period, and converting the end- of- period f . Arbit ra ge opport u nit y
How t o t ake?
am ount back t o t he borrowed currency at the forward rat e
No- arbit rage relat ion ( I nt erest rat e parit y)
20. Currency Exchange Rates - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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3 3 . FSA. Applica t ion s

2 1 . FSA I n t r oduct ion
3 2 . Fin a ncia l Re por t in g Qua lit y

2 2 . Fin a ncia l r epor t in g
m e cha nics
3 1 . Long- t e r m Lia bilit ie s
2 3 . Fina ncia l Re por t in g

FI N AN CI AL St a nda r ds
3 0 . I n com e Ta x e s REPORTI N G &
AN ALYSI S
2 4 . Unde r st a n din g Th e I ncom e St a t e m e n t
2 9 . Long- live d asse t s
2 5 . Un de r st a n din g Th e Ba la n ce Sh e e t
2 8 . I n ve n t or ie s
2 6 . Unde r st a n din g Th e CF St a t e m e n t
2 7 . Fina ncia l An aly sis Te ch nique s
FINANCIAL REPORTING & ANALYSIS - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Financi al St at em ent
Elem ent Addit ional disclosures required by regulat ory
Any com m ent ary by m anagem ent
FR Financial posit ion

Useful t o a wide r ange of user s in
Role s of FR & FSA Role of FR Firm 's perform ance m aking econom ic decisions
Changes in financial posit ion
> To evaluat e past , cur rent , and prospect ive

Use i nfo in a com pany' s Fin St at em ent s per for m ance & fin posit ion
Roles of FSA Use ot her rel ev ant info > To m ake econom ic decisions
Rev enues
Ex penses
I n com e St at em ent
Gains and Losses
Asset s
Liabilit ies
Role of som e FS Balance Sheet ( A= L+ OE)
Owner s' equi t y
CFO
CFI
CF statement
CFF
St at em ent of changes in Owners' equit y
disclose t he basi s of preparat ion for FS

( e.g: account ing m et hods, assum pt ions,...)
acquisit ions or disposals
legal act ions
em ploy ee benefit plans
Addit ional it em s: cont ingencies and com m it m ent s
FS not es ( foot not es)
si gnificant cust om er s
sales t o r elat ed par t ies
segm ent s of firm
ar e audit ed
not audit ed
operat i ng incom e or sal es by region
or business segm ent s
Supplem ent ary schedules reserves for an oil and gas com pany
info about hedging act ivi t ies and
financial inst r um ent s
I m port an ce of
assessm ent of financial per form ance and condit ion of a
com pany from t he perspect ive of it s m anagem ent
2 1 . FSA
Resul t s fr om oper at ions, wit h t rends
I n t rodu ct ion in sales and ex penses
Publicly held com panies in US Capit al resources and liquidit y , wit h t rends in CF
Gener al busi ness ov er v iew
discuss account ing policies t hat require
significant j udgem ent s by m anagem ent
discuss significant effect s of t rends, event s, uncertaint ies
MD&A
liquidit y and capit al resource issues, t ransact ions
or event s wit h liquidit y im plicat ions
Discont inued operat ions, ext raordinary
it em s, unusual or infrequent event s
Ext ensive disclosures in int erim financial st at em ent s
disclosure of a segm ent 's need for CF
or it s cont ribut ion t o revenues or profit
= independent review of an ent it y's FS

obj ect ive: audit or's opinion on fairness
and reliabilit y of FS, " no m at erial errors"
I ndependent r ev iew t h ough FS prepared by m gm t and are it s responsibilit y
3 par t s Reasonable assurance of no m at erial errors ( follow generally accept ed audit ing st andards)
FS pr epared in accor dance wit h accept ed account ing pr inciples, r easonable account ing pr inciples and est im at es, consist ency
Explanat or y par agr aph: w hen a m at er ial loss i s probable but
Au dit s of FS
am ount cannot be r easonably est im at ed. Uncer t aint ies
m ay r el at e t o t he going concer n assum pt ion - - > si gnal ser i ous
St andard audit or's opinion problem s and need cl ose exam inat ion by analyst
( under US GAAP) : Opini on on int er nal cont r ols
U nq u a lif ie d opini on: audit or bel iev es st at em ent s are free from m at erial om issions and errors
3 t ypes of Opini ons Qua lif ie d opini on: if st at em ent s m ake any ex cept ions t o account ing pr inci ples - - > explain t hese ex cept ions
Ad ve r se opini on: if st at em ent s ar e not pr esent ed fair ly or ar e m at er ially nonconfor m ing w it h account ing st andar ds
I nt erim report s Quart erly or sem i- report s ( NOT audit ed)
About elect i on of boar d m em ber s, com pensat i on, m anagem ent and qualificat ions
Ot h e r in fo sou r ce s and issuance of st ock opt ions
Proxy st at em ent s Filed wit h SEC
Corporat e report s and press releases Viewed as PR or sales materials
1. Articulat e t he Purpose & Cont ext of an alysis

2. Collect dat a
3. Process dat a
FSA fr a m e w or k
4. Analyze/ int erpret dat a
5. Report t he conclusions or r e com m e nda t ions
6. Updat e t he analysis
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Operat ing act ivit y: act ivit ies t hat are part of t he day- t o- day business funct ion of an ent it y
I nvest ing act ivit y: act ivit ies associat ed w it h acquisit ion & disposal of long- t erm asset
Cla ssifica t ion
Financing act ivit y: act ivit ies r elat ed t o obt aining or r epaying capit al fr om shar eholder s or cr edit or s
Cla ssifica t ion of
Depend on t he nat ure of t he firm
busine ss a ct iv it ie s H ow t o cla ssify
Not e: The sam e classificat ion is used on t he st at em ent of cash flows
but t hey ar e defined different ly t han business act ivit ies ar e defined here
N ot ice
Asset s
Liabilit ies
Elem ent s Equit y
Revenue
FS e le m e n t s
& a ccou n t s Expense
Accoun t & fin a ncia l Cha r t of a ccount s : set for t h t he act ual account s used in a com pany's account ing syst em
Account s
st a t e m en t Cont r a a ccount : offset or deduct ed fr om ot her account s
Liabilit ies
Asset s Cont r ibut ed capit al
Accou n t in g e qu a t ion Ow ner s' equit y
Ret ained ear ning
2 2 . Fin a n cia l r e por t in g Expa n din g: A = L + Cont r ibut ed capit al + BGN Ret ained ear nings + Rev - Exp - Div idend
m e cha nics
Unear ned ( Deffer ed) r evenue
Cash m ovem ent pr ior t o Acct . r ecognit ion
Pr epaid expense
Accr u a ls & V a lua t ion
Accru a ls Unbilled ( Accr ued) r evenue ( w hen billing, Un.Rev decr ease & Receivables incr ease)
a dj u st m en t Cash m ovem ent aft er Acct . r ecognit ion
Accr ued expense
V a lu a t ion a dj u st m e n t : m ade t o com pany's A or L so t hat account r ecor ds cur r ent m ar ket value ( not Hist orical cost )
Re la t ion sh ips a m on g I S, BS: show a com pany's financial posit ion at a point in t im e
BS an d st at e m en t of CFs, Changes in BS account s during an account ing period ar e
a nd of ow ne r s' e qu it y r eflect ed in I S, st at em ent of CFs and ow ner s' equit y
1. Jour nal ent r ies & Adj ust ing ent r ies ( r ecor d= t im e)
2. Gener al ledger & T- account s ( r ecor d= or der )
Accou n t in g sy st e m Flow of in for m a t ion 3. Tr ial balance ( list account balances at a par t icular point in t im e)
4. Fin. st at em ent
D e bit & Cr e dit
Usin g fin . st at em en t Analyst uses FS t o j udge t he fin. healt h of t he com pany

in se cur it y a na lysis Analyst can use his underst anding t o det ect m isrepr esent at ion
22. Financial reporting mechanics - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Obj e ct iv e of FR: pr ovide fin. info about t he r eport ing ent it y

Ov e rv iew FRS
I m por t ance of r epor t ing st andar ds in secur it y analysis and v aluat ion
I ASB ( I nt er nat ional Account ing St andar ds Boar d)

St a n da rd- set t in g bodies
( est ablishing st andar ds) US FASB ( Financial Account ing St andar ds Boar d)
I OSCO ( int er nat ional) : not a regulat ory, but it s m em bers regulat e significant port ion
St a n da rd set t in g &
Regu lat or y bodie s FSA ( in UK)
Re gu la t or y a u t h or it ie s 1. Prot ect i nvest ors
( enfor cing st andar ds) SEC ( in USA) 2. Ensure: m arket is fair, efficient , t ransparent
3. Reduce syst em at ic risk
St at us of global conver gence of account ing st andar ds

st andard set ting bodies
c. disagree
regulat ory aut horit ies
Bar r ier s t o developing one univ er sally accept ed set of financial r eport ing st andar ds
polit ical pressures from business groups and ot hers
Under st andabilit y
Verifiabilit y
Relev ance
En h a n cin g Com par abilit y ( consist ent am ong firm s and t im e periods)
Qu alit a t ive Fait hful pr esent at ion
ch a r act e r ist ics ( com plet e, neutral, free from error) Tim eliness
Tr ade off acr oss Enhancing char act er ist ics ( reliabilit y and relevance: t im ely)
Cost
Const raint s
Non- quant ifiable info: om it t ed
of Financial posit ion: A, L, E

Measurem ent s
of per for m ance: I ncom e, Ex pense
I FRS fra m e w ork
Accr ual basis
Assum pt ions
Going concer n
Cost can be r eliable m easur ed

Recognit ion pr incipal
Pr obably fut ur e econom ic benefit will flow t o ent it y
Ele m en t s of FS
H ist or ica l cost : am ount originally paid for t he asset
Cu r r e n t cost : would have t o pay t oday for t he sam e asset
Measurem ent bases Re alizable va lu e : am ount for w hich fir m could sell t he asset
Pr e se n t valu e : discount ed fut ur e cash flows
Fa ir va lu e : 2 par t ies in an ar m 's lengt h t r ansact ion would ex change t he asset
BS, I S, CFS, OE, Ex planat or y not es ( inclu. account ing policies)

Requir ed financial st at em ent s
Fair pr esent at ion

2 3 . Fina n cia l Going concer n basis
Report ing St an dards Accr ual basis
Ge n e r a l r e quir e m e n t s Aggregat ion
for FS u n der I FRS
No offset t ing
Pr inciples for PREPARI NG
Consist ency
Mat er ialit y
Com par at ive infor m at ion
Frequency of r eport ing
I ASB requires m gm t t o consider t he

fram ew ork if no explicit st andard exist s
Pur pose of fr am ewor k
I ASB sam e obj ect ive
Obj ect ives of financial st at em ent s FASB di fferent obj ect ives for biz and non- biz
I ASB em phasizes going concern

Assum pt ions
FASB: relevance, reliabilit y
Prim ary charact erist ics
Qualit at iv e char act er ist ics I ASB: com parabi lit y, underst andabi lit y also
I FRS ( by I ASB) #
I ASB: incom e+ expenses
US GAAP ( by FASB)
Perform ance FASB: Revenues, Expenses, Gains,
Losses, com prehensive incom e
I ASB: resource from w hich fut ure

econom ic benefit is expect ed
Asset definit ion
FASB: fut ure econom ic benefit
Financial st at em ent elem ent s
I ASB: define crit eria for recognit ion
" Probable"
FASB: define asset s and liabilit ies
Values of asset s t o be I ASB: allow

adj ust ed upw ard
FASB: not allow
Tr anspar ency
Char act er ist ics of a coher ent Com prehensiveness
financial r epor t ing fr am ewor k Consist ency
Valuat ion
I FRS
Pr inciples- based
Effect iv e FR r elies on br oad fr am ewor k
FASB in t he past
Bar r ier s t o cr eat ing a coher ent St andar d set t ing Rules- based
financial r epor t ing fr am ewor k specific guidance how t o classify t r x
FASB m oving now

Obj ect ives orient ed
blend t he ot her t wo
Measurem ent
23. Financial Reporting Standards - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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D ef.: represent Financial perform ance

Expense ( ordinary)
Expenses
Loss ( I nvest, Finance)
Ove r vie w I S Elem en t s Revenues ( ordinary)

I ncom e
Gain ( I nvest, Finance)
Multi- steps ( include: Gross Profit)

For m a t s Single- st ep
Dec 15, 2016 for U.S.GAAP report ing firm s

( m ay not adopt new standards early)
To be issued in May 20 14 and go in Jan 1, 2017 for I FRS reporting firm s
effect for periods beginning aft er ( m ay adopt new standards early)
Com m on size analysis of I S: convert it em s in I S int o % of t ot al Rev
An a lysis of I S Ot h e r s
A firm should recognize revenue w hen it has
transferred to a good or service to a custom er
Consistent w ith the accrual accounting principle
Sim ple
Re v e n u e r e cogn it ion issu e s Notice: revenue recognition w ill be little changed in m any transactions such as
Com plex Capit al st ruct ure
industries often sell bundles of goods and services ( softw are and telecom m unications)
I dentify the contract( s) w ith a custom er

NI Pref ered dividend
Basic EPS= Weighted aver age number of common shares outstanding I dentify the perform ance obligations in the contract
Determ ine the transaction price
A five - st e p pr oce ss for Allocate the transaction price to the
Form ula:
r e cogn izin g r e v e n u e perform ance obligat ions in t he cont ract
Ba sic EPS
Recognize revenue w hen ( or as) the
Stock split + stock dividend entity satisfies a perform ance obligation
EPS
New issuance Affected by an agreem ent bet w een t w o or m ore part ies
Treasury stock that specifies their obligations and rights
Com m on shares Probable is defined differently I dentical activity could be accounted

Con v er ged accou n t in g
under I FRS and U.S GAAP differently by tw o different reporting firm s
Preferred shares/ convert ible st a n da r ds issue d by I ASB Collect ability m ust be probable, how ever
Com plex capital structure an d FASB in M a y 2 0 1 4 A cont r a ct
Convert ible bond
Revenue is recognized based on the firm ’s progress consistent w ith the percentage- of- com pletion
Stock option m ethod in nat ure
D ilu t e d EPS tow ard com pleting a perform ance obligation
Diluted EPS > Basic EPS = > Ant i- dilut iv e: don't calculate Diluted EPS Long- term contract
Treasury stock m ethod

Method A prom ise to deliver a distinct good or service
I f- converted m ethod ( preferred convert ible; convert ible bond)
The custom can benefit from it on its ow n com bined
w ith other resources that are readily available
A per form a nce oblig a t ion
Operating com ponents Criteria of a distinct good or service The prom ise to transfer it can be identified
E. g. for a non- financial firm s, nonoperating transactions Dist ing u ish separately from any other prom ises
m ay result from investm ent incom e & financing expenses
Nonoperating com ponents The am ount a firm expects to receive from a custom er in
2 4 . Un de rst a n din g exchange for transferring a good or service to the custom er
Com pany disposes of 1 of its com ponent & operation

Th e I n com e St a t e m e n t Usually a fixed am ount but can also be variable
A t r a nsa ct ion pr ice A variable part can only include w hen it is
Condition: separate physically & operationally 1. Discontinued operations
certain and w ill not have to reverse it
I m plication: should rem ove from I S for analyzed
Contracts w ith custom ers by category
I FRS: prohibit
Assets and liabilities related to contracts including balances and changes
Unusual in nature + infrequent in frequency 2. Extraordinary item s
US GAAP Re qu ir e d disclosur e s Outstanding perform ance obligations and the transaction prices allocated to them
Report separately on I S N on - r ecu r r in g FR t r e a t m e nt & a na lysis of Managem ent j udgm ent s used t o det erm ine t he am ount and t im ing
n on - oper at in g it em s
I FRS + US GAAP: report above I N from continuing operations of revenue recognition including any changes t o t hose j udgm ent s
3. Unusual or infrequent item s
Change in accounting principle revenue should be recognized w hen earned

Accrual accounting
Change in account ing est im at e 4. Changes in account ing st andards
Prior- period adj ust m ent 1. seller can collect the price
I ASB 2. evidence of transfer ow nership
3. cost can be reliably m easured
I nvent ories
Gen e r al pr in ciple s
Revenue recognition 1. evidence of arrangem ent btw buyer and seller
Depreciation
Mat ching principle
2. product delivered or service rendered
Deplet ion Long- lived asset s ( report expense when have Rev) SEC
3. price is det erm ined or det erm inable
Am ort ization
4. seller reasonably sure of collecting m oney
Bad debt, w arranty expenses estim ation Gen er a l
% - of- com pletion m ethod ( reliably m easures outcom e)
Period costs
Adm in cost ( not dir ectly related to Rev) Ex p e nse r e cog n it ion 1 . Long t erm cont ract s US GAAP: no incom e 'til com pleting
Com pleted- contract m ethod
I FRS: rev= exp ( profit= 0)
Doubtful accounts: est im at ed cost ( expense, not direct ly reduce Rev)
Revenue includes:
Warrant ies:
1. Sale price: at the date of sales
1. When sell: estim ated cost Re ve n ue r e cog n it ion
I FRS 2. I nterest incom e: recognise over tim e
2. When repair: actual cost I ssu e
Straight- line m ethod 2 . I nst allm ent sales
Depreciation & am ortisation I nstallm ent m ethod: recognise profit according to cash receipt in relation to selling price
Accelerated depreciat ion ( residual value is NOT used t o calculate)
US GAAP Cost recovery: no profit 'til cash receipt > cost
Sale basis:
Special case s 1. Revenue: is based on FV of a non- barter transaction w ith u n r e la t e d pa r t ie s

I FRS 2. Other cases: no revenue; net off Rev & Exp
3 . Bart er t ransact ions
( no cash changes)
1. Rev: record if a com pany has t ransaction w ith cash paym ent for such services
US GAAP 2. Ot herw ise, Rev= Carrying am ount of asset surrendered
Uses Gross Rev w hen:

1. Prim ary obligator
4 . Gross revenue report ing 2. Bear invent ory & credit risk
( vs. net revenue report ing) 3. Ability to choose supplier
US GAAP 4. Reasonable latitude to establish prices
24. Understanding The Income Statement - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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D e f: fin. posit ion at a point of t im e

Asset s
Liabilit ies
Ele m e n t s
Equit y
Ove r vie w Account form at
2 com m on form at s
Report form at Only " Cla ssified BS" is re quir ed
Form a t s of BS
Pre se n t a t ion Classified BS ( A & L ar e classified int o cur rent & non- cur rent )
Liquidit y - based ( is pr efer r ed)
Used t o assess a fir m 's liquidit y , solv ency, and abilit y t o pay div idends t o shar eholder s
Uses & lim it a t ion of BS BS asset s,liabilit ies and equit y should not be int er pr et ed as m ark et v alue or int rinsic v alue
in fin a n cia l a n a lysis
Som e asset s and liabilit ies are difficult t o quant ify and ar e not repor t ed on t he BS
Cash & cash equivalent

I nvent ories
Market value ( updat e)
1. Trading securit ies
Gain/ Loss: I ncom e st m
Market value
Cu r re n t a sse t s Market able securit ies 2. Available for sale
( can be used up w it hin 1 fiscal y ear or 1 oper at ing cy cle) Gain/ Loss: ot her com pr ehensiv e incom e
3. Held t o m at urit y No gain/ loss
Receivable ( = Tot al r eceiv able - Allow ance for bad debt )

Ot hers
Account s payable
Not e pay ables
Cur r ent por t ion of long t er m debt
Cu rren t lia bilit ie s Tax pay ables
Cla ssifyin g Asset s &
Accrued liabilit ies
Lia bilit ies
Unearned r evenue/ incom e
2 5 . Un de r st a n din g
Th e BS US GAAP: cost m odel
Measurem ent base
For operat ing act ivit ies I FRS: cost m odel / r ev aluat ion m odel
Carry ing v alue = Or iginal cost - Accum ulat ed depreciat ion - I m pairm ent
Pr oper t y , plan & equipm ent ( PPE)
US GAAP: no specific r equir em ent
Measurem ent base
For invest m ent I FRS: cost m odel / r ev alut ion m odel
N on - cur r e nt a sse t s
I nt angible asset s Goodw ill ( = Purchase - FV of net asset )
Financial asset
Long- t erm invest m ent
Long- t er m debt
Me a sur e m e n t base : Am or t ised cost
Deferred t ax liabilit ies
N on - cu rren t lia bilit ie s
Financial lease
Cont r ibut ed capit al ( Com m on share + Addit ional paid- in capit al)
Preferr ed share ( classify as Equit y or Financial Liab: based upon com pany 's charact erist ic)
Reissued: affect Addit ional paid- in capit al
Aft er r epur chasing Unlist ed: decrease Cont ribut ed capit al
Sh a r e h olde r s' e qu ity Treasury st ock
Accum ulat ed ot her com prehensive incom e

Minorit y ( non- cont rolling) int erest
Ret ained earnings
Com m on- size analy sis of BS

curr ent r at io = ( cur r ent asset s/ cur r ent liabilit ies)
Liquidit y quick r at io = ( cash + m ark et able secur it ies + r eceiv ables) / ( cur r ent liabilit ies)
cash r at io = ( cash + m ark et able secur it ies) / ( cur rent liabilit ies)
An a lysis of BS
long- t er m debt - t o- equit y = ( long- t er m debt ) / ( t ot al equit y )
BS rat ios
t ot al debt - t o- equit y = ( t ot al debt ) / ( t ot al equit y)
Solv ency
debt r at io = ( t ot al debt ) / ( t ot al asset s)
financial lev er age = ( t ot al asset s) / ( t ot al equit y )
25. Understanding The Balance Sheet - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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De f: explain cash m ovem ent s over a per iod

Ov e r vie w det er m ine w hen, how , w her e is able t o gener at e enough cash
Pu r pose how t he com pany uses cash
CFO affect Net I ncom e
CFI affect LT Assets and cert ain investm ent s

Ele m e nt s
CFF affect capit al str uctur e
I / CFO
.Cash r eceived fr om cust om er s= Rev - delt a.Receivable + delt a.Unear ned rev
.Cash paid t o su pplier = COGS + delt a.I nvent or y - del.Payable + del.Pr epaid exp
.- - - - - - - - - - - for oper at ing = Oper at ing ex p + del.Pr epaid ex p - del.Accr ued exp
.- - - - - - - - -- - - - - - int er est = I nt er est exp - del.Accr ued exp
.- - - - - - - - - - - - - - - t axex = Tax exp - del.Tax payble - del.Defer r ed t ax
Sales fr om fixed asset s
I nflow Sales pr oceed fr om debt & equ it y inv est m ent
Elem ent s & form a t
Pr incipal r eceived fr om bor r owing t o other s
I I / CFI
Pur chase new fixed asset s
For m a t Direct m et hod Out flow Acquisit ion of debt

Loans m ade t o ot her s
Cr edit or : pr incipal of debt issued

I nflow
Shar eholder : pr oceed fr om stock issued
I I I / CFF
Cr edit or : principal paid on debt
Out flow
Shar eholder : dividend; t r easur y stock
I ndirect m et hod Non- cash char ge/ incom e ( + / - )

( how CFO can be obtained from N.I )
Non- oper at ing it em s
N onca sh inve st ing, Not report ed

fina ncing a ct iv it ie s Disclosed in: foot not e or supplem ent al schedule t o CF st at em ent
I n t er est inc & Div inc: CFI ; CFO D ir e ct m e t hod: is encour age
I FRS I nt er est exp & Div paid: CFF; CFO
I FRS vs. US GAAP
2 6 . Unde r st a nding I nt erest exp & Div inc & I nt erest inc: CFO D ir e ct m e t hod: is encour age, but
r equir e r econciliat ion bt w N.I & CFO
Th e CF St a t e m e n t U S GAAP Div paid: CFF
Maj or sou r ces and uses of cash

CFO
Tot al currency am ount s CFI
An a ly se a nd int erpret
CFF
% of Revenue
Com m on- size CFs, divided by % Cash inflow/ out flow
St ockholder s
available t o
To Fir m : FCFF= I N+ NCC+ I nt * ( 1- t ) - FCI nv- WCI nv ( = CFO+ I nt * ( 1- t ) - FCI nv) Debt holder s
Fr e e cash flow
To Equit y:
FCFE= CFO-FCI nv+ Net Bor r owing
CF to r evenue = CFO/net revenue
Cash r et ur n- on- asset = CFO/ aver age t ot al asset s
Cash r et ur n- on- equit y = CFO/ aver age t ot al equ it y

Per for m ance r at ios
i. Cash- t o- incom e = CFO/Operating income
Cash flow per shar e = ( CFO-pr efer r ed dividends) / ( Weight ed aver age num ber of com m on shar es)
Debt cover age = CFO/ Tot al debt

CF r a t ios
I nt er est cover age = ( CFO+ I nt er est paid+ t axes paid) / int er est paid
Reinvest m en t r at io = CFO/ cash paid for long t erm asset s
Cover age r at ios

Debt paym en t r at io = CFO/ cash long t er m debt r epaym ent
Dividend paym ent = CFO/ dividends paid
I nv esting and financing r at io = CFO/ cash out flow s fr om investing and financing activit ies
26. Understanding The CF Statement - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Rat io analy sis

Balance sheet
Ver t ical
a. Ana lyse s I ncom e st at em ent
Com m on size
Hor izont al
Chart s: st ack ed colum n graph, l ine graph
Recei v ables T.O = annual sal es/ av er age r ecei v ables

Recei v ables m anagem ent
Day s of sal es out st anding = 365/ recei vables T.O
I nvent ory T.O = COGS/ average invent ory

I nv ent or y m anagem ent
Days of inven t or y on hand = 365/ inven t or y T.O
Pay ables T.O = pur chases/ av er age t r ade pay ables

Act iv ity Tr ade cr edit m anagem ent
( m easure efficiency ) Num ber of days of payables = 365 / payables T.O
Tot al asset T.O =

Tot al asset s m anagem ent r ev enue/ av er age t ot al asset s
Fix ed asset s m anagem ent Fix ed asset T.O = r ev enue/ av erage net fix ed asset s
Wor king capit al m anagem ent Worki ng capit al T.O = revenue/ av erage w orki ng capit al
Current rat io = current asset s/ current liabilit ies

Quick rat io = ( cash + m ark et able securit ies + receiv ables) / current liabilit ies
Liquidity
( m easur e abilit y t o pay ST obligat ions) Cash rat io= ( cash + m ark et able securit ies) / current liabilit ies
Defensiv e i nt erv al= ( cash + m ar k et able secur it ies + r eceiv ables) / av er age daily ex pendit ures
Cash conver si on cycle = days sales out st anding + days of i nvent ory on hand - num ber of days of payables
Debt - t o- equit y = D/ E
Cla sse s of r a t ios Debt - t o- capit al = D/ ( D+ E)
Use of debt financi ng
Debt - t o- asset s = D/ A
Solv ency Financial lev erage = A/ E
I nt erest cov er age = EBI T/ I nt erest pay m ent s

Abilit y t o repay debt obligat ions
Fix ed char ge cov er age= ( EBI T + lease pay m ent s) / ( int erest pay m ent s+ lease pay m ent s)
Net profit m argin= Net incom e/ Rev enue

Gr oss pr ofit m ar gin= ( Net sales - COGS) / Revenue
Operat ing profit abilit y Oper at ing pr ofit m ar gin = EBI T/ Revenue
Pret ax m ar gin= EBT/ Rev enue
Form ula 1: ROA= Net incom e/ Average t ot al asset s

Profit abilit y ROA
27. Financial Analysis Form ula 2: ROA= ( Net incom e + int exp ( 1- t ax rat e) ) / Average t ot al asset s
Techniques Operat ing ROA = EBI T / Average t ot al asset s
Profit abilit y relat iv e t o funds
ROTC ( Ret urn on Tot al Capit al) = EBI T/ Average t ot al capit al
ROE = Net incom e/ Average t ot al equi t y
Ret urn on com m on equi t y = ( Net i ncom e - preferred divi dends) / Average com m on equi t y
Ra t io a na ly sis
Valuat ion Sales per shar e, EPS, P/ CF ... ( in Equi t y st udy sect i on)
Dupont 3: Net profit m argin x Asset t urnover x FL

Du p on t a na lysis DuPont 5: Tax bur den x I nt er est bur den x Ope. pr ofit m ar gin x Asset t ur nover x FL
Under st and business & ex i st ing financial posit ion per form ance
Pu r p ose s Forecast com pany 's perfor m ance
I Nput ( CF) int o valuat ion m odel
Valuat ion rat ios
Di v i dends and Ret ent ion Rat e
Net incom e per em ploy ee
and Sales per em ploy ee for servi ce and consul t ing firm s
Gr ow t h in sam e- st ore sales for rest auran t s an d ret ai l indust ri es

I ndust r y - specific r at ios
Sales per square foot for ret ai l indust ry

1. Equit y analy sis
Coeffi ci ent s of Rev enue

vari at i on of Oper at ing incom e
Business risk
Net i ncom e
Ra t ios u se d in
Capit al adequacy
VaR
For Bank s, I nsur ance
com panies, financial firm s Reser v e r equir em ent s
Li quid asset requir em ent
Net i nt erest m argin
Ev aluat e credit risk

Pu r p ose s Credit r at i ng process ( by agency )
2. Credit analy sis Credit research on rat ios
Rat i os: i nt erest cov er age rat ios, ret urn on capit al , debt - t o- asset s, CF t o t ot al debt ...
Alt m an Z- scor e
Pu r p ose s: ev aluat e t he per form ance business segm ent s ( subsidiaries, geogr aphic segm ent s,...
3. Segm ent anal ysis Business segm ent
Geogr aphic segm ent
Using rat io analy sis

M od e l a nd f or e ca st e a r nin g s Using t echniques: sensit iv it y analy sis, scenario analy sis, sim ulat ion
27. Financial Analysis Techniques - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
lOMoARcPSD|6909307

D e f: record goods available for sale
Merchandise com pany Finished good

slow - m oving or obsolete inventory I nventory turnover that is too low
( high days of inventory on hand) Overv iew Finished good
inadequat e invent ory levels and lost sales Classificat ion
Manufacturing com pany WI P
because custom er order could not be fulfilled High inventory turnover together w ith I n ve n t or y t u r n ove r , days of in ve n t or y
Raw m at erial
low sales grow th relative to the industry on h a n d, an d gr oss pr ofit m a r gin
high inventory t urnover reflect s great er I nvent or y cost flow m et hods

efficiency rat her t han inadequat e inventory High inventory turnover together w ith high I FRS- > Low er of cost or NRV
sales grow th relative to the industry average I n v en t ory accou n t in g
I nventory valuation m ethods US GAAP - > LCM= low er of cost or m arket
ending = beginning + purchases - COGS
- > decreasing dem and and potential
future inventory w rit edow ns
The finished goods category is grow ing + raw
m aterials and goods in process are declining Purchase price ( - discount )
Transport , dist ribut ion
- > increasing fut ure dem and
and higher earnings Raw m aterials and goods
Tr adin g Tax relat ed & dut y of im port
in process are increasing
Ex am in e in ve n t ory disclosu re s
I nstallm ent cost ( include: testing)
t o det erm in e w h et h er D et erm in in g I n ve n t ory cost
- > decreasing dem and or inventory obsolescence Purchase cost ( raw m at erial)
and potential future inventory w ritedow ns I ncreases in finished goods are
Conver sion cost ( labor + over head)
greater than increases in sales
M an u fact u rin g Allocat ion of fixed cost based on norm al capacit y
- > increase storage costs, insurance prem ium s, inventory taxes
Too m uch inventory St or age cost r elated t o pr oduct ion only
1. Add the LI FO reserve to LI FO inventory Specificat ion I ndicat ion

FI FO COGS = LI FO COGS - ( ending LI FO reserve - beginning LI FO reserve) FI FO
2. Subtract the change in the LI FO Pe p e r t u a l + pe r iodic syst e m
reserve for the period from COGS To con ve rt a FS from LI FO t o FI FO 4 m e t h ods LI FO
3. Decrease cash by LI FO reserve * tax rate
Com pu t in g en din g Weighted average cost
4. I ncrease ret ained earnings ( equity) by LI FO reserve x ( 1- t ax rat e)
in ven t ory an d COGS
I FRS: only LI FO is NOT perm it t ed
When the price is changing, LI FO and FI FO m ethod shall US GAAP:
affect key ratios - > adj ust LI FO to com pare w ith FI FO Applie d 1. All are allowed
LI FO invent ory < FI FO inventory 2 . Must use t he sam e m et hod for t ax report & FR
LI FO COGS > FI FO COGS
LI FO net incom e < FI FO net incom e Exam ple w hen the price is rising NRV= est im at ed SP - est im at ed selling cost
LI FO tax < FI FO tax
. . . . . . ..
I / Carr ying value of inventory> NRV = > revaluation
is t he difference bet w een LI FO invent ory report ed 2 8 . I n ve n t or ie s 1. Decrease inventory balance to NRV: carr ying value= NRV
and inventory had the firm used the FI FO m ethod 2. Recognise a loss= cost- NRV ( writ evdown)
LI FO reserve: positive w hen A LI FO firm m ust also record in COGS ( increase COGS)
inventory costs rise and vice versa report a LI FO reserve I I / CV< NRV
I n ve n t or y re port in g I f subsequent recovery = > write up ( but only to previous value)
I FRS
Occurs w hen a firm using LI FO sells m ore
( lower of cost & NRV)
inventories during a period than its produces
Wh en price is rising -> r educe cost of goods sold becau se LI FO r e se rve , LI FO liqu idat ion an d t h eir I f:
t he lower cost of prev iously produced inv ent or y is used -> A LI FO liquidation e ffect s on fin an cia l st at em e n t s an d rat io 1. Replacem ent cost> NRV = > m arket= NRV
an u nsust ainable incr ease in gr oss pr ofit m ar gin 2 . Rep. cost < NRV - Profit m argin = > m arket = NRV - Profit m argin
US GAAP
LI FO COGS > FI FO COGS earnings ( lower of cost & m arket ) N o w r it e- u p
gross, operating, net profit m argin ( LI FO) < earnings, Profitability
gross, operating, net profit m argin ( FI FO) I nventories disclosures are usually found in the financial statem ent s footnotes
Current ratio, w orking capital ( LI FO) < The cost flow m et hod ( LI FO, FI FO, et c. ) used
current ratio, w orking capital ( FI FO) LI FO invent ory < FI FO inventory Liquidity Total carr ying value of inventor y wit h car rying value by classificat ion
( raw m at erials, wor k- in- process, and finished goods) if appr opriat e
Effects on ratios: assum e
increasing price Carrying value of invent ories report ed at fair value less selling cost s
LI FO I nvent ory t urnover ( COGS/ average inventory) > FI FO I nvent ory t urnover
Activity The cost of invent ory recognized as an expense ( COGS) dur ing t he period
LI FO days of invent ory on hand ( 365/ inventory t urnover) < FI FO days of invent ory on hand Required invent ories disclosures
Am ount of invent ory writ edowns dur ing t he period
LI FO stockholders’ equity < FI FO stockholders’ equity Presen t a t ion & Reversal of invent ory writ edowns dur ing t he period
Solvency disclosu re s of in ve n t orie s includuding a discussion of circum st ances ( I FRS only)
LI FO debt ratio and debt- to- equity ratio > FI FO debt ratio and debt- to- equity ratio
Car r ying value of inventor ies pledged as collat er al
LI FO higher I FRS dem onst rat e t hat t he change will provide reliable and m ore relevant inform at ion
COGS and inventory t urnover
FI FO low er
US. GAAP explain why t he change in cost flow m et hod is preferable
I nflat ion ( increasing prices) & st able
LI FO low er Gross profit, net incom e I nventory changes
and invent ory balances or increasing invent ory quant it ies
Exception a firm changes t o LI FO from anot her cost flow m et hod
FI FO higher
LI FO low er
COGS and inventory t urnover Com pare t o FI FO, LI FO produces higher COGS in I S and low er earnings
FI FO higher Affect of in flat ion an d deflat ion of
Profit abilit y
Deflat ion ( decreasing price) & st able in ve n t ory cost s t o FS a n d rat ios
LI FO higher Gross profit, net incom e
or increasing invent ory quant it ies Com pare t o FI FO, LI FO result s low er invent ory value on BS, low er
and invent ory balances
FI FO low er current ratio, low er w orking capital. Quick rat io is unaffect ed
Liquidit y
FI FO provides t he m ost useful m easure for ending invent ory Calcu la t ion of fin an cia l rat ios Com pare t o FI FO, LI FO results higher invent ory turnover; low er days of invent ory
LI FO provides better approxim ation of current cost ( COGS) in hand; m ore recent and higher goods of COGS; low er and older inventory
The w eight ed average cost m et hod result s Usefulness w hen t he price is changing Act ivit y
in values betw een those of LI FO and FI FO Com pare to FI FO, LI FO results low er total assets, low er
stockholders' equity, higher debt ratio and debt- to- equity ratio
Solvency
28. Inventories - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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.asset s are expect ed t o pr ovide fut u r e benefit s over 1 year

D ef: .sh ould be used in oper at ion
Ove r v ie w
I nt an gible A
Tangible A
Classify
Financial A ( inv est m ent )
Measur em ent base

Depr eciat ion/ Am or t isat ion m et hod Ca p it a liz e cost : allocate to I ncom e St m
m ain capit alized cost shou ld be pur chase cost
Revaluat ion m odel . gradually ( Depreciat ion)
ex pendit u r e t o inst all & br ing asset t o t he locat ion r eady for use
Useful life of new A D isclosur e r e la t e d t o
Wh et h er t o use A as secur it y/ collat er al long- liv ed A Ex p e n se : all ar e r ecor ded t o I ncom e St m im m ediat ely
ot her expendit u r e = > exp in I ncom e St at em ent
I m pair m ent loss
Classificat ion of A Ta ngible A ( I FRS) I nt er est incom e fr om invest ing bor r owing am ount : decr ease t ot al bor r owing cost
Reconciliat ion of Car r ying value over t h e per iod Bor r ow ing cost : incur r ed can be capit alize t o
Con st ruct ion asset t he ext end t hat it associat ed wit h t he asset I f " Asse t for SALE" : Capit alized
cost = > I nv ent or y ( NO m or e Depr eciat ion)
D ef: A hold t o ear n r ent al incom e or capit al appr eciat ion . I nt er est exp : capit alize & becom e Depr eciat ion
US GAAP : cost m odel expense over t he life of t he asset
Cost m odel Capable of being separ at ed fr om t h e fir m

I n ve st m e n t pr ope r t y
Fair value m odel or ar ise fr om a cont r act u al or legal r ight
I FRS Valuat ion Under I FRS, an ident ifiable
Con t r olled by t h e fir m
int an gible asset m ust be
Gain/ Loss: r ecor d dir ect ly t o I ncom e St m iden t ifiable
Expect ed t o pr ovide fut ur e econom ic benefit s which
May be m ust be pr obable and cost m ust be r eliably m easur able
A cont r act ual ar r angem ent wher eby t he lessor , t he owner of t he asset , allows a
lessee t o use t he asset for a specified per iod of t im e in r et u r n for per iodic paym ent s Cannot be pur chased separ at ely
I nclude: Finance ( capit al) lease or oper at ing lease A lease u niden t ifiable May have an indefinit e life
E.g: goodwill
At incept ion: n o ent r y is m ade
r ecognized in t he lessee’s incom e st at em ent ; CF st at em ent : Record value of asset at pur chase pr ice + associat ed expendit u r e
Acq uisit ion of a sse t s
lease paym ent is r epor t ed as an out flow fr om oper at ing Dur ing t he t er m of t he lease: r ent Tot al pur chase pr ice is allocat ed t o each ot her on it s fair value
act iv it ies; No asset or liabilit y is r epor t ed on t h e balan ce sh eet expense = t he lease paym ent Oper at ing lease - > an an alyst is m ore int er est ed in t he t ype of asset acquir ed
Pur chased as par t of a gr oup
Ex t er nally pur chase
Asset s r em ains on t he balance sheet of t he lessor and is depr eciat ed higher net incom e in t h e fir st y ear and
Effect Effect s of capit alizing int an gible asset s ar e t h e
Lease paym ent s ar e r ent al incom e sam e as t he effect s capit alizing ot her expendit ur es lower net incom e in t he subsequen t year s
t he lower of t he pr esent value of fut ur e m inim um lease paym ent s or fair I nt angible A Pur chase pr ice is allocat ed t o t he ident ifiable asset s
value is r ecognized as an asset an d a liabilit y on t h e lessee’s balance sheet At in cept ion an d liabilit ies of t h e acqu ir ed fir m on it s fair valu e
The acquisit ion m et hod is used t o
account for business com binat ion Rem aining am ount of t he pur chase
The leased asset is depr eciat ed over it s life; t he pr esent value of t he Le a sing pr ice is r ecor ded as goo dw ill
lease paym ent is liabilit y t h at is am or t ized over t h e t er m of t he lease. Obt ain in a business com binat ion
The int er est por t ion of t he lease paym ent and t h e depr eciat ion of t he Cost s of any int er nally gener at ed “ goodwill”
Evaluat e On ly goodwill cr eat ed in a business
asset ar e r ecorded as expenses on t h e incom e st at em ent are ex pensed in t he period incur r ed
com binat ion is capit alized on t he BS
on t he cash flow st at em ent , t he int er est por t ion of
t h e lease paym ent is an oper at ing cash out flow I nt er nally cr eat ed : expendit u r es are ex pense as incur r ed
Under U.S.GAPP
Ov er t he t er m of t he lease US GAAP: ALL ar e ex pense
Finance lease
R&D
financing or oper at ing is ok) and t h e pr incipal I FRS: R= exp, D= capit alize
por t ion is a financing cash out flow Un der I FRS
For sale:
Lessor: r em oves t he asset fr om t he BS and r eplaces it wit h a lease r eceivable; I nt er est port ion Ex cluding > All expense befor e t echn ological feasibilit y: Ex pense
> Aft er t h at : Capit alize
is int er est incom e; r em ainder is a pr incipal r epaym ent t hat decr eases t he lease receivable
Lessee: adds t he asset and t he relat ed lease liabilit y t o t he BS - > equit y is init ially un changed. R&D in soft ware developm ent I nt er nal use:
Depr eciat ion and int er est expense com pr ise t he lease ex penses r ecorded on t he I S and will exceed Effect 1 . I FRS: sim ilar
t he lease paym ent in t h e ear ly year s of t he lease and be less t han t h e lease paym ent in t h e lat er 2. US GAAP: ALL ar e capit alized
year s of t he lease - > less pr ofit for t he ear ly year s of a lease and gr eat er pr ofit in t he lat er year s
2 9 . Lon g - live d Asse t s
Depr eciat ion ex pense = ( original cost -
higher net incom e ex pensing in t h at per iod and lower net incom e St r aigh t - lin e m et h od salvage value) / depr eciat ion life
in t he subsequen t per iods com pared t o im m ediat ely expensin g Capit alizin g an ex pen dit u r e delay s
t h e r ecognit ion of an ex pense
r educe var iabilit y of n et incom e by spr eading t he expense over t he m u lt iple per iods Acceler at ed DDB depr eciat ion in year x = ( 2/ depr eciable life
depr eciat ion in year s) * book value at t h e beginning of year x
capit alizing ex pendit u r es m ay r esult in ear nings t h at ar e higher over
m any per iods com par ed t o an ot her wise ident ical ex pensing fir m N et incom e
Gr owin g fir m s Unit s- of- pr oduct ion depr eciat ion = ( or iginal
Unit s- of- pr oduct ion cost - salvage value) / ( life in out put u nit s)
Ov er t h e life of an asset , t ot al net incom e is ident ical * ( out put unit s in t he per iod)
m et hod
gr eat er t ot al asset s; higher net incom e, higher r et ained ear nings,
higher shar eholder s’ equit y in t he per iod of t he expendit ur e I FRS r equir es fir m s t o depr eciat e t he
Capit alizat ion com ponent s of an asset separ at ely - >
lower net incom e, r et ained ear nings, shar eholder s’ equit y in subsequ ent per iods
r equir e useful life for each com ponen t
Shareho lder s’ equit y Fin it e life
r et ained ear nings, shar eholder s equit y I nt angible A: am or t izat ion Com p onent d ep reciat ion U.S.GAAP allows com ponen t
M e t h od: SLM + Acceler at ed
r eflect t he ent ir e r educt ion in n et incom e Ex pense im m ediat ely depr eciat ion but seldom u ses
Alloca t ion of cost of a sset s depr eciat ion + Un it of pr oduct ion
Fixed asset : depr eciat ion
Tan gible Longer useful lives - > decrease annual depr eciat ion
A capit alized ex pendit u r e: usually r epor t ed as an out flow fr om invest ing Nat ur al r esour ce: deplet ion
- > incr ease net incom e and vice ver sa
act ivit ies - > higher oper at ing cash flow, lower invest ing cash flow
Higher salvage values - > decr ease depr eciat ion
I m m ediat ely expendit u r e: usually r epor t ed as an out flow fr om oper at ing act ivit ies
- > lower oper at ing cash flow and higher invest ing cash flow Effect s of ca pit a lizing - > incr ease net incom e and vice ver sa
a n d e x pe n sing cost s Ef f e ct of choice of
A change in an accoun t ing est im at e is put int o
No differ ence in t ax t r eat m ent - > t h e sam e t ot al cash flow in bot h ways d ep reciat ion/ am or t iz at ion effect in t he cur r ent per iod and pr ospect ively
Changes in t ax t r eat m ent t o m at ch financial r epor t ing t r eat m ent : Cash flow fr om oper at ions m et hod and assum pt ions
Est im at es: involved when a
ex pensing will cause higher oper at ing cash flow in t h e fir st y ear Tax t r eat m ent
m anufact ur ing fir m allocat es Does not affect oper at ing m ar gin
Tax t r eat m ent is independent of t h e financial r epor t ing t r eat m ent , depr eciat ion expense bet ween
t axes and t her efor e cash flow, ar e unaffect ed by t h e choice COGS and SG&A affect gr oss m ar gin ( which is
com put ed befor e SG&A ex pense)
init ially h igher asset s, higher equit y com par ed t o ex pensing and oper at ing expenses
- > lower debt - t o- equit y and debt - t o- asset s
Capit alizin g an ex pen dit u r e
init ially h igher ROA and ROE but lower ROA, ROE in t h e subsequent y ear s
US GAAP: only cost m odel
lower ROA, ROE in t h e fir st y ear and higher in t h e subsequent y ear s Apply I FRS: bot h ( wit h Rev aluat ion: Car r ying am out = FV)
higher net incom e ( nu m er at or ) , lower asset s Ex pensing an expendit ur e
and equit y ( denom inat or s) aft er t h e fir st y ear Financial r at ios Re v a lu a t ion m ode l N ot e : I f Gain> Prev ious loss
vs. Cost m ode l = > 2 par ts:
Capit alizing in t er est r esult s in lower int er est expense 1/ Gain= Pr e loss: I ncom e st m
Revalut ion m odel FV> car r ying value = > Gain
com par ed t o expensing in t he year of expendit ur e 2/ Residual: Equit y
Analyst m ay include capit alized int er est as int er est expense Higher int er est I nt er est coverage EBI T/ in t er est expense FV< car r ying value = > Loss
for an alyt ical pur poses - > r educe int er est cover age r at io cover age r at io
Ther e is even t t h at m akes A decr ease in value significant ly

Cost of sale: BV = Or iginal cost - Accum ulat ed Depr Occu r r ed if I m pair m ent of indefinit e lived int an gible asset : at least An nually
= > Gain/ Loss I m pa ir m e n t of a sse t
Sale of asset " Held for u se" = > " Held for sale" : t est for im pair m ent before r eclassify
D ispose of A: sim ilar t o sale N ot e
D e r e cogn it ion
1/ Rem ove old A given up fr om B.S ( = carr ying value)
2/ Add FV of exchange A I m pair m ent loss = Car ying value - Recover able am out ( = higher of 'FV- Cost t o sales' or 'Value in use')
= > Gain/ Loss = > Decr ease long- lived A + r ecord loss on I m pair m ent
Ex change A I FRS N ot e: Gain < or = Previous loss
Car r ying value of A > Undiscount ed expect ed CF = > im pair ed

I m pa ir m e n t pr oce ss St ep 1 : Test for r ecover abilit y - - - - - - - - - - - - - - - - - - - - - - < - - - - - - - - - - - - - - - - - - - - - - - - - - - - = > NOT im pair ed
Wr it e down t o FV ( or Discount ed v alue)

US GAAP
St ep 2 : Loss m easur em ent Loss = Car r ying value - FV
N ot e: only 'Held for sale' can r ev er se Loss ( Gain)
29. Long-lived Assets - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Tax abl e incom e
Taxes payable cur r ent t ax ex pense
I ncom e t ax paid act ual cash fl ow

TAX RETURN
= past or current l oss - - > creat e DTA
Tax loss carryforward
Tax base = net am ount of asset / l iabilit y used for t ax report ing purposes
I ncom e before t ax
Account ing pr ofit
Earni ngs before t ax
Te rm inology
I ncom e t ax ex pense = Taxes payable + change i n DTL - change in DTA
= I ncom e t ax ex pense - Taxes payable

DTL
Cause: depr eciat ion
FI NANCI AL
REPORTI NG = Tax es pay able - incom e t ax ex pense
DTA
Causes: War rant y ex penses, Tax - loss car ry for wards
Valuat ion allow ance: cont ra account t o DTA
Carry ing v alue = net balance sheet v alue of asset / liabilit y
Perm anent difference v s. Tem porar y difference
r esul t in expect ed fut ur e ca sh I n flow

from Current A: current A
D TL: liabilit y Classify
fr om Non- cur r ent A: non- cur r ent A
ex pect ed ca sh Out flow

D TL v s. D TA Liabilit y : if rev ersal of t im ing difference is cert ain
D TA: asset Classify
Equit y : - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - uncer t ain
N ot e : I ncr ease DTA: I ncom e t ax ex pense decr ease

I n crease Tax rat e = > I ncrease DTA, DTL - - - - - - - - - DTL: - - - - - - - - - - - - - - - - - - - - - - incr ease
( from all t hose years before)
bet w een t ax base and carryi ng val ue

w ill rev erse
Te m pora ry
result in DTA or DTL
3 0 . I n com e Ta x e s
bet ween t ax able incom e and pr et ax incom e
P e r m a ne nt N OT rev erse
( 'cuz I nc/ Exp not allow for t ax purposes,...) m akes effect ive t ax rat e different from st at ut ory t ax rat e
Te m por a r y vs. Good w ill: no DTA/ DTL
Pe r m a ne nt d iffe r e nce s
US GAAP : no DTA/ DTL
I n it ia l r e cor d t r a n sa ct ion A business com binat ion N o D TA/ D TL

I FRS
The difference i s NOT cert ain
N ot e
DTA: suffi ci ent t axable i ncom e in t he fut ur e
I n ve st t o su b sid ia r ie s differences w ill be r ev ersed
DTL
no parent 's cont rol
Depends on t he t ax rat e ex pect ed t o be i n force

w hen t he under ly i ng t em porar y difference r ev er ses
M e a su re m e n t of The applicable t ax m ay depend on how
d e f e r r e d t a x it e m s t he t em porar y difference w ill be set t led
The deferred t ax i t em should also be t aken direct l y t o equi t y

I ncr ease depr eciat ion in t he subsequent
peri ods but not affect t he deferred t ax l iabilit y
Re cognit ion a nd m e a sur e m e nt
of cur r e nt & de fe r r e d t a x The t ax liabilit y on t he increase in book v alue is incorporat ed
int o t he r ecogni t ion of t he incr ease in r eval uat ion sur plus.
A ch a n g e t h a t le a d s t o a d e f e rr e d I n each subsequent per iod, am ount equal t o addit ional depr eci at ion less
t a x it e m is t a k e n d ir e ct ly t o e q u it y Upw ard r eval uat ion t he t ax l iabilit y i s t ransferred from reval uat ion surplus t o ret ained earnings
The pr evi ous unr eal ized gain i n t he asset ’s v alue
is real ized over t im e t hrough use of t he asset
The addit ional t o ret ained earnings offset s aft er- t ax
decr ease in net incom e ( and r et ained ear nings)
Depreciat ion - - > DTL ( if reverse, if not - - > equit y)

I m pairm ent s - - > DTA
Re cog nit ion a nd m e a sure m e nt of Rest ruct uring - - > DTA
curre nt a nd d e fe rre d t a x it e m s LI FO, FI FO
Post - em ploym en t benefit s and deferred com pensat ion - - > DTA
Unrealized gains/ losses on available- for- sale m arket able securit ies
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D e f: obligat ions hav e t o paid for m ore t han 1 y ear

LT debt
Ove r vie w
Lease
Cla ssify
Pension fund
Coupon r at e < Requir ed r at e = > I nt er est = Coupon pm t + Bond pay ble

W it h bon dholde r s - - - - - - - - - - - - - - > - - - - - - - - - - - - - - = > - - - - - - - - = Coupon pm t - Pr incipal r epaym ent
1 . Recor d t he sam e am ount discount ( or pr em ium ) at each per iod Not e:

I FRS: required Tot al int erest exp= Tot al coupon
Ty pe s of re cording discount + / - Discount ( Pr em ium )
( or pr em ium ) 2 . Effect iv e of int er est
US GAAP : not required bu t pre fe r
I nit ia l: Pr ice = CFF ( inflow )

For discount bond
Coupon pm t = CFO
Am ort isat ion= noncash
1 / Account ing f or b ond Pe r pe r iod: I nt erest exp = CFO ( out flow )
I nt er est ex pense For prem ium bond
I n t er est = CFO
Am ort isat ion of discount = CFF
Bon d
pa ya ble Carry ing am ount = Par value
At m a t ur it y = > Rem ov e bond pm t aft er cash pm t ( recor d NO gain/ loss)
Carry ing am ount # Purchase pr ice

Be for e m a t ur it y = > Recor d gain/ loss = Carr y ing am ount - Purchase price
2 / De re cognit ion of de bt I FRS: add t o discount / deduct fr om pr em ium ( decrease Payable)

I ssuance
US GAAP : capit alize as an asset = > am or t ise ov er t he t er m
I ssuance cost
Der ecognise I FRS: sim ilar t o nor m al case ( Gain/ Loss: r epor t in I ncom e St m )
( before m at urit y)
US GAAP : im m ediat ely ex pense t he asset
D e f : agr eem ent included r est r ict ions t o pr ot ect t he cr edit or s

Re st r ict ion Affirm a t iv e: cert ain act ions t hat issuer should do t o pr ot ect .. .
3 / Bond cov e r na nt s ( if violat e: t echnical def ault )
N e ga t ive : - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - is pr ohibit ed t o do t o - - - - - - -
D e f: a gr e e m e nt be t w e e n ow ne r of a sse t & ot h e r par t ie s

Lessor ( ow ner) : w ill receive pm t over t he lease period
Pa r t ie s Lessee ( user ) : have t he right t o use t he asset over t he lease period
3 1 . Lon g- t e rm
Lia bilit ie s D e f : agr eem ent allow ing t he lessee t o use asset for a per iod as a r ent al
1 / Ope r a t ing le a se
Account ing & r e por t ing For le ssor : Rev enue is r ecor ded w hen ear ned ( Asset is k ept on B. S)
( off- balance sheet f inancing)
by 2 par t ies For le sse e : only r ecor d Oper at ing expense = Fixed lease pm t
( no Asset / Liab r ecor ded at incept ion)
D e f : equiv alent t o a purchase t hat is dir ect ly financed by t he seller ( lessor )

1. Tr ansfer of ow ner ship
2. Able t o bar gain t he purchase opt ion
US GAAP:
3. Lease t erm is at least 75% useful life of A
Cr it e r ia 4. PV of lease pm t > = 90% of FV of A
( Ju st hav e t o sat isfy 1 fact or )
1. Tr ansfer of A at t he end of cont r act
Le a se 2. Lease has an opt ion t o purchase t he asset

I FRS
3. Lease t erm is for m aj or it y par t of econom ic life
4. PV of pm t am ount t o at least in subst ain t he FV of A
Cla ssifica t ion
PV of pm t = Car ry ing am t of A
2 / Fina ncia l le a se
Recor d: Receiv able = PV of pm t
Dir ect - lease t y pe
Asset = COGS
US GAAP Receipt of lease pr incipal = I nflow CFI

For le ssor
PV of pm t > Car ry ing am t
Account ing & r e por t ing
by 2 par t ies Sales- t y pe Pr ofit = PV - Car ry ing am t
I nt erest incom e ( CFI )
I FRS: dir ect - lease t y pe
At incept ion: recor d A & L = PV of lease pm t

For lesse e Asset : is deprecit ed
Aft er t hat per iod
Lease pm t
D e f : benefit offered t o em ployee aft er ret ir ing

Defined- cont r ibut ion: firm cont r ibut es an agree- upon ( defined) am t int o t he plan
Type s Defined- benefit : f ir m pr om ises t o pay a defined benefit t o t he em ploy ee during r et ir em ent
Ser vices cost incur r ed in t he per iod

Pe n sion sch em e
I nt er est accr ued on t he BGN liabilit ies
( & ot h er post - em ploym en t ben efit )
Act ur ial gain/ loss
Pe nsion e x pe nse
Changes in t er m s of t he pension plan ( assum pt ion)
Expect ed r et ur n on plan A
Re por t : Net pension A = > Gain: Ot her com prehensive incom e
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Revenue grow t h out of line w ith com parable firm s, changes in revenue
recognit ion m ethods or lack of t ransparency about revenue recognit ion
Decreases over t im e in t urnover rat ios ( receivables, invent ory, t ot al asset ) refers to characteristics of a firm 's financial statem ents
Bill- and- hold, barter, or related party- transactions prim ary criterion adherence to GAAP but not
for j udging necessarily result in highest qualit y
Net incom e not supported by operating cash flow s
Capitalization decisions, depreciation m ethods, useful Accou n t in g w arn in g sign s
useful to users in m aking decisions
lives, salvage values out of line w ith com parable firm s relevance
Fourt h- quart er earnings pat terns not caused by seasonalit y Financial report ing quality m aterial
Frequent appearance of nonrecurring item s High quality decision useful com plet eness
Em phasis on non- GAAP m easures, m inim al faithful presentation neutralit y
inform ation and disclosure in financial report s
absence of errors
shipping term s ( FOB shipping point versus FOB destination) ,

D istin gu ish bet w e en proport ion of report ed earnings
accelerating shipm ents ( channel stuffing) Quality of reported expect ed t o cont inue in t he fut ure
Revenue recognition choices E.g: higher profit s from increased
earnings ( not of
bill- and- hold transactions efficiency or increasing m ark et share
earnings report s)
sustainability
Estim ates of reserves for un- collectible accounts or w arranty expenses Possible accou n t in g m e t h ods im pact on the value of the firm s
Valuation allow ances on deferred tax assets t o m an a ge earn in gs, cash level of a firm 's earnings high fina ncia l r e por t ing
Depreciat ion m et hods, est im at es of useful lives and salvage values, recognition of im pairm ent s flow an d balan ce sh e e t it em s qua lit y ca nnot a ssur e hig h
to sustain the com pany's qua lit y of rep ort e d ea rn ing s
I nventory cost flow m ethods operations and existence over tim e
Quality of reported result
Capitalization of expenses m ust b e h igh to provide an adequate return to
Related- party transactions e nough the com pany's investors.
Cash flow s
Display the m ost com parable GAAP
m easure w ith equal prom inence Balance sheet item s
Provide an explanat ion by m anagem ent

Reconcile t he differences 1. Reporting is com pliant w ith GAAP and decision useful; earnings are sustainable and adequate
Non- US. GAAP are required to
Presenting non- GAAP 2. Reporting is com pliant w ith GAAP and decision useful; earnings quality is low
Disclosure other purposes
m easures such as earnings
Pre se n t at ion ch oice s m a y 3. Reporting is com pliant w ith GAAP; earnings quality is low and reporting choices and estim ates are biased
I nclude any non- GAAP m easure, Spe ct ru m for asse ssin g
that exclude certain in flu e n ce an a n a lyst 's opin ion
item are likely to recur in the future 3 2 . Fina ncia l Re por ting ( from best t o w orst ) 4. Report ing is com pliant w ith GAAP; t he am ount of earnings is act ively m anaged t o increase, decrease or sm oot h report ed earnings
nonrecurring it em s
Define and explain the relevance
Qua lit y 5. Report ing is not com pliant w ith GAAP alt hough t he num bers present ed are based on t he com pany's act ual econom ic act ivities
of such non- I FRS m easures 6. Report ing is not com pliant and includes num bers t hat are essentially fict it ious or fraudulent
Non- I FRS
Reconcile t he differences
t end t o decrease report ed
earnings and financial position
( on BS) for the current period tend to increase future period earnings
A registration process for the issuance Conservat ive account ing
of new publicly traded securit ies
Specific disclosure and report ing requirem ents including Dist inguish bet w een t end t o increase report ed earnings
periodic financial st at em ents and accom panying not es Biased accou n t in g ch oice s or im prove financial position for
t he current period tend to decrease future period earnings
An independent audit of financial reports Aggressive accounting
A st at em ent of financial condition ( or m anagem ent require
com m ent ary) m ade by m anagem ent Conservat ive bias w hen earnings are above t arget
used by som e m anagers to
A signed st atem ent by t he person responsible art ificially sm ooth earnings Aggressive bias w hen earnings are below t arget
for the preparations of the financial reports
A review process for new ly regist ered securit ies Securit ies regulations typically Pressure to m eet or exceed earnings targets
and periodic review aft er registration
Career considerat ions
fines
Mot ives t o issu e low
Me ch a n ism s & t h e ir I ncreasing com pensations
qu alit y fin a n cial re port s
suspension of participation in an pot e n t ial lim it at ion s I m proving perceptions of the firm s am ong cust om ers and suppliers
issuance and trading of securities Meet ing t he t erm s of debt covenant s
public disclosure of the results enforcem ent actions
of disciplinary proceedings
Motivation Listed above
pursue crim inal prosecution of
fraudulent or otherw ise illegal activities Weak int ernal cont rol
"clean" audit opinion only offers reasonable assurance ( free from Con du cive con dit ion s t o issu e low I nadequate oversight by board of directors
m at erial errors) , does not guarant ee t he absence of error or fraud Three fact ors Opport unit y
qu alit y or frau du le n t fin a n cial re port s Wide ranges of acceptable
An assessm ent of t he effect iveness of t he firm 's int ernal cont rol
account ing t reat m ents
by m anagem ent is required t o add for securit ies t rade in t he U.S
Audit ing Rationalization of the behavior
The firm s select and pay t heir audit ors m ay
lim it t he effect iveness of t his m echanism
Private contracts such as those w ith lenders
32. Financial Reporting Quality - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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use financial rat ios t o eval uat e t rends,

levels or how t he com pany has perform ed
Evaluat ing
a . Pa st fin a ncia l perform a nce Trends & com parison t o com pet it ors can
of a com pan y indicate com pany's business strat egy
E. g: A firm claim s im proving EPS by cut t ing cost
Reflect ing com pany's st r at egy - > exam ine operat ing rat ios & gross m argins over t im e t o
know if it is im plem ent ing t he st rat egy or suffered from sales
forecast GDP Grow t h

Si m ple m odel: m easure
Short er horizons: t op- dow n approach of profit abilit y
for ecast sales gr owt h Hist orical relat ionship Com plex m odel: use
b. Foreca st a com pa ny ' s assum pt ion for it em s
fu t u r e n et in com e a n d CF increases in working capit al and fi xed asset s necessary t o support t he forecast sal es grow t h
Make assum pt ions of fut ure sources & uses of cash Typical: noncash w orking capit al rem ains const ant
for ecast CF The m ost im port ant of t hese w ill be increases in w orking capit al, capit al expendit ures on
new fixed assets, issuance or repaym ent s of debt , and issuance or repurchase of st ock
t he firm m anagem ent 's professional reput at ion

Charact er and t he firm 's hist ory of debt repaym ent .
Collat eral The abilit y t o pledge specific collat eral reduces lender risk.
Thr ee C's
t he capacit y t o repay, t hat requi res close exam i nat ion
Capacit y of a firm 's financial st at em ent s and rat ios
La r ger com panies a nd t h ose w it h a w ider var iet y o f prod uct

c. FSA in a sse ssin g cre dit Scale and diversificat ion lines a nd gr eat er geogr aphi c diversi ficat ion are be t t er c r edit r isk s.
qu alit y for D EBT in ve st m e n t
Such it em s as operat ing ROA, operat ing
Operat ional efficiency m argins, and EBI TDA m argins
Credit r at ing agencies St abi lit y of t he relevant profit abi lit y m argi ns
use for m ulas t hat include indi cat es a higher probabilit y of repaym ent
Margi n st abilit y
Highly v ariable operat ing resu lt s m ak e lender s ner v ous.
Firm s w it h great er earnings in relat ion t o t heir debt and in

Leverage relat ion t o t heir int erest expense are bet t er credit risks.
By using m axim um or m inim um values of one or m any rat ios

Which r at ios? How m any r at ios? What m inim um or m axim um v alues? - > challenge t o analy st
3 3 . FSA:
d. FSA in scre e n in g for No guarant ee t hat out perform ed in
Ap plica t ions t he past cont inues
EQUI TY in ve st m e n t s
Backt est ing r efer s t o using a specific set of cr it er ia t o scr een hist or ical dat a Pay special at t ent ion t o t he pot ent ial
effect s of survivorship bias, dat a- m ining
t o det er m ine how por t folios based on t hose cr it er ia w ould hav e per for m ed.
bi as, and l ook- ahead bi as
Different com panies m ay use

different account ing m et hods
Why?
can use disclosures t o adj ust net incom e and assets of one firm to
w hat t hey w ould have been had t heir classificat ions been t he sam e.
I nvest m ent in securit ies
I FRS & U.S. GAAP
LI FO ending invent ory can be adj ust ed t o

a FI FO basis by adding t he LI FO reserve.
I nvent ory account ing differences LI FO cost of goods sold can be adj ust ed t o a FI FO
basis by subt ract ing t he change in t he LI FO reserve
can use qual it at ive i nform at ion in

Differences in depreciat ion m et hods & est im at es addit ion t o disclosures
When calculat ing solvency rat ios, analyst s should est i m at e t he present
Off- balance- sheet financing value of operat ing lease obligat ions and add it t o t he firm 's liabilit ies.
Tangible assets of acquired unit s

will be recorded at fair value
e . Adj u st m e n t s for com par in g I dent ifiable int angible assets
diffe re n t com pan ie s of t he acquired unit s will be
grow t hrough acquisit ion valued at t heir acquisit ion cost
Adj ust m ent s Goodwill, t he excess of acquisit ion price
over the fair value of acquired net assets,
The di fferences bet w een 2 firm s
will be shown on the balance sheet
Tangible assets will be

Goodw ill recorded at hist orical cost net
grow ing by creat ing of accum ulat ed depreciat ion
each business unit s I dent ifiable int angible assets
are not included in BS assets
goodw ill is subt ract ed from asset s w hen calcul at ing financial rat ios
Adj ust m ent s incom e st at em ent expense from im pairm ent of goodw ill in t he
current period should be reversed, increasing report ed net incom e.
can rem ove goodw ill t o calcul at e Pri ce t o Book value of equit y per share
I nt angible asset s m ay be revalue upw ard under

I FRS but not perm it t ed under U.S. GAAP
Ot her rat io: price t o t an gible book va lu e
Ot her int angible asset s
Not ice: a firm 's p r e- and post - acquisit ion financial st a t em ent s
m ay lack com par abilit y w hen t h e acquis it ion m et hod is used
33. FSA. Applications - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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3 9 . W ORKI N G CAPI TAL 3 4 . CORPORATE GOVERN AN CE

M AN AGEM EN T AN D ESG: AN I N TROD UCTI ON
3 8 . D I VI D EN D S AN D SH ARE
CORPORATE
FI N AN CE 3 5 . CAPI TAL BUD GETI N G
REPURCH ASES: BASI CS
3 7 . M EASURES OF LEV ERAGE 3 6 . COST OF CAPI TAL
CORPORATE FINANCE - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Ex. mining and oil product ion sect ors:

Cert ain companies and cert ain sect ors
not adhere t o high st andards of hum an right s
are excluded from port folios
Negat ive scr eening
No specific sect ors are excluded but invest ors at t em pt t o ident ify t he companies wit h t he best pract ices
across environm ent al sust ainabilit y, employee right s and safet y, and overall governance pract ices H ow Enviro nm ent a l, Socia l, a nd Gover na nce
Posit ive screening Fact or s m ay be used in I nv est m ent Analy sis
Refers t o invest ing in order t o promot e specific social or environm ent al goals
I m p a ct inve st in g
Refers t o invest ing based on a single goal, such as t he developm ent of alt ernat ive energy sources or clean wat er resources
The m a t ic in v est in g
The use of environm ent al, social, and governance fact ors in m aking invest m ent decisions
May include harm or pot ent ial harm t o t he environm ent , risk of loss due co environm ent al
Envir onm ent al and Social Consider at ions
accident s, t he changing dem ographics of t he workforce, and changing worker preferences ESG in t egr a tion o r ESG inv e st in g
in I nv est m ent Analy sis
is also t erm ed as su st ainable in ve s t in g or r e spon sible inv est in g or socially responsible invest ing
is t he syst em of int ernal cont rols and procedures by which individual companies are m anaged
t he arrangem ent of checks, balances, and incent ives t o minim ize and
m anage t he conf lict ing int erest s bet ween insiders and ext ernal shareowners
Vot ing cont rol is t ypically proport ional t o share ownership provides a fram ework chat defines t he right s, roles and
responsibilit ies of various groups wit hin an organizat ion
one class of shares m ay be ent it led t o several vot es per share,
while anot her class of shares is ent it led t o one vot e per share t he primary focus is t he int erest s m axim izat ion of t he m arket value of t he firm 's comm on equit y
is oft en used t o ensure t hat founding shareholders ( and Dual class st ruct ure D escr ibe Cor po r at e Gover nance of t he f irm 's shareholders prim arily concerned wit h t he conflict of int erest bet ween
Com pany ow nership and vot ing st ruct ure
t heir heirs) can m aint ain cont rol of t he board of direct ors Und er sh are h ol de r t heory t he firm 's m anagers and it s owners ( shareholders)
The int erest s of t he owners of shares wit h m ult iple voces will
cake precedence over t he int erest s of shareholders in general These groups i nclude shareholders, employees,
considers confli ct s am ong t he several groups t hat have
suppliers, and cust om ers, am ong ot hers
Ar e execu t i ve, n on - exec ut ive, o r ind e p end e nt di r ectors an int erest in t he act ivit ies and perform ance of t he firm
Under st akeholder t heory
Are involved in relat ed-part y t ransact ions wit h t he company lm port ant considerat ions
Are involved in relat ed-part y t ransact ions wit h t he company are whet her direct ors:
have a residual int erest t o t he net asset s of t he corporat i on af t er all li abil it ies have been set t led
Have served for m any years and m ay have become
t oo close t o t he com pany's m anagem ent Com po sit i on of a com pany 's board Shar e hold er s have vot ing right s for t he el ect ion of t he board of direct ors and for ot her im port ant corporat e m at t ers
An analyst m ust decide if t he board is responsive t o shareholder int erest s or has conflict s of int erest , and if t he board hav e an int e r est in th e on g oin g profit abi lit y and gr owt h of t h e firm
has t he m ix of expert ise t hat is needed t o deal wit h challenges and pursue t he best st rat egy for t he company
prot ect t he int e r est s of sh are h ol de r s;
The rem unerat ion plan seem s t o offer great er incent ives, paid in cash, t o achieve short - t erm perform ance
Fact or s Relev ant t o t he Analy sis of Cor por at e
hi r e, fir e, and set t h e com p e nsat ion of t h e firm 's senior m a nage r s
goals t c t he expense of building long- t erm com pany value t hrough equit y- based incent ives Gover nance and St ak eholder M anagem ent has a responsibilit y t o
set t he st rat egic direct ion of t he firm
Perform ance- based incent ive pay is fairly st able over t im e, indicat ing t hat t he perform ance t arget s are possibly easy t o achieve
Analyses m ay be concerned if Mana ge m ent incen t ive s m onit or financial perform ance and ot her aspect s of t he firm 's ongoing act ivit ies
Managem ent rem unerat ion is very high relat ive t o chat of comparable companies in t he indust ry a nd r e m u ner at ion th e fir m ' s execut iv es ( m o st - seni o r m a n ager s) oft en ser v e on t he b oar d o f dir ect or
Management incent ives are not aligned wit h current com pany st rat egy and obj ect ives The board of direct ors
bot h company execut ives and non- execut ive board
m em bers serve on a single board of direct ors
one-t ier board st ruct ure
I f a si gnificant port ion of a company's out st anding shares are held by an affiliat ed company or inst it ut ion,
t hose shareholders m ay be able t o exert enough influence t o dict at e t he company's policies and direct ion
non- execut ive board m em bers serve on a supervisory board t hat
Act ivist shareholders and invest ors buying shares t o profit from t heir act ivism can cause changes in t he composi t ion Co m p osi t ion o f shareh o ld ers oversees a m anagem ent board, made up of company execut ives
t wo- t ier board st ruct ure
of a firm 's shareholders, it s board m em bership, and it s corporat e st rat egy in a relat ively short period of t im e St akeh olde r Gr ou ps
and t heir I nt er est Pr im ary st akeholder s
I f t he right s of shareholders are weak, perceived increases in shareholder ret urns from being acquired t ypically receive compensat ion ( rem unerat ion) m ade up of a sal ary, a bonus
or from significant changes in corporat e st rat egy m ay be difficult or im possible t o realize based on some m easure of company perform ance, and perquisit es
Relat ive st r en gt h of sha r eh old er s' r ig ht s
Their int erest s can be expect ed t o include cont i nued em ploym ent
A failure t o manage st akeholder issues well or m anage ot her long- t erm risks t o t he company's sust ainabilit y Se ni or m a n agers and m axim izing t he coral value of t heir compensat ion
can have disast rous consequences for shareholders and ot hers wit h int erest s t ied t o company result s Execut ive bonuses are t ypically t ied t o som e m easure of f irm perf orm ance,
Man age m en t o f lo ng- t erm r isk s giving senior m anagers a st rong int erest in t he financial success of t he firm
h av e a n int e r est in th e su st a in ab ilit y

som e st ak e ho ld e r s can gain an adv a nt ag e The cont rol funct ions of audit s and a nd s uccess of t h e firm rat e of pay, opport unit ies for career advancem ent , t raining, and working condit ions.
board oversight m ay be weak Em p l oy ees
ne g at iv e im plica t io ns for c om p a ny p e rform a n ce and v a lu e.
Credit or s Their int erest s are prot ect ed t o varying degrees by covenant s in t heir debt agreem ent s wit h t he f irm
m ay have incent ive com pensat ion t hat causes m anagem ent
May choose lower t han- opt im al
t o pursue t heir own benefit rat her t han t he company's benefit
risk, reducing com pany value
Ris ks of poor go ve rnan ce a nd have an int erest preserving an ongoing relat ionship wit h t he firm , in t he profit abilit y of t heir t rade wit h t he firm ,
st akeholder lawsuit s st ak e hold e r m ana ge m ent Supp lier s and in t he growt h and ongoing st abilit y of t he firm , in t he firm 's solvency and ongoing financial st rengt h
Pot ent ial Risks of Poor Cor porat e Gov er nance
failure co com ply wit h governm ent al regulat ions Legal and reput at ional risks and St ak eholder M anagem en t and Benefit s
d ebt d efault an d b an krup t cy fr om Effect ive One
arises because an agent is hired t o act in t he int erest of t he principal,
I m pr ov e o pe r a t ional effi cie n cy 3 4 . CORPORATE GOVERN AN CE but an agent 's int erest s m ay not coincide exact ly wich t hose of t he principal
Th e pr incipal- age nt conflict
Avoid m any legal and regulat ory risks
AN D ESG: AN I N TROD UCTI ON
Reducing t he cost of debt financing Be n efit s of effect ive go v e rn ance t he risk of managers and direct ors is more dependent of firm
Redu ce t he ri s k o f d e bt de faul t or b a nkrupt cy and s take h old e r m an age m en t performance while shareholders hold diversified port folios of
Managers and direct ors m ay choose a l ower
level of business risk t han shareholders would st ocks and ar e not dependent on t he fir m for employment
Bet t er financial perform ance and great er company value
W hen direct ors who are also managers favor m anagem ent int erest s at t he expense of
Conf lict s of int erest bet w een shareholders shareholders or when direct ors favor one group of shareholders at t he expense of anot her
Com m unicacion and engagem enr wit h shareholders
and managers or direct ors
initi at in g sh a r eh o ld er law s uit s decreases t he abilit y of shareholders or non- execut ive direct ors t o monit or and
I nform at ion a s ym m et r y b et w een
evaluat e whet her m anagers are act ing in t he best int erest s of shareholders
sh a r eh o ld er s and m a nage r s
seeking represent at ion on t he board of direct ors pr essu re co m p anies for change Pr incipal- a gent and ot her Relat ions h ip s
proposi ng shareholder resolut ions for a vot e and raising t heir issues t o all shareholders or t he public t o gain wider support & Conflict s in C or po r at e Gover nance A single shareholder or group of shareholders
Act i v i st sh are h ol ders Maj orit y shareholders may cause t he company t o en t er int o relat ed part y t ransact ions, agreement s or specific
Proxy fight m ay hold a maj orit y of t he vot es and act against
t he int erest s of t he m inorit y shareholders t r ansact ions t hat benefit ent it ies in which t hey have a financial int er est , t o t he det r iment of minor it y shar eholder s
Tender off er M ar ket an d N on- m ar ket Fact o r s Confl ict s bet w een groups
Threat of host ile t akeover and exist ence of ant i- t akeover provisions of sharehold e rs
Shareholders' and credit ors' int erest s are considered t o be Sh ar e hold e r s m a y pr efe r m or e bu sin ess ris k t han c r edit or s do
j ud ges ' r u lings b eco m e l aw in so m e in st a nces. bet t er prot ect ed in count ries wit h a com m on- law syst em Conf lict s of int erest bet w een Equit y owners could also act against t he int erest s of credit ors by issuing new debt t hat increases t he default risk faced by
Com pany's legal environm ent credit ors and shareholders exist ing debt holders, or by t he com pany paying great er dividends t o equit y holders, t hereby increasing credit ors' risk of default
I n a civil law syst em , j udges are bound t o rule based only on specifically enact ed laws
Growt h of firm s t hat advise funds on proxy vot ing and rat e companies' corporat e governance The company m ay raise prices or reduce produce qualit y in order t o increase profit s t o t he det rim ent of cust omers
Conflict s of inte rest bet w een
shareholders and ot her st akeholders The company m ay em ploy st rat egies t hat significant ly reduce t he t axes t hey pay t o t he governm ent
A single board of direct ors including int ernal (execut ive direct ors) and ext ernal direct ors ( non- execut ive direct ors or independent direct ors)
I n a on e- t ie r b oard
The chairm an is somet im es t he company CEO
refers t o t he m anagem ent of company relat ions wit h st akeholders and is based on having a good
There is a supervisory board t hat t ypically excludes execut ive direct ors underst anding of st akeholder int erest s and m aint aining effect ive comm unicat ion wit h st akeholders
The l egal in fra st ru c tu r e ident ifies t he laws relevant t o and t he legal recourse of st akeholders when t heir right s are violat ed
The supervisory board and t he m anagem ent board ( m ade up of execut ive direccors) operat e independent ly I n a t wo - t ier b oard
The m anagem enr board is t ypically led by t he company's CEO Boa r d st r u c tur e
refers co t he cont ract s bet ween t he company and it s st akeholders t hat spell
W hen a lead independent direct or is appoint ed, he has t he abilit y t o call m eet ings of t he independent direct ors, separat e from m eet ings of che full board out t he right s and responsibilit ies of t he company and t he st akeholders
Th e c on t r act ua l infra s tru ct ur e
is based on four t ypes
Elect ions for som e board St a ke h o lde r m a na g em e n t
= > lim it s t he abilit y of shareholders t o replace board m em bers in any one year of infrast ruct ure
posi t ions are held each year refers t o a company's corporat e governance procedures, includingt it s int ernal
St aggered board
The o r gani zat io n al in frast ru ct ur e syst ems and pract ices chat address how it m anages it s st akeholder relat ionships
Select ing senior m anagem ent , set t ing t heir com pensat ion and bonus st ruct ure, evaluat ing t heir perform ance, and replacing t hem as needed
Govern m en t al infra st r uc t ur e comprises t he regulat ions t o which companies are subj ect
Set t ing t he st rat egic direct ion for t he company and m aking sure t hat m anagem ent im plem ent s t he st rat egy approved by t he board
Approving capit al st ruct ure changes, significant acquisit ions, and large invest m ent expendit ures St ak eholder M anagem ent , M echanism s There are st andard pract ices wit h respect t o t he company's relat ionship wit h shareholders
Rev i ewing co m pa n y p erfor m a n ce and i m p lem ent in g an y n ecessar y co r rect ive st eps t o M anage St akeholder Relat ionships is oft en held of t he end of a fiscal year
Boa r d r e s pon si bili t ie s and M it igat e Associa t ed Risks
Planning for cont inuit y of managem ent and t he succession of t he CEO and ot her senior m anagers provides shareholders wit h t he audit ed financial st at em ent s for t he year, addresses t he company's
Est ablishing, monit oring, and overseei ng t he firm 's int ernal cont rols and risk m anagem ent syst em Annual general m ee t ing perform ance and significant act ions over t he period, and answers shareholder quest ions
A shareholder who does not at t end t he annual general m eet ing can vot e her shares by proxy
Ensuring t he qualit y of t he firm 's financial report ing and int ernal audit , as well as oversight of t he ext ernal audit ors
r equir e a sup e rm aj o r it y vo t e for p assage
Report t o t he board, ret ains t he overall responsibilit y for t he various board funct ions
Funct ions and Responsibilit ies of a Com pany ' s Spe cia l r e solut ions or e x tr a or dina r y ge ne r a l m e e t ings can be called anyt im e
Ov er sight of t he financial r epor t ing function and im plem ent at ion of account ing policies
Boar d of D ir e ct or and it s Com m it t ees t he candidat e wit h t he m ost vot es for each single board posit ion is elect ed
Effect iveness of t he company's int ernal cont rols and t he int ernal audit funct ion
Au di t co m m i t te e M a jor it y vot ing
Recom m ending an ext ernal audit or and it s com pensat ion
shareholders can cast all t heir vot es ( shares t im es num ber of board posi t ion elect ions) for a single board candidat e or divide t hem am ong board candidat es
Propo sin g r e m e di es b ased o n t he ir r ev iew o f inte rn al a nd ex t e rn a l audit s
Cum u la tive vo t i n g result in great er m inorit y shareholder represent at ion on t he board compared t o maj orit y vot ing
Ov er s ight of t he com p a n y's corp orat e g ov e rn a n ce cod e
Minorit y shareholders m ay have special right s by law when t he company is acquired by anot her company
I mplem ent ing t he company's code of et hics and policies regarding conflict s of int erest
Governance comm it t ee
Monit oring changes in relevant laws and regulat ions
Ensuring t hat t he com pany is in com pliance wit h all applicable laws and regulat ions, as well as wit h t he com pany's governance policies
Proposi ng qualified candidat es for elect ion t o t he board Bo a r d c om m it t e e s

Man a ging t h e sear ch pro cess Nom inat ions c om m it t ee
At t em pt ing t o align t he board's com posit ion wit h t he com pany's corporat e governance policies
Reco m m e nding t o t he bo a rd t h e a m ount s a nd t y p es of com p e nsat io n t o be pa id t o direct o r s and senior m a n ager s Compen sat ion com m i t t ee
or rem u nerat ion com m it t ee
Oversight of em ployee benefit plans and evaluat ion of senior m anagers
I nform ing t he board about appropriat e risk policy and risk t olerance of t he organizat ion
Ris k com m it t e e
Overseei ng t he ent erprise- wide risk m anagem ent processes of t he organizat ion
Reviewing and report ing t o t he board on management proposals for large acquisit ions or proj ect s, sale or ot her disposal
of company asset s or segment s, and t he performance of acquired asset s and ot her large capit al ex pendit ures I nvest m e nt com m i t t ee
34. CORPORATE GOVERNANCE AND ESG. AN INTRODUCTION - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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St ep 1: I dea gener at ion

St ep 2: Analyzing proj ect proposal
Capit al budget ing process St ep 3: Creat e firm - w ide capit al budget
St ep 4: Monit oring decisions and conduct ing a post audit
Maint ain business ( no need det ailed analysis)

Replacem ent
a. Cost reduct ion ( need det ails)
Expansion ( com plex)
New product / m arket developm ent ( com plex)
Pr oj ect Cat egor ies
Mandat ory ( r equired by Gov,...)
pet proj ect
Ot her ( not easily analyzed)
high risk ( R&D)
# account ing incom e

sunk cost - - > exclude
Base on incr em ent al CF ext ernalit ies ( - ) : Cannibalizat ion - - > include !
Ba sic p rincip les Convent ional CF vs. Unconvent ional CF

Oppor t unit y cost ( CF a firm 'll lose if undert ake t he pr oj ect ) - - > include !
Tim ing of CF is im por t ant ( ealier is wor t h m ore t han lat er)
Aft er - t ax basis ( CF t hat firm can k eep)
Financing cost s - - > exclude ! ( r eflect ed = discount rat e)
I ndependent : unrelat ed & can accept all

I ndependent vs. Mut ually exclusive proj ect s M.E: only 1 in a set can be accept ed
I nt e r a ct ions Proj ect sequencing
Unlim it ed: firm can undert ake all
Unlim it ed funds vs. Capit al Rat ioning C.R: firm has const raint budget
3 5 . Capit al
Bu dge t in g NPV
I RR
Pay back period ( num ber of y ear s t o r ecov er init ial cost )
M e t hods
Discount ed payback period ( lik e Payback , but uses t he present values)
Pr ofit abilit y I ndex = ( PV of fut ure CF) : ( CFo)
Average account ing r at e of ret urn = ( Ave. I N) : ( Ave. BV)
Con flict in g r a n k in g s: N PV is pr e fe r r e d
Advant age Direct ly m easures t he expect ed increase in value
N PV pr ofile a n d com pa r e NPV Disadvant age Not consider size of proj ect
N PV & I RR m e t h ods
Advant age Measure profit abilit y = %
I RR May have m ult iple I RR or not

Disadvant age
May differ fr NPV in Mut ual exclusive proj ect s
Eur ope: PP m or e t han I RR and NPV

Locat ion
# FAQs
Larger: NPV, I RR
Com pany Size
W hich m e t hods a r e
popula r ? Privat e: PP
Public vs Privat e Public: NPV, I RR
Mor e educat ed - > NPV, I RR

Managem ent educat ion
Re la t ionship bet w ee n N PV , A posit iv e NPV pr oj ect - > increase st ock price

com pa n y va lu e a n d st ock pr ice
35. Capital Budgeting - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Target capit al st ruct ure ( MV)
u se for proj e ct s h a v e sa m e Weight s use Current capit al st ruct ure + Trend

I f lack inform at ion
r isk s a s firm or I ndust ry average
YTM approach ( # coupon)

Cost of fixed- rat e debt ( Rd)
Debt rat ing approach
W ACC = W d* Rd* ( 1 - t ) + W e * Re + W p * Rp
CAPM: Re = Rf + Bet a* ( Rm - Rf)
W ACC
Cost of equit y ( Re) Dividend Discount Model: Re = Do* ( 1+ g) / Po + g
Bond yield + risk prem ium : Re = Bond yield + Risk prem ium
Cost of prefer red st ock s: Rp = Dp/ P
if inform at ion on t arget capit al st ruct ure is not available,

use t he current capit al st ruct ure based on m arket value
or t he average capit al st ruct ure in t he firm 's indust ry
Should be calculat ed based on a firm 's t arget capit al st ruct ure weight s
3 6 . Cost D/ E: fr. com parable com pany

Of Ca p it a l St ep 1: unlever
Be t a A = Be t a E * [ 1 / { 1 + ( 1 - t ) .D/ E} ]
Pure- play m ethod

D/ E: fr. t his com pany
Pr oj e ct be t a St ep 2: re- lever
Be t a Pro. = Be t a A * [ 1 + ( 1 - t ) .D/ E]
I n developing m arket : Re = Rf + Bet a.[ ( Rm - Rf) + CRP]
CRP = Sove r e ign yie ld spr e a d * ( St dde v e qu it y in de x / St dde v bon d in de x )
Br e a k poin t : occu r w h e n 1 of W ACC's com pon e n t s ch a n ge s

M CC sche dule : show s t he
M a r gina l Cost of Ca p it a l W ACC for diffe re nt
a m ount s of fina ncing Break point = Am ount of capit al at w hich t he com ponent 's cost changes / Weight of t he com ponent in t he capit al st ruct ur es
Cor rect : ( - ) fr. NPV

FC: fee charged when r aises ex t ernal equit y
Flot a t ion cost I ncorrect : ( + ) direct ly t o Ke
( not ongoing expense)
36. Cost Of Capital - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Sa le s r isk : about firm 's sales ( Q & P)

Bu sin e ss risk : risks associat ed Ope r a t in g r isk risk about operat ing
Le ve r a ge : am ount of wit h a firm 's operat ing ear nings earnings caused by fixed operat ing cost
fixed cost a fir m has
Fin a n cia l r isk : shareholders bear when
used debt financing ( debt + lease)
= ( % EBI T) / ( % Sales) = ( EBI T+ F) / ( EBI T)

DOL
= ( % EPS) / ( % EBI T) = EBI T/ ( EBI T- I )
Ca lcula t e DFL
= ( % EPS) / ( % Sales) = ( EBI T+ F) / ( EBI T- I )
3 7 . M e a sur e s DTL = DOL* DFL
Of Le ve r a ge
Use m ore debt and less equit y - - > Net effect will eit her
increase or decrease ROE
Effe ct of fina ncia l le ve r a ge reduces net incom e t hrough added
on N e t in com e & ROE int erest expense but also reduces
net equit y
D e f: t he quant it y of sales for w hich TR= TC
Br e ak e ve n qu a n t it y . + .
=
37. Measures Of Leverage - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Regular div pay consist ent % profit
Special div cash paid t o shareholders in addit ion t o Regular div

Cash dividends
Liquidat ing div occur when firm goes out of business
Ex pla in Def: pay in new shares rat her t han cash

St ock dividends
Def: divide each exist ing share int o m ult iple shares
St ock split s
Def: opposit e of st ock split
Reverse st ock split s
direct ors approve pm t of dividend

1. Declarat ion dat e
1st day t hat st ocks t rade wit hout div
2. Ex- dividend dat e
D ivide n d pa ym e n t ch r on ology
shareholders of record are designat ed t o receive div.
3. Holder- of- record dat e
3 8 . D ivide n ds An d Sh a r e div. are m ailed out

4. Paym ent dat e
Repu r ch a se s
Buy in t he open m arket
Te n de r offe r : t ypically at a prem ium price

Sh a r e re pu r ch a se m e t h ods Buy a fixed num ber of shar es at a fixed price
also a Tender offer, but wit h a range of price
Dut ch auction
Repurchase by direct negot iat ion
EPS only increases if fund earns not hing

Repo is financed w it h com pany's fund
Effe ct s of sh a r e EPS decrease
Aft er- t ax borrowing cost > Earnings yield
rep u rch a se on EPS & BV PS
Repo is financed w it h debt Repo price > Original BVPS BV PS decrease
Re po = Ca sh divide n d
Assum e all ot hers being equal
38. Dividends And Share Repurchases. Basics - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Cash balances ( selling goods, collect ing

r eceiv ables, from shor t t erm inv est m ent s)
Shor t t er m funding ( t r ade cr edit fr om
Pr im a r y sources Def: sour ces of cash used in day - t o- day , do NOT AFFECT operat ions
v endor s, lines of cr edit fr om banks)
Effect ive CF m anagem ent
Sou r ces of liqu idit y Liquidat ing asset s ( shor t t er m or long liv ed)
a.
Renegot iat ing debt agreem ent s
Def: AFFECT oper at ions
Se con da r y sources Filing for bank rupt cy
Reorganizing com pany
D r a gs on liquidit y : delay/ r educe Cash I nflow s; incr ease bor r ow ing cost
Fact or s in flu en ce liqu idit y Pulls on liquidit y : acceler at e Cash Out flow s
Cu r r en t r at io = CA/ CL
Qu ick r at io = ( Cash + ST m ar k et able secu r it ies + Receiv ables) / CL
Receivables t urnover = Credit sales/ receivables
Receiv ables Days of receivables = 365/ Receivable t urnover
b. Liquidit y m e a sure s
I nv ent ory t urnover = COGS/ av erage invent ory
I n v en t or y Days of invent ory = 365/ I nvent ory t ur nover
Payables t urnov er r at io = purchases/ aver age t rade pay able

Payables Days of pay ables = 365/ Payables t ur nov er
Def: t urn raw m at er ials int o cash

pr oceeds fr om sales
Operating cycle = Day s of inv en t or y + Day s of r eceiv ables
c. W ork ing ca pit a l
t urn cash invest m ent in invent ory
Cash conversion cycle = Oper at in g cy cle - Day s of pay ables back int o cash collect ed
d. Ex pla in t he e ffe ct of diffe re nt Have suff icient cash on hand

t ype s of CFs a ffe ct a com pa ny 's Pu r p ose of m an agin g a fir m 's daily cash posit ion Av oid k eeping excess cash
ne t da ily ca sh posit ion
Face - P
% discount =
Face
Face - P 360
Discount-basis yield=
Face Days
Face - P 360
3 9 . W ork in g M oney market yield =
P Days
Ca pit a l M a n a ge m e n t e . Com pa r a ble yie lds
( a lre a dy in Qua nt )
Dif fer fr. BEY in Qua nt
Face - P 365
Bond-equivalent yield=
Face Days
Ca sh M a na ge m e nt Read curricullum 4.2

I nv e st m e nt Policy
Aging schedule: show t he account s int o cat egories of days out st anding
Receiv ables W e ight e d average collect ion period : average day s of r eceiv able
Too low : loss- sale

I n v en t or y Too high: capit al t ied up
f. Ev a lua t e
pe rform a nce of 365
%discount
Cost of trade credit = ( 1 + ) Days past discount -1
1 %discount
Accou n t s pay able

Term : 2/ 10 net 60
Uncom m it t ed line of cr edit

Lines of cr edit Com m it t ed ( r egular ) line of cr edit ( ov er draft )
Rev olv ing line of cr edit
Cost = ( I nt + Com m it m ent f ee) / Loan
Fixed asset s
Fr om ban k s I nv ent ory
Loan collat er alized by
Account receivables
Blanket lien
g. Sh or t t e rm
funding choice s Bank er's accept ances Cost = I nt / ( Loan- I nt )
Fact oring
Non- bank finance com panies

direct placem ent
Com m ercial paper
t hrough dealers
Non ban k
Cost = ( I nt + Com m ission+ Back up cost ) / ( Loan- I nt )
39. Working Capital Management - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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OVERVI EW
RI SK M AN AGEM EN T: AN I N TROD UCE
Por t folio
M a n a ge m e n t PORTFOLI O RI SK & RETURN
BASI CS OF PORTFOLI O
PLAN N I N G & CON STRUCTI ON
Portfolio Management - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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pur chases and sales ar e m ade in t he

m ark et ( sim ilar t o closed-en d fun ds)
r efer s t o ev aluat in g indiv idual inv est m ent by t h eir
ETFs ar e m ost oft en passiv ely m an aged cont r ibut ion t o t he r isk and r et ur n of an inv est or 's por t folio
ETFs' m ar k et prices are v ery close t o t h eir Differ ent t o close- end fun ds ETF t o ex am ine t h e risk and r et u r n of indiv idual inv est m ent s in isolat ion
NAVs du e t o special r edem pt ion pr ov isions
div er sificat ion helps t o r educe port folio r isk w it hout necessar ily r educing t he ex pect ed r et ur n
No shares issued ow ned by a single inv est or Port folio a p p roa ch = ( t he risk of an equally weight ed por t folio of
t o in ve st ing n securit ies) / ( t he r isk of a single securit y
m anaged accor ding t o t hat inv est or 's needs and pr efer ences Separat ely m anaged account select ed at r an dom from t he n securit ies)
Diver sificat ion r at io: m easur em ent of = 1 - - > No div er sificat ion effect
buy expect ed out perform ing securit ies
and sell securit ies short t hat are expect ed t he ben efit s of div ersificat ion The sm allest , t he best diversificat ion effect
t o underperform t he overall m arket Long/ Shor t funds Diver sificat ion w or ks best w h en finan cial m ar ket s ar e oper at ing nor m ally and vice ver se
Long/ short wit h long st ock posit ions t hat

are j ust offset in value by stocks sold short Who sav e and inv est for a v ar iet y of reason s including
Equit y m ark et - neut r al funds pur chasing a house or educat ing t heir childr en
Be neut ral t o overall m arket m ovem ent s
indiv idual m ak es t he inv est m ent
Long bias: a long/ short fund dedicated t o a
I ndividual invest ors decisions an d t akes on t he r isk
lar ger long position r elat ive t o shor t sales DC pension plans
Long bias, Shor t bias No guarant ee for specific fut ure pen sion pay m ent s
Short bias: a gr eat er short posit ion
relat ive t o long posit ions Ot he r form s of ar e funded by com pan y con t ribut ions and hav e an
St r at egies
One t im e corporat e event s, such as M&A p oole d in ve st m e nt s obligat ion t o prov ide specific benefit s t o r et ir ees - - >
Ev ent - dr iv en funds Hedge funds
inv est m ent s ar e usu ally r eliable
DB pension plans
Pr ofit fr om m inor m ispr icings in debt secur ities t y pically hav e a v er y lon g t im e hor izon
Fix ed incom e ar bit r age fu nds
m inim ize t he int erest rat e changes effect s
a fund dedicat ed t o prov iding fin ancial suppor t
long/ short posit ions in convert ible bonds on an ongoing basis for a specific pur pose
and equit y shares
Endow m ent
Conv er t ible bond ar bit r age fu nds Ex : Univ er sit ies endowm ent
Profit from a relative m ispr icings between two
a fu nd for charit able purposes t o support specific act ivit ies
speculat e on changes in int ernat ional or t o fun d r esear ch r elat ed t o a par t icular disease
int erest rat e and curr ency exchange rat es Typ e s of Foun dat ion
Global m acr o fun ds
in ve st or s
obj ect iv e is t o ear n m ore on t he bank 's loan s and
t aking a com pany pr ivat e by buy ing all available Bank inv est m ent s t han t he bank pay s for deposit s of v arious t y pes
shares, usually funded by issuing debt I nst it ut ional invest ors
rest r uct u ring t he com pany t o incr ease cash flow inv est custom er pr em ium s Life insur ance
Buyout funds ( Private equit y funds) an d fund cust om ers claim s
I nv est ors t y pically ex it t he inv est m ent w it hin t hr ee t o fiv e y ear s. 4 0 . PM - An Pr oper t y and
I nsur ance com panies casualt y ( P&C)
sim ilar t o buy out funds, ex cept t hat t he com panies
Ove r vie w
pur chased ar e in t he st ar t -up phase m anage t he pooled funds of m any inv est or s
I nv est m ent com panies
pr ov ide adv ice and ex per t ise t o t h e st ar t - u ps Venture capital funds
m anage t he pooled funds in part icular
st y les ( e.g., index , gr ow t h , bon d inv est in g)
Each inv est or ow ns shar es
Mut ual funds r est r ict t o par t icular subcat egor ies
NAV = Tot al net v alue of asset s/ are one form of pooled invest m ent s ( i.e, a single port folio
of inv est m en t or region s
t he num ber of such shares issued that contains investm ent funds fr om m ultiple investors
Sov ereign w ealt h funds pools of asset s ow ned by a govern m ent
No up-front fees No- load fu nds I nv est ors by new ly
issued shares at NAV
Up- fr ont fees, r edem pt ion an d redeem at NAV
Risk t oleran ce
fees or bot h Load fu nds Open-end funds I nv est m ent obj ect iv es
Ret ur n obj ect iv es
Do not t ak e new inv est m en t s int o Liquidit y

t he fund or r edeem shares I nv est m en t Policy St at em ent ( I PS) Legal
Tr ade lik e equit y shar es Closed- end fu nds
Planning step
I nv est m en t con st raint s Tax
Char ge ongoing m anagem ent fees Tim e h orizon
I nv est in shor t- t er m debt secur it ies Un ique circu m st ances

M u t u a l fu n d s
Pr ov ide int er est incom e w it h v er y Money m ark et funds
low r isk of ch an ges in shar e v alue analyzes of t he r isk and r et ur n char act er ist ics
St e p s in of v ar ious asset classes t o allocat e funds
2 categories PM p r oce ss
I nv est in fix - incom e secu r it ies ident ify t h e m ost at t r act ive
Differ ent iat ed by bond m at u rit ies, Bond m ut ual funds secu rit ies w ithin t he asset class
cr edit r at ings, issuer s and t ypes Top- dow n analy sis: ex am ine cur rent econom ics and
Execution step
Passively m anaged for ecast s: GDP gr ow t h, inflat ion, int er est r at e,...
Ty pes
t he port folio is const ruct ed t o m at ch t he I ndex funds Bot t om - up analy sis: use m odel v aluat ions
perform ance of particular index t o ident ify un der v alued secur it ies
t he m anagem ent select s individual securit ies Monit or r isk , r etu r n, w eigh ts of assets,...ov er
wit h t he goal of pr oducing r et urns gr eat er St ock m ut ual funds t im e - - > r ebalance, adj ust allocations
t han t hose of t heir benchm ark indexes
m easur e por tfolio per for m ance an d
Have higher t urnover of port folio securit ies Feedback step
Act iv ely m anaged fu nds ev aluat e t o t h e ben chm ark port folio
- - > gr eat er t ax liabilit ies t han index funds
Annual m anagem ent fees are higher
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a m easure of the vol atility of asset

prices and interest rates - > not good
choice for non- norm al probability
distributions ( e. g. negative skew or
positive excess kurtosis) Standard devi ation
m easures the m arket risk of equity

securities and por tfol ios of equity
securities - > considers the risk
M e a su re s of risk
reduction benefits of diversification
- > suitable for securities held in a
w ell- diversified portfolio Beta
a m easure of the price sensit ivity of

debt securities to changes in interest
rates Duration
sensitivity of derivatives values to

the price of the underlying asset Del ta
sensit ivity of delta to changes in the

price of the underlying asset Gam m a
sensitivity of derivatives values to D e riva t ive s risk s

the vol atility of the price of the
underlying asset Vega I dentify the risk tol erance of the or ganization
I dentify and m easure the risks
sensitivity of derivatives values to The risk m anagem ent
that the organization faces
changes in the risk- free rate process seeks to
Rho Modify and m onitor these risks
the m inim um loss over a period that May increase its exposure
w ill occur w ith a specific probability to r isks it decides to take
V a lu e a t Risk ( V a R) De fin e r isk m a n a ge m e n t May decrease its exposure to r isks that it is less w ell &
The process does not seek to
the expected value of a loss, given that m inim ize or elim inate all risks respond by m aking organizational changes, purchasing
the loss exceeds a m inim um am ount insurance or entering i nto hedge transactions
Con dit ion a l V a R ( CV a R) Risk ( uncertainty) is not som ething to be avoi ded
exam ines the effects of a specifi c Specifi c risks and overall level of r isk are under m anagers’ control
( usually extrem e) change in a key Determ ining the optim al bundle of r isks for the or ganization and
variable such as an interest rate or Risk m anagem ent
im plem enting risk m itigation strategies to achieve that bundle of risks
exchange rate Stress testing
Scenario analysis refers to a sim ilar w hat- if analysis of Establishing processes and
expected l oss but incorporates changes in m ultipl e input s M e t h ods for m e a su rin g a n d policies for risk governance
m odifyin g risk e x posu re s a n d
I nfrequent events of an organization Su bj e ct ive a n d M a rk e t - ba se d fa ct ors t o con side r in ch oosin g Determ ining t he organization’s risk tolerance
are quite difficult to quantify the risk e st im a t e s of risk a m on g t h e m e t h ods I dentifying and m easuring existing risks
Market pri ces of insurance, deri vatives, or other securi ties Fe a t u r e s of a r isk Managing and m itigating risks to
used to hedge the risks can be used to estim ate the risks m a n a ge m e n t fr a m e w or k An overall risk m anagem ent fram ew ork
achieve the optim al bundle of r isks
encom passes several activities
Operational risks are difficult to quantify for a single or ganization Monitoring risk exposures over tim e
Unexpected changes in tax law s or the regulator y Com m unicating across the organization
environm ent can im pose large costs on an organization
Perform ing strategic risk analyst
Goal of r isk m anagem ent is to r etain
the optim al m ix of r isks
the decision often com e from top One w ay to avoi d a risk is to not the risk tol erance of the or ganization
m anagem ent ( a part of r isk engage in the activity wi th the the elem ents of its optim al
tolerance) uncertain outcom e ri sk exposure strategy
Risk governance ref ers to senior
m anagem ent’s determ ination of the fram ew ork for oversight of
Som e risks can be prevented such as
the risk of a data breach the risk m anagem ent function
Diversifi cation m ay offer a w ay to Seeks to m anage risk in a w ay that

m or e efficiently bear a specifi c risk supports the organizational overall goals
De fin e r isk gove r n a n ce a n d de scr ibe
a term used to describe a sit uation 4 1 . Risk M an agem en t : risks that should be pursued
e le m e n t s of e ffe ct ive r isk gove r n a n ce
w here an organization has decided An in t r odu ce in an effective m anner
to bear a risk Risk governance
Self- insurance Provides organization- w ide guidance on the risks that should be subj ect to lim its
risks that should be reduced or avoi ded
a risk that an organization has
decided not to bear Risk transfer M odifyin g risk e x posu re s ri sk m easurem ent
A risk m anagem ent com m ittee can provide a w ay for integration of risks
an insurance com pany has agreed t o various parts of the or ganization to bring up issues of
m ake a paym ent if a third party fails the best w ays to m itigate undesir able risks
to perfor m under the term s of a
contract or agreem ent w ith the Determ ining an organization’s risk tolerance involves setting the overall
organization risk exposure the or ganization w ill take by identifying the risks the firm can
fidelity bonds: insurers pay for A surety bond effectively take and the risks that the or ganization should reduce or avoi d
losses that result from em ployee its expertise in its lines of business
theft or m isconduct Ex pla in h ow r isk t ole r a n ce
a ffe ct s r isk m a n a ge m e n t its skill at responding to negative outside events
a w ay to change the distribution of Som e factors to determ ine its regulatory environm ent
possible outcom es and is
accom plished prim arily w ith its financial strength and ability to w ithstand losses
derivative contracts Risk shifting Managem ent should exam ine risks w ithin and outside
May use m ultiple m ethods to r educe a single risk considering their various risk characteristics
Risk profi le that the m atches risk Criterion is alw ays a com parison of com bine risks characteristics to m eet
tolerance and cost versus potential Ch oosin g a m on g risk
the costs and benefits of risk m odifica t ion m e t h ods Risk budgeting: the pr ocess of organization’s risk tolerance
returns m odification allocating firm resources to goal: allocate acceptable risk to the m ix
assets ( or investm ents) by of assets or investm ents that have the
greatest expected returns over tim e
uncertainty about w hether the
counterparty to a transaction w ill May be a single m etric such as
fulfill its contractual obligations Credit risk Risk bu dge t in g a n d it s portfol io beta, value at risk, por tfol io
r ole in r isk gove r n a n ce duration or returns variance
the risk of l oss w hen selling an asset at a tim e May be constructed based on
w hen m arket conditions m ake the sales pri ces categories of i nvestm ents such as
Fin a n cia l risk s
less than the underlying fair value of the asset Liquidity risk dom estic equities, dom estic debt
securities, international equities and
Risk budget
uncertainty about the m arket prices international debt securities or
identify specifi c risk factor s that specifi c risk factors: interest rate
of assets and interest rates Market risk
com prise the overall risk of the risk, equity m arket risk, foreign
portfoli o or organization exchange rate ri sk
hum an error or faulty organizational processes Operational risk
organization is unable to continue to

operate because of r unning out of
cash Sol vency risk
regul atory environm ent changes Fin a n cia l a n d n on - fin a n cia l

im posing costs on the firm or sour ce s of r isk
restricting its activities Regulatory risk
political actions outside a specific Governm ental or political risk

regul atory fram ew ork ( including tax risk)
N on - fin a n cia l risk s
Legal risk
incorrect asset valuations based on
analytical m odels Model risk
extrem e events are m ore l ikely than

the organization’s analysis indicates Tail risk
incorrect account policies and estim ates Accounting risk
For individuals: risk of death

( m ortality risk) , longevity risk
Th e se risk s oft e n in t e ra ct in m a n y w a ys
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represent s t he invest or' s preferences in t erm s of

risk and retur n ( i. e, his degr ee of risk aversion)
I nv est or 's ut ilit y
Arit hm et ic m ean ret urn = ( R1+ R2+ R3+ . . . + Rn) / n

gener ally slope upw ar d plots com binations of risk and expected
A m ore risk- averse investor w ill ret urn am ong w hich an invest or is indifferent I ndifference cur v e
have steeper i ndifference curves
is the I RR on a portfol io based on all of
Money weight ed r at e of ret urn its cash inflow s and outflow s.
the total return on a security portfol io befor e

Gross ret urn deduct ing m anagem ent and adm inistration fees
M a j or re t u rn
m e a sure s
Pret ax nom inal ret urn the return prior to paying taxes
Av er age r et ur ns
Aft er t ax nom inal ret urn the return after deducting tax liability
Ot her ret urn m easures
Real ret urn nom inal return adj usted for inflation
Se le ct ion of a n
opt im a l port f olio a return to an investor that is a m ultiple
of the return on the underlying asset
Leveraged ret urn is calculated as the gain or loss on the investm ent
as a percentage of an investor 's cash investm ent
t he line repr esent ing t he com binat ions of risk- free
Capit al allocat ion line ( CAL)
assets and t he opt im al risky asset portfolio
Mean
m easures of Populat ion variance

invest m ent risk
Var iance
( St andar d deviat ion)
Sam ple variance
Positive: m ove t oget her

m easures t he ext ent t o which t wo
variables m ove together over tim e Negat ive: m ove in opposite dir ection
= 0: No linear relationship
Ca lcula t e & in te rpre t
4 2 . Port folio
Risk & Re t ur n Covar iance
CAL com bine with indifference - Pa r t I

curves repr esent s an individual's
preferences for risk and ret urn
= + 1: perfect ly positively correlat ed
st andardized m easure = - 1: perfect ly negatively correlat ed

of co- m ovem ent = 0: no linear relat ionship
Cor r elat ion
has no units and bounded by - 1 and + 1
For each level of expected por tfol io r eturn, the portfol io that has the
least risk is know n as a m inim um - variance portfol io. Taken together,
these portfol ios form a line called the m inim um - variance frontier. Asset classes w it h gr eat est av er age r et ur n
Minim um v ariance
front ier of r isk y asset s also have h ighest st andar d deviat ion
On a risk versus return graph, the one risky portfol io Real r et ur n m uch m or e st able
that is farthest to the left ( has the least risk) Ch a ra ct e rist ics of t h e m a j or t han nom inal r et ur ns
Global m inim um v ar iance por t folio are negatively skewed
a sse t cla sse s con side re d in
Those portfolios that have the greatest expected return f orm in g port f olios gr eat er kurt osis ( fat t er t ails
for each level of r isk m ake up the efficient frontier Ret ur ns dist r ibut ions
t han norm al dist ribut ion)
coincides w ith the top portion of the
m inim um variance frontier
Liquidit y is a m aj or concer n in em er ging
Efficient fron t ier of risk y asset s m ar k et s & t hinly -t raded secur it ies
Risk- averse investors w ould only choose a
portfol io that lies on the efficient frontier
t he one t hat dislikes risk ( i. e,
I n te rpre t pr efers less risk to m ore risk)
m ay hold very risky assets if he feels the
Risk av er se inv est or ext ra ret urn he expect s is adequat e
com pensat ion for t he addit ional risk
Risk a ve rsion &
it s im plica tion actually pr efers m ore risk to less
Risk - seek ing ( risk - lov ing)
who has no pr eference regarding risk and would be
indifferent bet ween t wo equal expect ed r et urns
Risk neut r al
Port f olio sta n da rd de via t ion
Ef f e ct on port f olio's risk of

in v e st in g in a sse t s t h a t a re
le ss t h a n pe rf e ct ly corre la t e d
cor r elat ion decr eases -- > r isk decr eases
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I nvest or s ar e r isk aver se, ut ilit y m axim izing, and r ational.

Markets are free of frictions like costs and taxes.
All invest ors plan using t he sam e t im e period.
Assum pt ions
All invest ors have t he sam e expect at ions of securit y ret urns.
I nvest m ents ar e infinit ely divisible.
Prices are unaffected by an investor's trades.
CAPM
Wa= weight of risky asset a

Wb= weight of r isk - free asset b
St andar d deviat ion =
Equat ion a . Risk f re e a sse t +

Port f olio of risk y a sse ts
The line of possible risk and r et urn com binat ions given t he
risk- free rate and the risk and retur n of a portfolio of risky assets
CAL ( Capit al Allocat ion Line) Different investor m ay have different CAL
t he CAL for all invest ors under t he assum pt ion of

hom ogenous expect at ions ( sam e efficient front ier)
CML uses total risk on the X- axis SML
- - > only efficient por tfolios will plot on
SML use beta ( system atic risk) on the Com par e with CML
X- axis - - > all properly priced securities
and portfolios of securities w ill plot on SML f ,g,h . CAPM & SM L
b.
Com pare t he rat e of ret urn on a securit y t o t he required r at e
of ret urn indicat ed by t he SML t o det erm ine whet her t he
security is overvalued, undervalued, or properly valued
CML (Capit al Mar k et Line)
4 3 . Port folio
Risk & Ret u rn The risk cannot be diversified away
Sy st em at ic ( non div er sifiable
- Part I I r isk or m ar ket r isk)
The r isk can be elim inat ed by diver sificat ion
Nonsy st em at ic ( unsy st em at ic, unique,
div er sifiable or fir m - specific r isk )
c. Risks
Tot al risk = sy st em at ic risk + u nsy st em at ic risk

Diversificat ion t o elim inat e unsyst em at ic risk is cost less ( CAPM underlying
assum pt ion) - - > cannot receive addit ional ret urns by t aking on unsyst em at ic risk
Macr oeconom ic
Types of Factors Fundam ent al
St at ist ical
with k factors
Fact or sensit ivit y of Fact or loading
Mult ifact or m odels Firm size, Firm B/P, Rm-Rf
Fam a & French thr ee- factor m odel
d. Re t u rn For m ula
ge n e ra t in g Carhart suggest 4t h fact or: pr ior period ret urns
- - > t o m easure pr ice m om ent um
m ode ls
Definit ion: t he sensit ivit y of an asset 's
ret urn t o t he ret urn on t he m arket index
Single- fact or m odel

= covariance of asset i's ret urn wit h t he
m arket ret urn/ variance of m arket port folio
Mar k et m odel
e . Ca lcu la t e Be t a
Slope of r egression of r et urn s

on m ar k et index
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plan for ach ieving invest m ent success

force invest m ent discipline
a . Re a sons for a w r itt e n I PS
ensures t hat goals are realist ic by requiring invest ors t o
art iculat e t heir circum st ances, obj ect ives, an d const raint s
Cir cum st ances & Sit uat ion

Descript ion of Client I nv est m ent obj ect iv es
Stat em ent of t he purpose of t he I PS
I nv est m ent m anager
Cust odian of asset s
Stat em ent of dut ies & responsibilit ies of
Client
Procedures t o updat e I PS & t o
respond to various possible sit uat ions
Absolut e
For m s relat e t o a specific benchm ark
Relat iv e and can be st rict
Risk obj ect iv es depends on financial

Abilit y circum st ances
c. I n vest m ent obj ect ives ( derived from
d. Risk t olerance
com m unicat ions wit h t he client ) based on t he invest or's at t it udes
Willingness & beliefs - - > subj ect ive
Absolut e
Ret urn obj ect iv e
Relat iv e
The need t o draw cash from t he port folio for ant icipat ed or unexpect ed
fut ure spending needs. High liquidity needs oft en translate to a high
Liquidit y por tfolio allocat ion t o bonds or cash.
Oft en the period over which assets are accum ulated and before
wit hdrawals begin. Risky or illiquid invest m ents m ay be inappropriat e
Tim e hori zon for an invest or wit h a short t im e horizon.
b. M a j or com pone nt s of a n I PS
Concerns t he tax t reat m ents of t he invest or's various
e. I nvest m ent con st raint s account s, t he relat ive t ax t reat m ent of capit al gains
Tax sit uat ion and incom e, and the invest or's m ar ginal t ax bracket .
Const raint s such as governm ent rest rict ions on

Legal & regulat ory port folio cont ents or laws against insider t rading
4 4 . Ba sics Of Por t folio
Pla n n in g & Con st r u ct ion Restrictions due t o investor pr efer ences ( religious,
Uni que cir cum st ances ethical, et c.) or ot her fact ors not already considered
I nvest m ent guidelines ( how t he policy will be

execut ed, asset t ypes perm it t ed, leverage)
Evaluat ion of perform ance ( e.g: benchm ark)
Correlat ions wit hin a
Definit ion & cl ass shoul d be v ery high
Specificat ion Corr elat ions bet ween
classes should be low
Equit ies
St r at egic
( baseline) f. Asset Bonds
asset allocat ion classes
Cash
Cat egories Real est at e
Appendices Hedge funds, PE funds,
com m odit y funds, art work ,
Alt ernat iv e int ellect ual propert y right s
Tact ical asset allocat ion ( devi at e

from st r at egic asset allocat ion)
Rebalanci ng: how & w hen
I dent ify inv est able asset cl asses

Risk , Ret urn, Correlat ion
St r at egic
asset allocat ion Effi ci ent front ier
I dent i fy port folio w hich best m eet s risk &
requi rem ent of invest or ( based on I PS)
t o t ake advant age of perceived short

t er m opport uni t ies
g. Principles of
portfolio const ruct ion Tact ical asset allocat ion m anager's abilit y t o ident ify short t erm opport unit ies
success depends on
t he exi st ence of such shor t t er m oppor t uni t ies
m anager's sk ill
success depends on
Securit y select ion opport unit ies ( m ispricing or inefficiencies)
Risk budget i ng
Role of asset allocat ion
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5 0 . Equit y Va lua t ion.

Conce pt s And Ba sic Tools 4 5 . M a r k e t Or ga niza t ion & St r uct ur e
4 9 . I nt r oduct ion To I ndust r y EQUI TY 4 6 . Se cur it y M a r k e t I ndice s

And Com pa ny Ana lysis
4 8 . Ove r vie w Of Equit y Se cur it ie s 4 7 . M a r k e t Efficie ncy
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Sav ing
Borrowing
I ssui ng equit y
Allow ent it ies t o Risk m anagem ent
M a in funct ions
Ex changing asset s
of fina ncia l sy st e m
Ut ilizing inform at ion
Equilibrium int erest rat e

Det erm ine t he ret urns t hat equ at e D &S
Allocat e capit al t o m ost efficient uses
F.A: secur it ies, cur rencies...
Prot ect unsophist icat ed invest ors Financial A vs. Real A R.A: com m odit ies, real est at e...
Est ablish m inim um st an dard of com pet ency Pu b lic se c : t rade on ex changes
Help invest ors evaluat e perform ance Obj e ctive s of Public vs. Privat e securit ies Pr iva t e se c: not t r ade on exchange
Prevent insider m a rk e t r e gula t ion
De b t
Prom ot e com m om FR requirem ent s
Cla ssifica tion: Asse t s & M a r k e t Eq u it y
Require m inim um level of capit al Debt vs. Equit y vs. Derivat ive
De r con t r a ct : val ues depend on t he v alues of ot her asset s
Com plet e m arket ( Availabilit y) Pr im a r y: for new ly i ssued sec
Operat ional efficiency ( Low cost ) Cha r a ct e r ist ics of Prim ary vs. Secondary m arket Se cond a ry: subsequent s sales of sec
I nform at ional efficiency ( P reflects fundam ent al in fo) w e ll- functioning fin. sy st e m M one y: for debt securit ies < 1y
Allocat ional efficiency ( at t he best efficiency) Money vs. Capit al m arket Ca p it a l: for equi t y+ debt securit ies> 1y
Tr ades occur at specific t im es Com m on st ock

All bids+ asks are declared, and t hen one n egot iat ed price is set for t he st ock Equi t y Preferr ed st ock
in sm aller m ark et s Cal l m arket
Warrant s
t o set openi ng prices and prices aft er used
Mut ual funds
t rading halt s on m aj or ex changes
Dist inguish
Trade occur any t im e t he m arket i s open Securit ies som et im es r efer as Deposit or ies
Pooled inv est m ent v ehicl es ETFs and ETNs
auct ion pr ocess Cont inuous m ar k et Cl a ssifica tion ABS
Price is set by of m a rk e t s
dealer bid- ask quot e 4 5 . M a rk e t Organ iza t ion Asse t cla sse s Hedge funds
Quot e- dr iv en m ar k et s ( t rade w it h dealer s) & St r u ct u re Fix ed incom e Conver t ible debt = F.I + Equit y
1 . Price
2 . Display precedence M a tch in g ru le s
Currencies
Order- driven m ark et s
3 . Tim e precedence Dist inguish Forwar d, Fut ures, Swap, Opt ion
Con t ract s I nsur ance Credit defaul t sw ap

Br ok er ed m ar k et s
Com m odit ies
I PO v s. Secondary issues Real asset s
Public offeri ngs v s. Privat e placem ent s Prim ary m arket Pr im a r y vs.
Brokers
Securit ies t rade aft er init ial offerings Se conda r y m a rk e t s
Block brokers help large t rades
I m port ance: prov ide Liquidit y + Price info Secondary m arket
I nv est m ent bank s
M .O: ex ecut e at t he best P Brokers,Dealers & Exch anges Ex changes
L.O Market vs. Lim it order Alt ernat i v e t rading sy st em s ( ATS)
Dealer s ear n profit fr. bid- ask spread

Good- t il- cancelled Fin a ncia l
I m m ediat e- or - cancel int e r m e dia r ie s Securit izers
Or de r
Good- on- cl ose Deposit ory inst it ut ions
Good- on- open Validit y I nsurance com panies
St op- sell r efer w ho buy A in 1 m ar ket & r esell in anot her m ar ket
St op order Arbit rageurs
St op- buy
Cle a r ing h ou se s: int erm ediar ies bet ween buy er s & sel ler s
Clearinghouses & Custodians Cu st odia n s
Long = Buy
Long vs. Short Short = Sell
borr ow secur it ies & sell

Short sales
Posit ions bor r ow funds t o buy A
1 Initial margin
Leveraged posit ions Margin call P= P0
1 Maintenance margin
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Se cu rit y used t o pr esent t he per form ance of an asset

class, secur it y m ar k et or segm ent of a m ar k et
m a rk e t in de x
Pr ice index: calculat e price only

Ca lcula t e a n index
Re t u r n index: include P+ I ncom e
Which t arget m arket ?

Which securit ies?
I n de x con st r u ct ion
How weight ?
& m a n a ge m e nt
Re- balancing frequency?
Re- exam ining when?
= Su m of st ock pr ices / N u m ber of st ock s adj ust ed for split s

Adj ust for st ock split
Pr ice - w e igh t e d index Adv : sim ple
Adv & Disad D isa d: % change in a high- pr iced st ock will hav e a gr eat er
effect on t he index
Equivalent t o a por t folio t hat has equal dollar

am ount s invest ed in each index st ock
Equ a l- w e igh t e d index
W e igh t in g m e t h ods NOT adj ust
Weight s based on t he m ar ket - cap of each index st ock

. M a r k e t - ca p w e ight e d index
Cr it icism : lar ge com pany has gr eat er im pact
Float - adj ust ed m ar ket cap- weight ed index
4 6 . Se cu rit y M a r k et f loa t : ( - ) shar es fr om Cont r olling shar eholder s

M a rk e t I ndice s Fr e e floa t : Mar ket float - Not available t o foreign invest ors
Fu n dam en t a l w eight ing

( earnings, dividends, cash flow)
Re ba la n cin g & Re ba la n ce : adj ust t he weight s of securit ies uses for Equ a l- w e igh t ed in dex
Re con st it u t ion
Recon st it u t ion : add & delet e securit ies t hat m ake up an index
Reflect m arket sent im ent

Pr ox y for m easuring of m arket ret urn & risk
Use s of securit ies
Pr ox y of bet a & risk- adj ust ed ret urn
m a rk e t in dice s
Benchm ark of m anagem ent perform ance
Model port folio for index fund
Broad m arket equit y

Mult i- m arket vs. Mult i- m arket wit h fundam ent al weght ing
Types of e qu it y in dice s Sect or index
Mar ket - cap
St yle index Value/ Gr owt h
I lliquidit y, t ransact ions cost s, high t urnover of

Large universe const it uent securit ies = > D ifficu lt & ex pen siv e
Types of Fix ed I n com e in dice s t o re plicat e F.I in de x
Dealer m arket & infrequent t rading
based on fut ur e cont r act

Com m odit ies index
Alt ern a t ive in vest m en t in dice s m ay hav e upw ar d- bias
Hedge fund index
Real est at e index
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Act ive inv est or ca n't beat t he

Efficie n t m ar k e t De f: Cur r ent pr ice of a secur it y fully , quick ly , r a tiona lly
m arket = > Pa ssiv e inv est or
r eflect s all available infor m at ion about t hat secur it y
Mark et value
D ist in gu ish D e f: t he value t hat a rat ion al invest or
would willing t o pay
I nt rinsic value
Num ber of m arket part icipant s

Availabilit y of inform at ion
Fa ct or s a ffe ct e fficie ncy
I m pedim ent s t o t rading
Transact ion and inform at ion cost s
can't use Technical analy sis

Weak form
can't use Fundam ent al+ Technical

Sem i- st rong form
For m s of EM H Port folio m anagers can st ill a dd va lue by:
diversify port folio, tax m anagem ent ...
St rong- form
can't ear n abnor m al pr ofit
Fundam ent al analysis

I m plica t ions of e a ch for m of EM H Technical analysis
Choosing bet ween act ive and passive
anuary effect ( or t ur n- of- the- year effect )

Tur n-of- t he- m ont h effect
Calendar
anom alies Day- of- t he- w eek effect
4 7 . M a r k e t Efficie ncy Anom alies in
Weekend effect
Tim e- series dat a Holiday effect

Over r eaction and
m om ent um anom alies
M a rk et pricing
a nom a lies Size effect
Anom alies in
Value effect
cross- sect ional dat a
Closed- end investm ent funds
Ear nings announcem ent s
Ot her anom alies I PO
Econom ic fundam ent als
I m plicat ions for invest ors
Loss aver sion

I nvest or overconfidence
Repr esent at iveness
Gam bler 's fallacy
Be ha v ior a l fina nce
Conserv at ism
Disposit ion effect
Narrow fram ing
I nform at ion cascades; herding behavior
invest or s dislike a loss m ore t han

t hey like a gain of an equal am ount
Low av er sion
over est im at e t heir abilit ies t o analyze secur it y infor m at ion and iden t ify
Evid e nce of ir r at iona l be ha vior differ ence bet w een secur it ies’ m ar ket pr ices and int r insic values
I nv estor over confidence
act in concert on t he sam e side of t he infor m at ion cascade r esult s w hen

m ar ket , acting not on pr ivat e analysis investor s m im ic the decision of ot her s
Her ding
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I n clude:
1. St at ut ory v ot ing
2. Cum ulat iv e v ot ing ( ser v e m inorit y shareholders bet t er )
Ch a r a ct e r ist ics Callable

Com m on shares Put able
Cum ulat ive vs. Non- cum ulat ive

Part icipat ing vs. Non-part icipat ing
Preference shares
Convert ible preference shares
Som e com panies' equit y shares are div ided int o different classes
Eq u it y cla sse s which m ay hav e different v ot ing right s and priorit y in liquidat ion
Charact erist ics: usually issues t o inst it ut ional inv est ors
Vent ure capit al ( prov ide capit al t o f irm s in ear ly life- cycle
3 m ain t y pes Leveraged buyout s ( LBO) ( buy all fir m 's equit y = debt )
Privat e equit y securit ies
Privat e invest m ent in public equit y ( PI PE)
pot ent ially gr eat er r et ur n for inv est or s once t he firm goes public
D ist in g u ish
higher report ing cost s
less abilit y t o focus on long- t erm prospect s
Com par e t o pr iv at e equit y fir m s m ore liquid
Public equit y securit ies m ore financial disclosure
bet t er corporat e gov ernance
Direct invest ing

Global deposit ory receipt s (GDRs) ( US inst it ut ional invest ors can buy )
N on - d om e st ic e qu it y Am erican deposit ory receipt s (ADRs)

4 8 . Ove r vie w Deposit ory receipt s (DRs) Global regist ered shares ( GRS)
Of Equ it y Se cu r it ie s
Basket of list ed deposit ory receipt s (BLDR) ( ETF t hat is a collect ion of DRs)
Div idends, com pounding of reinv est ed div idends

Capit al gains or losses fr om changes in share pr ices
Ret urns
For eign ex change gains or losses on shares t raded in a for eign curr ency
pays k nown, fixed dividend t o inv est ors

Risk & Re t u r n ch a r a ct e r ist ics of Preferred st ock is less risk y
t han com m on st ock because receiv es div idends before com m on st ock
v a r iou s t y p e s of e q u it y se cu r it ie s
has a claim equal t o par v alue if t he firm is liquidat ed
Put able shares are t he least risk y
Risk s
Callable shares are t he m ost risky
Cum ulat iv e pr eferr ed shares are less r isk y t han non- cum ulat iv e prefer red shares
Role of e qu it y
Prov ide funds t o t he firm t o buy pr oduct iv e asset s, t o buy
se cu r it ie s in f in a n cin g ot her com panies, or t o offer em ploy ees as com pensat ion
com p a n y 's a sse t s &
Provide liquidit y when raise addit ional funds
cr e a t in g com p a n y v a lu e
is t he share pr ice m ult iplied by t he num ber of shares out st anding

Market value of equit y reflect s inv est ors' ex pect at ions about t he t im ing, am ount , and risk of t he firm 's fut ure CFs
D ist in g u ish is t he difference bet ween t he financial st at em ent v alue of t he firm 's asset s and liabilit ies
( + ) ret ained earnings increase book v alue of equit y
Book value of equit y
r eflect s t he firm 's past oper at ing and financing choices
N.I / ( av erage B.V)

ROE = N.I / ( B.Vt - 1)
oft en uses as pr ox y for m inim um requir ed r et urn of inv est or s

Com p a r e Cost of equit y
depends on est im at es of fir m 's fut ure CF & risk
I nvest ors' required
rat es of ret urn
48. Overview Of Equity Securities - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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To under st and a com pany 's business env i r onm ent

befor e engaging in anal ysis of t he com pany
t he fi rm 's pot ent i al growt h
com pet it ion
r isk
I ndust r y envi r onm ent pr ovides i nfo abt
I n du st ry a n a lysis appropriat e debt l ev els
cr edit r isk
Firm 's financial condit ion w hich i ndust r ies t o ov er w eight or under w eight
I ndust r y v aluat ion
Pr oduct s & serv ices
Com pa n y a n a lysis a com ponent in a per form ance at t r ibut ion analysis of a por t folio's r et ur n
Low - cost st rat egy I ndust ry present at i on
Different iat ion st rat egy Com pet it ive st r at egy
Product s & serv ices supplied

Macroeconom ic fact or s has earnings highly dependent on t he business cy cl e
Cy cl ical
Technology Ex t e r n a l in flu e n ce s Sensit iv it y t o business cy cles
Dem ogr aphic fact or s on in du st ry grow t h , Gr ouping by Non- cy clical has earnings l ess dependent on t he business cy cl e
Governm ent s profit a bilit y a n d risk
St at ist ical m et hods highly cor relat ed r et ur ns - - > sam e gr oup
Social influence
Basic m at erial and pr ocessing

Slow growt h
Consum er discret i onary
High prices
Consum er st aples
Lar ge inv est m ent requir ed 1. Em br y onic st age
Energy
High risk of failure
Classificat ion Financial serv ices
Rapid growt h I n du st ry cla ssifica t ion I ndust r ial and producer durables
Li m it ed com pet it iv e pr essures Com m er cial classif icat ions Technology
Falling prices 2. Grow t h st age
Telecom m unicat ions
I ncreasing profit abilit y
Ut ilit ies
I ndust r y classif icat ion sy st em s
Growt h has sl owed
GI CS
I nt ense com pet i t ion
4 9 . I n t rodu ct ion Sy st em s RGS
I ncr easi ng indust ry
To I n du st ry An d I ndust ry Cl assificat ion Benchm ark ( I CB)
ov er capacit y Produ ct & in du st ry life cycle Com pa n y Ana lysis
3. Shakeout st age Uni t ed Nat ions
Declining profit abilit y
Eur opean Com m unit y
I ncr eased cost cut t ing Gover nm ent classificat ions
Aust r alia & New Zealand
I ncr eased failur es
Nort h Am erica ( US, Canada, Mexi co)
Slow growt h
Consolidat i on Cyclica l
High barriers t o ent ry dem and for t he pr oduct t ends not t o fluct uat e w it h t he busi ness cy cl e
4. Mat ure st age Defensiv e ( st able)
St able pricing
N on - cyclica l dem and is so st rong t hat it is l argel y un affect ed by t he busi ness cycle
Superi or firm s gai n m arket share Growt h
Negat ive growt h Sen sit ivit y t o bu sin ess cycle cy clical indust ries oft en include growt h firm s
Declining prices non- cy clical can be affect ed by sev er e recessions
5. Decline st age
Consolidat i on defensiv e i ndust ries ar e not alw ay s safe env ir onm ent s
Lim it a t ion s of such d e scr ip t or s
business cy cle t im ing differs across count r ies and r egions
cl assificat i on of firm s i s som ew hat arbit rary
Answer t o describe 2 forces:

> Ba rrie rs t o e n t ry D e f : a set of sim ilar com panies uses for valuat ion com par isons
> I n du st ry con ce n t ra t ion 1. Riv alr y am ong exist ing com pet it or s
. Pe er grou p ident ify com panies i n t he sam e indust r y
> I n du stry ca pa cit y 2. Threat of new ent rant s
> M a rk e t st a bilit y sh a re Fiv e - for ce s St ra t e gic a na lysis
H ow t o form ? use ot her info t o verify
3. Threat of subst it ut e product s
4. Bar gaining pow er of supplier s Ev aluat e t he relat ionships bet ween m acr oeconom ic v ar iables and indust ry t rends
5. Bar gaining power of cust om ers Est i m at e indust r y var i ables using differ ent appr oaches and scenar ios
Check est i m at es against t hose from ot her anal yst s
Com par e t he val uat ion for differ ent indust r ies
Ele m e n t s of a n Com pare t he v aluat ion for indust ri es across t im e t o det erm ine ri sk and rot at ion st rat egies
in du st ry a n a lysis Analy ze indust r y prospect s based on st r at egic groups
Classify indust ries by t heir life- cy cle st age
Posit ion t he indust r y on t he exper ience cur ve
Consider dem ogr aphic, m acr oeconom ic, gov er nm ent al, social, and t echnological influences
Ex am ine t he forces t hat det erm i ne indust ry com pet i t ion
49. Introduction To Industry And Company Analysis - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Size of differences bet ween

m arket price and int rinsic value
Eva lua t e w he t he r a Confidence about valuation m odel
com pa ny is m isprice d Confidence about t he input s
Why st ock is m ispr iced
I f m ar ket price will m ov e t oward int rinsic v alue
d. Prefer red st ock

e. Com m on st ock
Dividend discount m odels St able & m at ure
f. Appr opriat e for
com panies t hat ar e Non- cyclical
1. DCF m odels Dividend- paying
FCFE m odels
Advant ages
.
Disadv ant ages
Equit y va lua t ion m ode ls
h. St ock price / fundam ent als
Types of m odels
e. Ent er prise value / EBI TDA or revenue
2. Mult iplier m odels Advant ages

.
Disadv ant ages
5 0 . Equit y
Explain:
Va lua t ion:
Conce pt s And Advant ages
3. Asset- based m odels .
Ba sic Tools Disadv ant ages
Pr eferred st ock value = D p/ Kp
D1
DDM V0 =
ke g
Gor don gr ow th m odel
D CF m ode l
FCFE t
V=
( 1+ k e ) t
FCFE ( reflect fir m 's capacit y t o pay div idend)
use int rinsic value

Based on fundam ent al
M ult iplie r m ode l
t rading m ult iple
Based on com par able
Asse t - ba se d m ode l Equit y= MV of asset s - MV of liabilit ies
50. Equity Valuation. Concepts And Basic Tools - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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5 1 . F.I SECURI TI ES: D EFI N I N G ELEM EN TS
5 2 . F.I M ARKET - I SSUAN CE, TRAD I N G & FUN D I N G
5 3 . I N TROD UCTI ON TO F.I VALUATI ON
FI XED I N COM E
5 4 . I N TROD UCTI ON TO ASSET- BACKED SECURI TI ES
5 5 . UN D ERSTAN D I N G F.I RI SKS & RETURN S
5 6 . FUN D AM EN TALS OF CRED I T AN ALYSI S
FIXED INCOME - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Corpor at ions
Sover eign nat ional gover nm ent
Non- sov er eign Gov
Bond issuer
Quasi- gover nm ent ent it y
Supr anat ional ent it y
Tim e r em aining t il m at ur it y: Ter m To Mat ur it y

Mat ur it y dat e Bonds have no m at ur it y: Per pet ual Bonds
Ba sic fea t u res
Pr ice> Par : Pr em ium Bond
Par value Price< Par: Discount Bond
Fix counpon r at e: Plain Vanilla Bond

Coupon r at e Hav e no coupon: Zer o- counpon Bond
Dual- cur r ency bond

Paym ent cur r ency Cur r ency opt ion bond
N e ga t iv e cov erna nt ( pr ohibit ion f r om Bor r ower )

I n den t u re
Affirm a t iv e cov erna nt ( pr om ission fr om Bor r ower )
E.g: a bond issued by a Chinese fir m t hat is

denom inat ed in Yen & t r aded out side Japan
Bear er bond ( adv : avoid t ax )
Eu robo n ds 2 f orm s
Regist er bond
Spe cia l Pu rpose En tit y ( SPE) : also

called bankr upt cy r em ot e vehicle
I ssuing e nt it ies
Source s of repa y m ent
Secur ed Bond ( backed by specific asset s)
Types
Unsecur ed Bond ( represent a claim )
Over collat er alizat ion ( collat eral has a great er value t han Par)
I nt er nal Excess spr ead ( yield on t he fin. A is great er t han bond yield)
Tr anches
Colla t era l & Credit enha nce m ent
Cr edit enhancem ent Sur et y bond ( issued by insurance com panies & prom ise t o
m ake up short fall in t he cash av ailable t o serv ice t he debt )
Ext er nal Bank guar ant ee ( sam e)

Let t er of credit ( a prom ise t o lend m oney t o t he issuing ent it y )
Municipal bond ( exem pt fr . nat ional+ issuing st at e incom e t ax)

Ta x a t io n of Bond I nco m e Capit al gain ( t axed at a lower r at e t han or dinar y incom e)
5 1 . F.I secu r it ie s:
Defin in g elem en t s Bullet st r uct ur e Ba llon pa ym e n t: t he final inst allm ent of a loan t hat is lar ger t han r egular inst allm ent
t he principal is fully paid off w hen t he

Fully am or t izing last periodic paym ent is m ade
Am or t izing Par t ial am or t izing ballon paym ent at bond m at ur it y
Sinking fund pr ovision

Acceler at ed sinking fund pr ovision
Fa ct ors affe ct in g Float ing- Rat e not e ( cap & floor ; collar )
issu a n ce & t radin g coupon r at e incr eases over t im e
of F.I St ep- up coupon bond accor ding t o pr edet er m ined schedule
coupon rat e will go up by a cert ain am ount if t he

Cr edit - linked coupon bond credit rat ing of t he issuer falls and vice v ersa
CFs of fixe d- in com e st ru ct u r e
issuer can m ake coupon paym ent s by increasing t he principal am ount of
Paym ent - in- kind ( PI K) t he out st anding bonds, essent ially pay bond int erest wit h m ore bonds
Ty pe s of bond Defer r ed ( split ) coupon bond regular coupon paym ent s do not begin unt il a period of t im e aft er issuance
Capit al- index ed bond

I ndexed- annuit y bond Pr in cipa l pr ot e ct e d bon d: not pay less t han
I nflat ion-indexed Par even w hen t he index has decreased
I ndex- linked bond I ndex ed zer o- coupon bond
I nt erest - indexed bond
are t raded debt securit ies, t ypically wit h no periodic int erest
Equit y- linked not es pay m ent s, pay m ent at m at urit y is based on an equit y index
in bond indent ur es ar e as e m be dde d opt ion s

D e f . an act ion t hat m ay be t aken if an event act ually occur s bonds wit h no cont ingency pr ovisions ar e
called st ra igh t or opt ion - f re e bon ds
Am e r ica n st yle : can be called anyt im e aft er 1st call

Eu r ope a n st yle : only be called at specified call dat e
Call opt ion Be rm u da st yle : can be called on specified dat es aft er
Benefit issuer t he first call dat e, oft en on coupon pay m ent dat es
Con t in gen cy provision t o avoid t he higher int erest rat es required on callable
m a k e - w h ole call pr ovisions bonds but st ill preserv e t he opt ion t o redeem bonds early
bondholder has t he right t o sell t he bond back

Put opt ion t o t he issuing com pany at a prespecified price
Benefit bondholder
Conver t ible bond + Cont ingent Conver t ible Bond
War rant s
51. F.I securities. Defining elements - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Gov er nm ent and gover nm ent r elat ed bonds

fr om financial corporat ions
Cor por at e bonds
Ty pe of issu er fr om non- financial cor por at ions
St r uct ur e finance ( secur it ized bonds)
S&P, Moody's, Fit ch, et c,.

Cre dit qu alit y
Money m ar k et secur it ies ( < = 1 y ear )
Or igin a l m at u r it ies Capit al m ar k et secur it ies ( > 1 y ear )
Globa l m a r k e t s Float ing r at e
classificat ion Cou pon st r u ct u re Fixed r at e
U.S. dollar s, eur os,...

Cu rr en cy den om in at ion
Dom est ic, for eign, eur os bonds m ar k et ,...
Geography developed m arket s, em er ging m arket s
I ndex - linked bonds, inflat ion- linked bonds

I n de xin g
t ax ex em pt bonds, m unicipal bonds or m unis,...
Ta x st a t u s
Re f e r e nce r a t e in Most used : LI BOR

floa t in g- r a t e de b t
1 . D e t e rm in in g fu n din g n e eds
2 . St r u ct u r in g t h e de bt se cu r it y
3 . Cr ea t in g t h e bon d in den t u r e
4 . N a m in g a bon d t r u st e e
5 . Re gist e r in g t h e issu e w it h se cu r it ie s re gu la t ors
M e ch an ism for issu in g 6 . Assessin g dem a n d & pricin g t h e bon ds giv en m ar k et con dit ion s
bon ds in pr im a r y m ar k e t w it h invest m ent bank or syndi cat e
purchasing t he ent ire issue and
Underw rit t en offering ( pur chase & sell) selling t he bonds t o dealers
7 . Se llin g t h e bon ds Best effort offering invest m ent bank sells t he bonds on com m ission
Auct ion com m only used t o issue gover nm ent debt
D ef: t he t rading of previously t rading bond

Gov . Bond: T+ 1
Se con da r y m a r k e t s for b on ds
Corporat e Bond: T+ 3
Se t t le m en t t im e
5 2 . F.I m a r k e t s: Som e m oney m ark et securit ies: T+ 0
I ssua nce , Tra din g &
Fu n din g
Fixed- rat e
Back ed by t h e Tax in g Pow er of gove r n m e n t
Float ing- rat e
Sov ere ign bon ds
I nflat ion- index ed bond
Se cu r it ie s issu e d
by som e e n t it ie s Tax- backed debt
N on sove r eign gove rn m e n t bon ds Rev enue bond
Age n cy bon ds ( issued by t hose cr eat ed by nat ional gov er nm ent s for specific purposes)
Su pra n at ion al bon ds ( e.g: I MF, WB, ADB...)
Bank debt
Difficult ies:
1 . Det er ior at ion in a com pany's act ual
When m at ur e: " Rolle d ove r " 2 . Significant sy st em ic financial dist r ess
Typ e s of de b t issu e d
Com m ercial paper
by cor por a t ion US: % discount fr om FV
Quot ed pr ice EU: add- on yield
Corporat e bond
Medium - t erm Not e ( not necessar ily m edium - t er m ) *
Cust om er deposit s
Sh or t - t e r m fu n din g
Cer t ificat es of deposit
a lt e r n at ive s a va ilable t o
I nt erbank fund
banks
Cent ral bank fund m ark et
One day: overnight repo

is an agreem ent why w hich one part y sells a securit y t o a count erpart y w it h a
com m it m ent t o buy it back at a later date at a higher price Long period: t erm repo
H igh er, t he lon ge r t he repo t erm

Low er, t he h igh e r t he cr edit qualit y of t he collat eral securit y
Repo ra t e Low e r w hen t he collat eral securit y is delivered t o t he lender
H ighe r w hen t he int erest rat es for alt ernat iv e sour ces of funds are h igh e r
H igh e r , t he lon ger t he r epo t er m
Repo Low er , t he h igh e r t he cr edit qualit y
t he per cent age difference bet ween t he of t he collat er al secur it y
m ar ket value and t he am ount loaned Low er , t he h igh e r t he cr edit qualit y
Repo m ar gin or t h e h a ir cu t of t he bor r ower
Low er w hen t he collat eral securit y is in
high dem and or low supply
Lender s m ust com pet e for bonds by offer ing lower r epo rat e
refers t o t aking t he opposit e side of a repurchase t ransact ion, lending funds by buying
t he collat eral securit y rat her t han selling t he collat eral securit y t o borrow funds
Rev erse repo a greem en t
52. F.I markets. Issuance, Trading & Funding - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Present value of it s fut ure cash Rows,

discount ed at t he bond's yield- t o- m at urit y.
Ca lcula t e a bond's pr ice For annual- coupon bond
For sem iannual- coupon bond
Price & YTM: inversely relat ed

Re la t ionship a m ong P, Price < Par when coupon rat e < YTM and vice v ersa
C.Ra t e , m a t u r it y, YTM Prices are m ore sensit ive t o changes in YTM for bonds wit h
lower coupon rat es and longer m at urit ies and vice versa
D e f: t he m arket discount rat es for a single pm t t o be received in t he fut ure

Spot r a t e
t : days fr t he last coupon pm t dat e t o t he set lem ent dat e

Fla t pr ice , a ccr ue d Fu ll pr ice = Pa r * ( 1 + YTM ) ^ t / T T: days bet ween 2 coupon pm t
in t er e st , fu ll pr ice
of a bond Accru e d in t e r e st = c.p* ( t / T)
Fu ll ( dir t y) pr ice = Fla t ( clean) pr ice + Accr u e d in t e r e st
D e f: a m et hod of est im at ing t he required YTM of bonds

M a t r ix pr icin g t hat are current ly not ( infrequent ly) t raded
5 3 . I nt r oduct ion
t o F.I v a lua t ion St r eet conv ent ion
True y ield
Current y ield ( = annual c.p/ Bond price)
Yie ld m e a sur e s for Fix e d- r a t e bon d Sim ple y ield D e f : ( annual c.p + st raight - line am ort izat ion of discount ) / Flat pr ice
fix e d- r a t e , floa t ing- r a t e ,
m one y m a r k e t inst r um e nt s Yield- t o- call t he low e st of v ar ious YTC & YTM is Yie ld- t o- w orse
Floa t in g- r a t e n ot e
T- bill: discount basis
M on e y m a r k e t in st r u m e n t
A yield curve shows t he t erm st ruct ure of int erest r at es

by displaying yields across different m at urit ies.
The spot curve is a yield curve for single paym ent s in t he
Spot cu r ve , yie ld cu r ve , pa r fut ure, such as zero- coupon bonds or st r ipped Treasury bonds.
cu r ve , for w a r d cur ve The par curve shows t he coupon rat es for bonds of various m at urit ies t hat
would result in bond prices equal t o t heir par values.
A forward curve is a yield curve com posed of forward rat es, such as
l- year rat es available at each year over a fut ure period.
Ca lcula t e spot fr om f or w a r d, Form ula: ( 1 + S 2 ) ^ 2 = ( 1 + S 1 ) * ( 1 + 1 y1 y )

for w a r d fr om spot r a t e s
G- spread ( disadvant age: only correct if Spot y ield curve is flat )

Com p a r e , ca lculat e ,
int e r pr e t y ie ld sp r e a d Yie ld spr e a d ( difference Zero- volat ilit y spread ( add t o each Spot r at e)
bet ween t he yields of 2 bonds) Opt ion- adj ust ed spread
m e a sur e s ( OAS = Z- spread - Opt ion cost )
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a process by which financial asset s are purchased by an ent it y t hat

Def. of t hen issu es securit ies supp ort ed by t he CFs from t hose financial asset s
securit izat ion
a r educt ion in funding cost s

D e f . ar e str uctur ed secur it ies issued by an SPV for Pr im ar y benefit s an increase in t he liquidit y of t he und erlyin g financial asset s
which t he collat er al is a pool of debt obligat ions
low er funding costs for bor r ow er s
May use int erest earned on port folio securit ies, Be n e fit s for se cu r it iza t ion for r educes int er m ediat ion cost s
cash from mat uring port folio securit ies and from higher r isk -adj ust ed r et ur ns for lender s
sale of port folio securit ies t o cover t he promised e con om ie s a n d fin a n cia l m a r k e t s
payment s t o holder s of senior and mezzanine bonds Managed by a collat er al m anager , inv est or s' legal claim t o the m or t gages or ot her loans is st r onger
do not r ely on inter est pay m ents loans when being securit ized will be activ ely t raded - - > increase t he liquidit y
Com par e t o
Collat eralized bond obligat ions ( CBOs) backed t r adit ional st r uct ur e bank s can lend m or e by secur it izing loans
by corporat e an d em ergin g m arket debt
lead t o financial m ot ivat ion that allow s inv estors t o inv est in securit ies
Collat eralized loan obligat ions ( CLOs) t hat bet t er m at ch t heir pr efer r ed r isk , m at ur it y , and r et ur n char act er ist ics
backed by leveraged ban k loan s
prov ides div er sificat ion and risk r educt ion
St ruct ured finance CDOs backed by resident ial I nclu d e
or com m ercial MBS, ABS, or ot her CLOs Colla t e r a lize d de bt
Syn t h et ic CDOs backed by credit
obliga t ion s ( CDOs) is t he fir m t hat is r aising funds t hr ough t he secur it izat ion
The seller
default sw aps on st ruct ured securit ies
co m m o nly backed by aut o m o bile lo ans,
t ypically issue a float ing- rat e t ranche ( 70- 80% ) Senior bonds credit card receiv ables, ho m e equit y lo ans,
m anufact ured ho using lo ans, st udent lo ans,
sm all business adm inist rat io n ( SBA) lo ans,
f ixed rat e int erest Mezzanine bonds buys financial asset s from t he seller and co rpo rat e lo ans, co rpo rat e bo nds, em erging
issues asset -backed securit ies ( ABS) m ark et bo nds, st ruct ured financial pro duct s
CDOs issue 3 tr anches is an ent it y
support ed by t hese financial asset s
Subor dinat ed bonds independent loans owned by t he t rust ( SPV) - - > MBS
leveraged invest m ent (equit y or r esidual t r anche) Se cu r it iz a t ion pr oce ss of t he seller
A special pur pose a single class of ABS
v ehicle ( SPV)
t o ear n r et ur ns fr om t he spr ead bet w een m ult iple classes wit h different priorit ies of
m ay issue
funding costs and por t folio r et ur ns claim s t o t he CFs underlying & different
specificat ions of paym ent s ( wat erfall st ruct ure) each cl ass is called t ranche
Ar bit r age CDO
De f . are ABS backed by various t ypes of financial asset s such as car ries out collection and ot her r esponsibilit ies relat ed t o financial asset s
sm all business loans, acount s receivables, credit card receivables,
The ser v icer m ay be the sam e entity as the seller , not hav e to be
aut om obile loans, hom e equit y loans, m anufact ured housing loans
Back ed by aut om obiles
Mat ur it y : 36 t o 72 m ont hs t he differ ences classes of secur it ies, each w it h a differ ent a par t icular r isk is r edist r ibut ed acr oss
claim t o t he cash flow s of t he under ly ing asset s t he t r anches but t ot al r isk is unchanged
I ssuers: financial subsidiaries of aut o manufact urers, comm ercial banks,
credit unions, finance com panies, ot her sm all financial inst it ut ions Tr anches
I nt er est pay m ent s any cr edit losses ar e fir st absor bed by t he t r anche w it h t he low est
De scr ibe t ypica l st r u ct u r e s pr ior it y and aft er t hat by any ot her subor dinat ed t r anches, in or der
Scheduled pr incipal pay m ent s
CFs com ponent s Au t o Loa n ABS of se cu r it iza t ion s Cr edit t r anching
if car is sold, tr aded in,
r epossessed, st olen, w r eck ed r efer s t o classes t hat r eceiv e t he pr incipal pay m ent s fr om under ly ing
Pr epay m ent s
secur it ies sequent ially as each pr ior t r anche is r epaid in full
N on - m or t ga ge Tim e t r anching
Senior -subor dinat ed st r uct ur e a sse t - ba ck e d se cu r it ie s Som e st r uct ur es hav e bot h t im e t r anching and cr edit t r anching
I nt ernal credit enhancem ent s such as a reserve account , Cr edit enhancem ent
an excess int erest spread, overcollat eralizat ion,...
D e f . is a loan for w hich t he collat er al t hat under lies t he loans is r esident ial r eal est at e
Back ed by cr edit car d r eceiv ables w hich ar e r ev olv ing debt (non-am or t izing)
indicat es t he per cent age of t he v alue of t he r eal est at e collat er al t hat is loaned
I ssuer s: bank s, r et ailer s, t r av el and ent er t ainm ent
Loa n - t o- v a lu e rat io The low er LTVs, the less cr edit r isk
com panies, and ot her cr edit car d issuer
With fix ed or floating inter est r ate US. 15- 20 years; Europe: 20- 40 years or 50 years;
I nt er est pay m ent s Japan: m ay have t erm s of 100 years
Mat ur it y
Cr ed it Ca r d ABS
No principal paym ent s during lockout period because principal
paym ent s are used t o purchase addit ional receivables CFs inter est r at e is unchanged ov er t he life of t he m or t gage
Fix ed- r at e m or t gage
t o preserve credit
qualit y of securit ies Typically have an early amort izat ion provision Adj ust able- r at e m or t gage
or v ar iable- r at e m or t gage E. g An index - r efer enced m or t gage
Apar t m ent s ( m ult i- fam ily ) t he loan becom e an adj ust able- r at e
War ehouses (indust r ial use pr oper t y ) Hy br id m or t gage m or tgage after the initial fix ed- r ate per iod
I nt er est r at e
Shopping cent er s
ar e back ed by inter est r ate changes to a differ ent fix ed
Office buildings
incom e-pr oducing
5 4 . I n t rodu ct ion t o Rollover or renegot iable m ort gage r ate after the initial fix ed- r ate per iod
Healt h car e facilit ies r eal est at e Asse t - Ba ck e d Se curit ie s
Senior housing init ial int er est rat e t er m s ( fix ed or adj ust able)
can be changed at t he opt ion of t he bor r ow er t o
Hot el/ r esor t pr oper t ies adj ust able or fix ed for the r em aining loan per iod
Conv er t ible m or t gage
RMBS loans ar e r epaid by hom eow ner s Re side n t ia l m or t ga ge loa n s
Com par e t o RMBS Fully am ort izing
Com m er cial MBS loans ar e r epaid by r eal estate inv estor s
balloon pay m ent
St r uct ur ed as noncour se loans and in t r anches w it h cr edit r isk Char act er ist ics
losses absor bed by t he low est pr ior it y t r anches in sequence Com m e r cia l Am ort izat ion of principal I nt er est- only lifet im e
M or t ga ge - ba ck e d Par t ially am ort izing
Net operat ing income is calculat ed aft er int er est - only m or t gage I nt er est - only ov er
t he deduct ion for real est at e t axes but se cu r it ie s som e init ial per iod
bef ore any relevant i ncome t axes Debt - t o- service- coverage rat io ( DSC) =
= ( net operat ing incom e) / ( debt service)
The higher t he bet t er D e f : a par tial or full r epay m ent of pr incipal in ex cess of the
Analy sis focuses on the cr edit of scheduled pr incipal r epay m ent s r equir ed by t he m or t gage
Loan- t o- value rat io = the pr oper ty , not of the bor r ow er
t he lower t he bet t er ( current m ort gage am ount ) / ( current appraised value) E. g. sell hom e dur ing m or t gage t er m ; r efinance m or t gage;
pr epay by pay ing m or e t han scheduled pay m ent s
Pr epay m ent pr ov isions
Pr epay m ent lock out per iods No
Defeasance Penalt y benefit s t he lender
Loan- level call prot ect ion pr epay m ent penalt y
Yes
Pr epay m ent penalt y point s
Yield m aint enance char ges Call ( prepay m ent) prot ect ion
t he lender has no claim against
CMBS- level call prot ect ion prov ided t he asset s of t he bor r ow er ex cept
for t he collat er al propert y it self st rat egic default
by t he low er - pr ior it y t r anches
Non-r ecour se loan
For eclosur e
ar e securit ies collat er alized by RMBS t he lender has t he a claim against t he bor r ow er for t he am ount
Recour se loan by w hich t he sale of a r epossessed collat er al pr oper t y falls shor t
Tot al pr epay m ent r isk is not
changed but r eappor t ioned am ong
t he v ar ious CMO t r anches
Agency RMBS
bet t er m at ch inv est or pr efer ences
( m or t gage I ssued by gov er nm ent agencies. E. g: GNMA, Ginnie Mae
incr ease pot ent ial m ar k et pass-t hr ough
Benefit s has m ult iple bond classes Collat er alized m ort gage Or issued by gov er nm ent - sponsor ed ent er pr ises. E. g: Fannie Mae, Fr eddie Mac
for secur it ized m ar k et secur it ies)
(CMO t r anches)w it h differ ent obligat ions ( CMOs) Mor t gages that back m ust be confor m ing loans that m eet cer t ain m inim um cr edit
r educe funding cost s ex posur es t o pr epay m ent r isk
qualit y st andar ds such as dow n pay m ent , LTV r at io, size, docum ent at ion, insur ance
Resident ial Mor t gage- back ed
has differ ent claim against t he CFs
secur it ies (RMBS) include I ssued by pr iv at e com panies
of t he m or t gage pass-t hr oughs Non- agency RMBS
Each t r anche m ay be back ed by nonconfor m ing m or t gages
has differ ent m ix tur e of
cont r act ion and ex t ension r isk Pass- t hr ough r at e, t he coupon r at e on t he RMBS
Separ at e CFs int o t r anches r et ir ed sequent ially W AM is equal t o t he weight ed average of t he final m at urit ies of all
Sequential Pay CMO M ot iva t ion for cr e a t in g t he m ort gages, weight ed by each m ort gage's principal balance as a
Weight ed av er age m at ur it y ( WAM)
se cu r it ize d st r u ct u r e s w it h and w eight ed av er age coupon (WAC) proport ion of t he t ot al out st anding principal value of all m ort gages
t o m ak e pr edict able pay m ent s of the under ly ing pool of m or tgages
r egar dless of act ual pr epay m ent s
m u lt iple t r a n ch e s a n d t h e WAC is the w eight ed av er age of the
ch a ra ct e r ist ics & r isk s of inter est r ates of all m or tgages in the pool
r educe contr act ion & ex t ension r isk
se cu r it iz e d st r u ct u r e s Single mont hly
the upper and low er bounds on m ort alit y rat e (SMM)
the actual pr epay m ent r ates for Planned Am ort izat ion
suppor t t r anches to be sufficient Class ( PAC) CMO RM BS; CFs a n d r isk s Key char act er ist ics tim ing a nd a m ount of Condit ional prepaym ent rat e
I nit ial PAC collar Specific ( CPR) , which m ay be
CFs fr om m or t ga ge loa ns
assum pt ions com pared t o t he Public
Cont ract ion risk from a nd M BS a r e unce r ta in;
w hen t he pr epay m ent r at es is re duce s t he principa l Securit ies Adm inist rat ion
fast er - t han- ex pect ed
outside of t hese abov e bounds CMO St r uct ur es outsta nding - > r e duce s ( PSA) benchm ark for
Br ok en PAC Pr epay m ent r isk s include pr epay m ent s expect ed prepaym ent rat es
t ot a l int e r e st pa id
incr ease t he pr epay m ent r isk of t his w ill r educe

Ex t ension r isk fr om
t he PAC t r anches' pr epay m ent r isk and v ice v er sa
slow er - t han- ex pect ed
The lar ger the suppor t t r anches r elativ e to PAC pr epay m ent s
t r anches, t he sm aller t he pr obabilit y t hat CFs t o Suppor t t r anches
PAC t r anches differ ing fr om scheduled pay m ents Ex t er nal cr edit enhancem ent Thir d par t y guar ant ee
m or e cont r act ion & ex t ension r isk & higher pr om ised int er est r at e
Reser v es fund ( cash or ex cess spr ead)
Float ing- r at e t r anches
occur s w hen t he ABS is issued w it h a face less
Cr edit enhancem ent of t han the v alue of t he under ly ing collat er al
non-agency RMBS I nt er nal cr edit enhancem ent Over collat er alizat ion
t he subor dinat ed t r anches absor b t he fir st losses

Senior / subor dinat ed st r uct ur es
A shift ing int er est m echanism
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1 . An inver t ors w ho holds a fixed- r at e bond t o m at urit y w ill earn an annualized

r at e of r et ur n = YTM w hen purchased
2 . Sells a bond pr ior t o m at ur it y w ill ear n a r at e of r et ur n = YTM ar pur chase if
YTM at sale has not changed since purchase
3 . I f YTM for t he bond incr e a se s aft er purchasing but before 1st coupon dat e, a buy- and- hold
Sou r ce s of r e t u r n s invest or r ealized r et ur n w ill be h ighe r t han t he YTM of t he bond w hen pur chased
4 . I f . .. , inv er t or s w ill ear n a r at e of r et ur n t hat is low e r t han t he
YTM at bond pur chase if t he bond is held for shor t - period
5 . I f YTM for t he bond de cr e a se s aft er pur chasing but befor e 1st coupon dat e, a bond inv est or w ill
ear n a r at e of r et ur n t hat is low e r t han t he YTM at bond pur chase if t he bond is held for long- t erm
D e f: m easure t he approxim at e % P change for changes in yield

M a ca ula y durat ion ( weight ed average of years unt il each CF)
M a ca u la y, m odifie d,
e ffe ct ive du r a t ion M odifie d durat ion ( % change in P for 100 b.p change in yield) For m ula : ModDur = MacDur/ ( 1+ Yield/ k )
Effe ct ive durat ion
Effe ct ive du ra t ion is t h e

m ost a ppr opr ia t e Bonds wit h e be dde d opt ion s: hav e u n ce rt a in fut ure CF
m e a su r e of in t e r e st r at e m eans our PV calculat ion based on YTM ca n n ot be used
r isk for bon ds w it h
e m be dde d opt ion s
D e f . of k ey rat e dur at ion ( par t ial durat ion) is t he sensit iv it y of t he value of a bond or
Key r a t e du ra t ion a n d por t folio t o changes in t he spot r at e for a specific m at ur it y , holding ot her spot r at es const ant
it s k ey u se in m e a su rin g
par t icularly useful t o m easur e t he effect of a
t h e bon d' s sen sit ivit y nonpar allel shift in t he yield curv e on a bond por t folio
H ow a bon d's m a t u rit y, Mat urit y: ( usually) proprt ional

cou pon & yie ld le ve l a ffe ct Coupon rat e: inverse proport ional
it s I n t er est Ra t e Risk ? Bond's YTM: inverse proport ional
Calculat e t he weight ed average num ber of not w or k for a por t folio t hat cont ains
5 5 . Un der st a n ding F.I periods 't il t he port folio's CF will be received bonds w it h em bedded opt ions
r isks & r e t u r n s
Du ra t ion of a port folio Take a weight ed average of t he durat ions
2 m e t h ods of t he individual bonds in t he port folio For m ula : P.Dur= W1.D1 + W2* D2 + ...
( m or e t ypica l)
Assum pt ion: parallel shift in t he y ield curve
M on ey du ra t ion & Pr ice va lu e Money durat ion = Annual Mod.Dur * Full price of bond
of a ba sis poin t ( PV BP) PVBP
V + V + 2V 0
V=
( YTM 2 ) 2V 0
Con vex it y Approxim at e convexit y
Ca lla ble bond: less P volat ilit y at low yield

Put a ble bond: less P volat ilit y at high yield
Charact erist ics
Opt ion - fr e e : Posit ive convexit y + P falls at a decreasing rat e as yields increase
Con ve x it y a dj u st m en t % ch an ge pr ice = - ( de lt a YTM ) * D u r + 0 .5 * Con ve x it y* ( de lt a YTM ) ^ 2
D e f: relat ion bet ween t he v olat ilit y of bond yields & t im es t o m at urit y
St ru ct u re of yie ld vola t ilit y
i.e : ST bond has m ore price volat ilit y t han a longer- t erm bond wit h great er durat ion
ST inv est : horizon ret urn > original bond yield

Re la t ion ship a m on g a bon d's
h oldin g pe riod r et u rn , du ra t ion , LT inv est : horizon ret urn < original bond yield
Decrea se in Yield
in vest m e n t h orizon Horizon= Mac.Dur: horizon ret urn = original y ield
Cr e dit spr e a d & liqu id a ffe ct YTM Spread t o t he benchm ark includes: credit risk prem iu m + illiqu idit y pre m iu
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The probabilit y of default

D e fa ult r isk
Cre dit risk t he port ion of t he value of a bond or

loan a lender or invest or will lose if The expect ed loss is t he probabilit y of
t he borrower default s default m ult iplied by t he loss severit y
Loss se ve rit y
1. 1st lien loan

2. Senior secur ed
3. Senior Unsecur ed m ay NOT be absolut e if having negot iat e
Se nior ra nk ing Ra nk ing 4. Senior subor dinat ed
5. Subor dinat ed
Ret ur n im pact = - Mod.Dur * ( delt aSpr ead)
Sm a ll spre a d cha nge s 6. Junior subor dinat ed
Re t u rn im pa ct
% change pr ice = - ( delt aYTM) * Dur + 0.5* Convex it y* ( delt aYTM) ^ 2 Re cove r y r a te : pa r i pa ssu ( debt s at the sam e level 'll be paid equally)
La r ge r spr e a d cha n ge s
Cor por a te fa m ily r a ting ( CFR) : r at ed on Senior unsecur ed debt
Cr edit cycle Ra t ing
Cor por a te cr e dit r a ting ( CCR) : based on NOTCHI NG
Financial m ar ket per for m ance
Econom ic condit ion Yie ld spre a d Rat ings ar e dynam ic
Fa ct or s a ffe ct
Br oker - dealer capit al Risk in re ly ing on Rat ing agen cies ar e NOT per fect
Gener al m ar ket dem and & supply Age n cy ra t in gs Event risks are difficult t o assess
Rat ing lag m ar ket pr icing
Rat ing agencies publish benchm ark values for financial 5 6 . Fu n da m e n t a ls of

Ev a lua t e t he cre dit qua lit y Soundness of st rat egy
rat ions t hat are associat ed wit h each rat ings classificat ion cre dit a n a ly sis
Track record
Char act er Account ing policies and t ax st rat egies
EBI TDA
Fraud and m alfeasance record
Funds from operat ion s ( FFO)
Prior t reat m ent of bondholders
Free cash flow before dividends Com m on m e t rics
Port er's five forces ( discussed
Free cash flow aft er dividends
I ndust ry st ruct ure on equit y valuat ion)
Debt / capit al Fin a ncia l ra t io
Debt/ EBI TDA I ndust ry cyclicalit y
Le ve ra g e rat io
FFO/ debt I ndust ry fundam ent als I ndust ry growt h prospect s
Capacit y I ndust ry published st at ist ics
EBI TDA/ int erest expense
Cove ra g e ra t io ( m easure t he borrower's abilit y Com pet it ive posit ion
EBI T/ int erest expense t o generat e CFs t o m eet int erest paym en t )
Tra dit iona l cre dit a na ly sis 4 Cs
Operat ing hist ory
Com pany fundam ent als
Managem ent 's st rat egy and execut ion
Rat ios and rat io analysis
Affirm at ive requires t he borrower to t ake certain act ions
Covenant s
Negat ive rest rict s t he borrower from t akin g certain act ions
I nt angible asset s
Depreciat ion
Collat er al
Equit y m arket capit alizat ion
Hum an and int ellect ual capit al
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5 7 . DERI VATI VE M ARKETS AN D I N STRUM EN TS
D ERI VATI VES 5 8 . BASI CS OF D ERI VATI VE PRI CI N G AN D VALUATI ON
5 9 . RI SK M AN AGEM EN T APPLI CATI ON S OF OPTI ON STRATEGI ES
DERIVATIVES - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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I t s r etur n is based on anot her

inst r um ent ( under ly ing assets)
Physical
D e fin it ion
Finance The biggest t rading volum e
Under ly ing assets
Event
Organized m arket - > liquid

Buy an asset at one pr ice St andard t erm s
Concurrent ly sell it at higher price Ex change No default r isk
Ar bit r age
- > Riskless profit w it hout invest m ent Arbit ra ge & t h e la w of on e price Daily set t lem ent
W h e r e de r iv a t ive s a r e t ra de d?
NO arbit rage opport unit ies exist privat e bet w een 2 part ies - > illiquid
The law of one pr ice Cust om ized t erm s
OTC default risk & legal risk
Difficult t o under st and
Com plex at t he end of t he cont ract : set t lem ent
Crit icism
Zero- sum gam e 5 7 . D e r iv a t ive
Legal gam bling Firm and binding agreem ent - > obligat ion
M ar k e t s an d
For w ar d com m it m ent No prem ium paid up front
I n st r u m en t s Ch a ra ct e rist ics
I nform at ion about underlying pr ice
The long has t he flexibilit y - > opt ions
Pr ice discov er y
Contingent claim s Prem ium is paid up front by t he long
Cont r ol risk
Risk m anagem ent
Pu r pose s of de riv a t ive s m a r k e t Exchange, OTC, Forwar d com m it m ent
Mispr iced - > adj ust quickly - > For w ar ds
m arket efficiency
Mar ket efficiency Exchange, Forw ard com m it m ent
Fut ur es
Low t nx cost
Tr ading efficiency Exchange, OTC, Cont ingent Claim s
Opt ions
Ty pe s of de riv a t ive s OTC, Forward com m it m ent s
Swaps
a cont ract t hat provides a bondholder
( lender) wit h prot ect ion against a
dow ngrade or a default by t he borrow er
Credit default swap ( CDS) - > m ost com m on
Cr edit derivat ives Types
Credit spread opt ion
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St orage, insu rance cost s - - > v ery l ow , not si gni ficant for financial asset s
Cost s of holding an asset Oppor t uni t y cost of t he i nvest ed funds i n t he asset
Monet ar y : div i dend pay m ent s, int erest pay m ent s

Benefit s of holding an asset Non- m onet ar y : conv eni ence y i eld
Cost of carry
Net cost of holding an asset
Ex pla in con ce pt s
Valuat ion of deri vat i ves i s based on a
no- arbit rage condit ion wit h risk - neut ral pricing
asset posi t ion at t im e 0 + short posi t ion in a
forw ard cont ract at t im e 0 = ( payoff on t he
Cash i nflow > cash out flow
asset at t im e T + payoff on t he short forw ard
- > int rinsic v alue > 0 I n t he m oney : payoff > 0 Risk of a deri vat i ve is ent irel y based on t he risk of t he at t im e T) / ( 1 + Rf) ^ T
under lyi ng asset , w e can const r uct a fully hedged
Out of t he m oney: payoff < 0 Money ness
port folio and discount it s fut ure CFs at t he risk - free rat e
At the m oney : payoff = 0
risk y asset + deri vat i ve = risk - free asset
I n t he m oney: S- X> 0
Three replicat ions am ong a deriv at iv e, it s risk asset - risk - free asset = - deri vat i ve posi t ion
Out of t he m oney: S- X< 0 Call opt ion underlyi ng asset and a risk - free asset
Ex e rcise , t im e va lu e a n d deri vat i ve posi t ion - risk - free asset = - risk y asset
At t he m oney: S = X m on e yn e ss of a n opt ion
I n t he m oney: X- S> 0 Op t ion Price of a forward or fut ures cont ract is
t he forw ard price speci fied in t he cont ract
Out of t he m oney: X- S< 0 Put opt ion Price & Va lu e of f orw a rd
Value of a forw ard or fut ures cont ract i s zero at ini t iat ion. I t s val ue m ay
At t he m oney: X = S a n d fu t u r e s con t r a ct s
increase or decrease during it s l ife, w it h gains and losses i n t he v alue of a
opt ion prem ium = int rinsic v alue + t im e v alue Tim e val ue i s t he am ount by w hi ch an long posi t ion j ust opposi t e t o gai ns or losses in t he value of a short posi t ion
opt ion's pr ice is gr eat er t han it s ex ercise
v alue. Tim e v alue is zero at ex pirat ion F0 ( T) + , an ar bit r ageur could t ake shor t
posit ion, sell asset at t im e T at F 0 ( T) + ,
buy at S 0 , wit h funds bor r owed at Rf,
I f t here are no cost s or benefit s r epay t he loan at cost of S 0 ( 1+ Rf) ^ T,
The val ue of a call opt ion is t he great er of zero or t he underlyi ng asset price m inus t he ex erci se price Eu r ope a n opt ion fr om holding t he under ly i ng keep t he posit ive differ ence bet ween
The val ue of a put opt ion is t he great er of zero or t he ex erci se price m inus t he underlyi ng asset price a t e x pira t ion 5 8 . Ba sics of asset , forw ard price of an asset F0 ( T) + and S 0 ( 1+ Rf) ^ T,
Det erm in e va lu e & price t o be del ivered at t im e T is
Deriva t ive Pricin g F0 ( T) - , do opposit e t r ansact ion
one part y pays a float ing rat e and t he ot her a n d V a lu a t ion ( Pa rt 1 ) of a forw ard con t ra ct
pays a fixed rat e on a not ional princi pal am ount The val ue of a forw ard cont ract is zero
A Sim ple int erest - rat e sw ap
at init iat ion. During it s life, at t im e t ,
The fi r st paym ent is k now n at ini t iat ion and t he r est of t he paym ent s ar e unknow n t he value of t he forw ard cont ract i s
Sim ilar t o but different from
The unk now n paym ent s ar e equi val ent t o t he paym ent s on off- m ar ket FRAs At expirat ion, t he payoff t o a l ong forward is S T - F0( T) , t he difference bet ween
a series of forward cont ract s
t he spot price of t he asset at expirat ion and t he price of t he forw ard cont ract
t o Replicat e a sw ap w it h a val ue of zero at ini t iat ion, t he Sw a p con t r a ct s
sum of t he present val ues of t hese FRAs m ust equal zero
The price of a sw ap is t he fi xed rat e of int erest specified in t he sw ap cont ract . I f holding an asset has cost s and benefit s,
t he no- arbit rage forward price is
The val ue depends on how expect ed fut ure fl oat ing rat es change over t im e. An increase Di st inguish bet ween Be n e fit s a n d cost s a ssocia t e d
in ex pect ed short - t erm fut ure rat es w i ll produce a posi t ive val ue for fi xed- rat e payer, and t he val ue and pr ice The pr esent val ues of t he cost s and
a decrease in ex pect ed fut ure rat es w i ll produce a negat ive val ue for fi xed- rat e payer
w it h h oldin g t h e u n de rlying
benefit s decr ease as t im e passes. The
a sse t a n d it s e f fe ct s val ue of t he forw ard at t im e t is
Gai ns and losses on fut ures cont ract s are set t led daily At expir at ion t he cost s and benefi t s of holding t he asset ar e zer o and
do not affect t he val ue a l ong for war d posit ion, w hich i s S T - F0 ( T)
Prices of forw ards and fut ures t hat have t he sam e t erm s m ay
be different i f int erest rat es are correl at ed w it h fut ures prices
W h y f orw a rd a n d A forw ard rat e agreem ent ( FRA) is a derivat i ve cont ract t hat has
Fut ur es ar e m or e val uable t han forw ar ds w hen i nt er est r at es and fut ur es prices
fu t u r e s price s diffe r a fut ur e int er est r at e, rat her t han an asset , as i t s under lyi ng
ar e posit iv el y cor relat ed and less v al uable w hen t hey ar e negat iv el y cor relat ed.
I f int er est r at es ar e const ant or uncor r elat ed w it h fut ure A fir m t hat int ends t o bor row in t he fut ur e can l ock
prices, t he prices of fut ures and forw ards are t he sam e an i nt er est r at e w it h a long posit ion in an FRA
FRAs are used by fi rm s t o hedge
t he r isk of bor row ing and lending A fir m t hat int ends t o lend in t he fut ur e can l ock
t hey i nt end t o do in t he fut ur e. an i nt er est r at e w it h a shor t posit ion in an FRA
Forw a rd Ra t e Agr e e m e n t ( FRA)
E.g
58. Basics of Derivative Pricing and Valuation - P1 - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Fa ct ors de t er m in in g
t h e va lu e of a n opt ion
a n d t h e ir e ffe ct s
Tips t o r e m e m be r e qua t ion :

SEX Y COP
Pr ices of Eur opean and Am erican opt ions w ill be equal unless
t he right t o exercise prior t o expir at ion has posit iv e v alue
C: cal w it h st r ik e pr ice X
no advant age t o The under lying m akes no cash pay m ent s P: put w it h st r ik e pr ice X
early exercise C( Am er ican) = C ( Eur opean) S: underlying
Cir cu m st a n ce s t h e +: Long
The underlying m akes cash pay m ent Call opt ions
va lu e s of Eu r ope a n a n d - : Shor t
C( A) > = C( E) ( dividend am ount is large enough)
Value ( Am er ican) > = Am er ica n opt ion s diffe r Exercise pr ice on t he put = ex er cise price on t he
The opt ions ar e Value ( Eur opean) call = face value of t he risk less bond = X
deep in t he m oney P( Am er ican) > P( Eur opean) Fiduciar y call: a call opt ion and a risk - fr ee zero- coupon
Put opt ions
bond t hat pay s t he st rik e price X at ex pir at ion
Early ex ercise can be valuable
Pr ot ect iv e put : a shar e of st ock and a put at X
5 8 . Basics of
Wh ere: De riva t ive Pr icing a nd Fiduciary call = pr ot ect iv e put
Probabilit ies
Rf = risk- free rat e
U = size of an up- m ove Va lu a t ion - Pa r t 2
On e - pe r iod bin om ia l
D = size of an dow n- m ov e
m ode l t o det e rm in e
Calculat ing t he pay off of t he opt ion at m at ur it y t h e va lu e of a n opt ion
in bot h t he up- m ov e and dow n- m ov e st at es Pu t - ca ll pa r it y for
Calculat ing t he expect ed v alue of t he opt ion in one y ear as Eu r ope a n option s Synt het ic call
t he pr obabilit y - w eight ed av er age of t he pay offs in each st at e
Calculat e t he v alue of an opt ion by
Discount ing t his expect ed value
back t o t oday at t he r isk - free r at e
is der ived wit h a forwar d cont r act r at her t han t he under lying asset it self
Pu t - ca ll- forw a rd pa r it y Sy nt het ic put

The pr esent value of an asset 's for war d pr ice is equal t o it s
spot pr ice, we can subst it ut e t he pr esent value of t he forwar d for Eu r ope a n option s Com binat ions
pr ice int o t he put - call par it y r elat ionship at t he init iat ion of a
for war d cont r act t o est ablish put - call- f or war d par it y as
Synt het ic underlying
Sy nt het ic bond
Cover ed call
Ar bit r age oppor t unit y
58. Basics of Derivative Pricing and Valuation - P2 - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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= Long st ock + short call

= S - C
Covered call = call is covered by a long st ock
Cove r e d ca ll
Payoff diagram
Payoff ( covered call) = Payoff ( Long st ock) + Payoff ( short call)
= ST - Max( 0, S T - X)
Profit ( Covered call) = Payoff ( Cov ered call) - So + C
Max loss when payoff is m in - > S T = 0 - > Max loss = So - C
Max profit when payoff is m ax - > ST > X
5 9 . Risk M a n a ge m e n t Payoff diagram ( Covered call) : sim ilar t o payoff diagram of short put
Applica t ions of
Opt ion St r a t egie s = Long st ock + Long put
= S + P
Prot ect ive put = Long put prot ect s pot ent ial loss of a st ock
Pr ot e ct ive put
Payoff diagram
Payoff ( Prot ect ive put ) = payoff ( Long st ock) + Payoff ( long put )
= ST + Max( 0, X - S T)
Profit = Payoff - So - P
Max loss when payoff is m in - > S T = 0 - > Max loss = So + P - X
Max profit when payoff is m ax - > ST > X - > Max profit is indefinit e
Payoff diagram ( prot ect ive put ) is sim ilar t o t hat of long call
59. Risk management Appications of Option Strategies - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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ALTERNATIVE INVESTMENTS - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Less liquidit y of underlying invest m ent s

More specializat ion by invest m ent m anagers
Higher m anagem ent fees
a . Al vs Tr a dit ional Less regulat ion and t ransparency
I nv e st m e nt s More problem at ic and less available
hist orical ret urn and volat ilit y dat e
Different legal issues and t ax t reat m ent s
Low correlat ion wit h t radit ional invest m ent s
Hedge funds
Privat e equit y funds
Real est at e
Ca t e gor ie s Com m odit ies
fine wines, Stam ps, aut om obiles, ant ique fur nit ur e,
and ar t , as w ell as pat ent s, an int angible asset "
Ot her
Low cor r elation w it h t r adit ional inv est m ent s

Pot ent ial port folio Higher av er age r et ur ns t han
diversificat ion benefit s t r adit ional inv est m ent s
Pot ent ia l benef it s Sur v iv or ship bias

Problem of ret urn m easures biased
Backfill bias
upward, risk m easures biased downward
Should include analysis of hist orical downside
frequencies & worst ret urn in a m ont h
6 0 .1 . Alt e r n a t ive
I n ve st m e n t s - Pa r t 1 Risk vary across alt er nat ive invest m ent s
Lept okurt ic & negat ively skewed
St andard deviat ion of ret urns m ay be Sm oot h ret urns due t o appraisals or
a m isleading m easure of risk infrequent m arket t ransact ions
Result ing Sharpe m easures bias upward
and est im at es of bet a m isleading
I nvest ors should consider downside risk m easur es such
as value at risk ( VaR) or Sort ino rat io
For publicly t raded securit ies, such as REI Ts and ETFs, m ar ket ret urns
I nvest m ent and risk are used and st andard definit ions of risk are m ore applicable
m anagem ent process Use of derivat ives int r oduces operat ional,
financial, count er part y & liquidit y risk
Risk of m anagem ent underperform ance
Risk m ana ge m ent Hedge funds and privat e equit y funds ar e m uch less
t r anspar ent t han t r adit ional inv est m ent s
Many alt ernat iv es invest m ent s are illiquid
When calculat ing opt im al allocat ions, indices of hist orical ret urns and st andard
deviat ions m ay not be good indicat ors of fut ure ret urns and volat ilit y
Correlat ions vary across periods and are affect ed by event s
Or ganizat ion
Por t folio m anagem ent
Oper at ions and cont r ols
Due diligence Risk m anagem ent
Legal r eview
Fund t er m s
60.1. Alternative Investments - Part 1 - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Aggressively m an aged port folio of

in v est m ent s across asset classes & regions
Use leverage, derivat ives, t ake long
& short posit ions
Goal of generat ing high ret urns in
absolut e value or over a specified
m arket benchm ark
Buy out s funds acquire public Set up as lim it ed part nerships
com panies or est ablish ed com panies Ty pical char act er ist ics Rest rict ions on redem pt ions
Sig nificant percent age of purchase
Lock up period: Minim um t im e
price fin an ced t hrou gh debt before in vest ors can w it hd raw funds
Leveraged bu you t s
Debt t ypically collat eralized by Lim it ed t o qualified invest ors Not ice period: Days w it hin w hich t he
asset s of t arget com pany fun d has t o fulfill a redem pt ion
Target com pany becom es or rem ains privat e requ est , t y pically 30- 90 days
I nvest ing in or financing t o privat e Charged a fee t o redeem shares

com panies wit h high pot ent ial grow t h Fu nd s t hat hold a port folio of hedge funds
Vent ure capit al Definit ion
Typically t h ese are st art - up or youn g com p anies
Cat egor ies Mak ing hedge funds accessib le t o sm aller in v est ors
Minorit y equit y invest m ent s in m ore
m at ure com panies Allow ing diversificat ion am ong hedge funds
For expanding or rest ruct uring, Benefit s Having expert ise on conduct ing due diligence on hedg e funds
Developm ent capit al
ent ering new m arket s or financing
Able t o neg ot iat e bet t er redem pt ion fees, i.e.
m aj or acquisit ions Funds of funds
short er lock- up period and/ or not ice period
Buying debt of m at ure com panies in
Ext ra fees at fun ds of fund s level
financing difficult ies
an d individu al h edge fu nd level
I nvest ors plan t o t urn around t he Dist ressed in v est ing Draw backs High expense rat io w hich w ill drag
com pan y an d expect debt t o
down earning s over t im e
increase in v alue
Buy shares of firm being acquired
Typical st ruct ure as a lim it ed part nership
and sell short t he firm m aking t he
I nvest ors provid e com m it t ed capit al which fun d St ruct ure acquisit ion
Merger arbit rage
m anagers draw down t o invest in p ort folio com p anies
Managem ent fee of 1- 3% of com m it t ed capit al unt il Buy t he ( un dervalued) securit ies of firm s in
fully in vest ed; fees calculat ed on NAV aft er t hat financial dist ress w hen analysis indicat es
St r uct ur e and fees v alu e w ill be in creased by a successful
I ncent ive fees t ypically 20% profit s aft er rest ruct uring; possibly short overvalued
LPs have received init ial invest m ent back Fees Event - driven ( Profit from short - t erm event s) securit y t ypes at t he sam e t im e.
Dist ressed/ rest r uct urin g
Fees paid periodically m ay exceed 20 % over t im e: clawback
provision requires m anagers t o ret urn ex cess fees Gain b oard seat s t o influence
Act ivist shareholder com pany decisions
current m anagem ent t eam involved in
t he acquisit ion, rem ain wit h t he com p any Managem ent buy out ( MBO)
Sp in offs, asset sales, securit y
Special sit uat ions issu ance or repurchase
Current m anagem ent t eam is being replaced Managem ent buy - ins ( MBI )
Buy convert ible bonds and sell t he
Debt is t he key t o financing a buyout
Fixed incom e convert ible arbit rage sam e issu er' s com m on st ock s
deal: e.g equ it y 30% , debt 70 %
Usually, debt = bank loans
Fixed incom e asset backed Take advant age do m ispricing across d ifferent ABS
( leveraged loan s) + h igh yield bon ds Relat ive value ( Profit from a pricing
Leveraged loans: usually largest am ount discrepancy bet ween relat ed
Fixed incom e general Relat ive value w it hin fixed incom e m arket s
securit ies)
Mezzanine financing m ay be used inst ead of high LBO financing
yield bond s. Mezzanine refers t o debt or preferred Trade opt ions based on im plied
shares w it h w arrant s or conversion opt ions versus expect ed volat ilit y
Volat ilit y
Covenant s included t o prot ect invest ors: m aint ain
specified financial rat ios, subm it inform at ion, rest rict Acr oss asset classes or in st r um ent s
from furt her borrow ings, lim it dividend dist ribut ions Mult i- st rat egy
Undervalued/ depressed st ock price: St r at egies Em phasizes a t op- dow n approach t o

PE firm s perceive t hat int rinsic value LBO: Financing ident ify econom ic t rends across t he world
of t he com pany exceeds it s m arket Use long and/ or short posit ions t o pot en t ially
price, t hus w illing t o pay a prem ium profit from a view on overall m arket direct ions
Willing m anagem ent : exist ing Macro Trades are m ade based on expect ed
m anagem ent is lookin g for a deal m ovem ent s in econom ic variables
I nefficient com p anies: PE firm s seek Trade opport unist ically in t he fixed incom e,
t o generat e at t ract ive ret urns on H e dge fu nds
equit y, currency, and com m odit y m arket s
equit y by im proving t he inefficient
com panies Long und ervalued securit ies & short
6 0 .2 . Describe dif f erent overvalued securit ies, equal values
St rong and sust ainable cash flow:
cash flow is necessary t o m ake Charact erist ics of at t ract ive t arget com panies ca t egories & issues Market neut ral in long and short posit ions
Pr iv at e equit y st r at egies in valuing and
int erest paym ent s on t he increased
debt load ca l cu lat ing ret urns I dent ify high grow t h com p anies,
Low leverage: t o m ake it easier t o Fundam ent al grow t h t ake long posit ions
( Part 2 )
ut ilize debt t o finance a large port ion
of t he purchase price Focusing on pub lic equit y m arket s, I dent ify undervalued com p anies,
Asset s: phy sical asset s can be used Pr iv at e equit y t aking long & short posit ions in Fundam ent al v alue t ake long posit ions
as securit y and secured d ebt is equit y and equit y deriv at ives
cheaper t han unsecured debt Equit y h edge fu nd st rat egies Long und ervalued securit ies & short
overvalued securit ies, m ay have net
I dea st age: fun d t o t ransform t he idea int o a long or short exposure
Quant it at ive direct ional
business plan and access m ark et pot ent ial Angel inv est ing
I dent ify overvalued securit ies, net
Seed capit al su pport s produ ct developm en t an d/ or short exposure
Form at ive st age Short bias
m arket ing effort s. First st afe vent ure capit al fnds invest Seed st age
Sect or specific I dent ify opport unit ies in part icular sect or
St art - up: organ ize produ ct ion Vent ure capit al
Early st age
1 st st age: began produ ct ion
ret urns t end t o be bet t er t han t hose
2 nd st age: init ial expansion of global equit ies in d own
Lat er st age equ it y m arket s and t o lag t he
3rd st age: m aj or ex pansion
ret urns of global equit ies in u p
Mezzanine or " bridge" ( pre- I PO) m ark et s.
Benefit s
Most ly for privat e bu t called Pot ent ial benefit s and risks Best ret urns during different t im e periods
Developm ent capit al or m inorit y
PI PEs for pub lic com panies equit y invest ing correlat ions t end t o increase during
Risks periods of financial crisis
Dist ressed in v est ing
Ot hers
Provision of m ezzanine funds
Frequency of valuat ion varies: daily,
I nvest ing in com panies in specific indust ries w eekly, m ont hly, or quart erly
Sell port folio com pany t o com pet it or Use of m arket or est im at ed values of underlyin g posit ions
Trade sale
A com m on p ract ice of using average quot e = [ ( bid+ ask) / 2]
Sell port folio com pany t o ot her PE invest ors if m arket value is use. A m ore conservat ive approach is t o
Secondary sale
Valuat ion use bid for long s and ask for short s
Sell port folio com pany shares t o public Est im at ed values are used for illiquid or non= t raded invest m ent s.
I PO
Procedures for in- house valuat ion should be developed t o ensure
Pr iv at e equit y ex it st r at egies consist ency and redu ce effect s do pot ent ial conflict s of int erest
I ssu e port folio com p any debt t o fun d
dividen d paym en t ( t o privat e equ it y ow n er) Recapit alizat ion I nvest m ent st rat egy.
I nv est m ent process.
Out right sale of t he firm ' s asset s wh en
t he firm is deem ed n o long er viable Source of com pet it ive advant ages.
Writ e- off/ Liquidat ion
Hist orical ret urns.
Ret urn: possible higher ret urn opp ort unit ies by PE funds due Valuat ion and ret urns calculat ion m et hods.
t o abilit y t o invest in privat e com panies, influence on port folio
Longevit y
com panies' m anagem ent & operat ions, use of leverage
Pot ent ial diversificat ion benefit s given less t han perfect correlat ion Am ount of asset s under m anagem ent
Due diligence: fact or s to consider
Managem ent st yle
US privat e equit y perform ance index out perform ed
st ocks based on NASDAQ and S&P 50 0 Key person risk
Measuring hist orical p erform ance of PE m ay be Div er sificat ion benefit s, Reput at ion
problem at ic due t o survivorship, backfill and ot her biases per for m ance & r isk
Grow t h plans
Higher risks in PE invest ing t han com m on st ocks
Syst em s for risk m anagem ent
Likely large difference in ret urns bet ween t op quart ile
Appropriat en ess of ben ch m ark
( I RR = 22 % ) and bot t om quart ile ( I RR = 3% )
Hedge fund - " 2 and 20 " ( 2% m anagem ent fee &
Market or com p arable: using m ult iples ( e.g EBI TDA
Com m on st ruct ure 20 % incent ive fee) . FOF - " 1 and 10 "
m ult iple, net incom e & revenue m ult iples)
DCF: PV of t he relevant expect ed fu t ure cash flows ( FCFF & cost of
Hu rdle rat e: fee st ruct ure m ay specify t h at t he Hard hurdle rat e: incent ive fee b ased
capit al; FCFE & cost of equit y; capit alize in com e or cash flow Por t folio com pany v aluat ion incent ive fee is only earned aft er having ach ieved
Fee st r uct ur e on ret urns in excess of t h e hurdle rat e
Asset - based: Asset s - Liabilit ies = Value t o equit y holders a specified ret urn known as hurdle rat e
Soft hu rdle rat e: on t he ent ire ret urn
Current and ant icip at ed econom ic condit ions High w at er m ark: t o avoid paying t wice for t he sam e perform ance
I nt erest rat e and capit al availabilit y expect at ions
Refinancing risks
Choice of m anager ( general part n er) ,
GP experience & know ledge
Financial & operat ing Fact ors t o consider
I nv est m ent consider at ion &
Valuat ion m et hodology
Due diligence
Alignm ent of GP' s incent ives wit h int erest s of LPs
Plan t o draw on com m it t ed capit al
Planned exit st rat eg ies
Fact ors in DD of hedge funds also apply
60.2. Describe different categories & issues in valuing and calculating returns - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Direct invest m ent s: sole ownership, j oint vent ures
I ndir ect inv est m ent s: lim it ed par t ner ships,
or ot her for m s of com m ingled funds
Form s of re a l e st a t e
A claim on an asset : m or t gages
inve st m e n t
Mor t gage- back ed securit ies ( r esident ial and com m er cial)
Shar es of RE operat ing com panies; shares of REI Ts
Dir ect equit y invest m ent by

individuals and fam ilies
Debt financing for hom e ow nership Dir ect holder of t he m or t gage
by financial inst it ut ions
I ndirect inv est m ent in m or t gage loan pool
Resident ial propert y
Adequat e proport ion of pur chase
pr ice as equit y
Befor e offer ing a m or t gage, due
diligence process should include Credit r ev iew of t he bor row er
Pr oper t y appr aisal
Direct equit y and debt invest m ent

Com m ercial propert y Lim it ed t o cert ain t ypes of inv est or s
I ndirect invest m ent vehicles
MBS: asset - backed securit ized debt

obligat ions t hat represent right s t o receive
cash flow s from por t folio of m or t gage loans
Mor t gages, m or t gage- back ed securit ies ( MBS) Com m ercial MBS: backed by com m er cial proper t ies
Sub- ca t e gor ie s Resident ial MBS: back ed by r esident ial pr oper t ies
Mor t gage REI T: I nvest pr im ar ily in m or t gages

Real est at e invest m ent t rust s ( REI T) Equit y REI T: inv est pr im ar ily in
com m ercial or resident ial propert ies
I nflat ion hedge

I ncom e from har vest quant it ies &
Re a l e st a t e agricult ural com m odit y prices
Farm land
Ret urn drivers: sam e as t im erland
Tw o proper t y t y pes Row cr ops, per m anent cr ops
Farm land, t im erland

I ncom e st r eam fr om sale of t im ber product s
Ret ur n dr iv er s ar e biological gr ow t h, com m odit y
pr ice changes and land price changes
Tim erland
Hist orically not cor r elat ed w it h ot her asset classes
Flex ibilit y because t im ber can be gr ow n
and easily st ored by not harv est ing
Hist orically, r eal est at e r et ur ns ar e highly cor r elat ed wit h global equit y r et ur ns
but less cor r elat ed wit h global bond r et ur ns. The const r uct ion m et hod of r eal
est at e indexes m ay cont r ibut e t o t he low corr elat ion wit h bond r et ur ns.
Pot ent ia l bene fit s a nd r isk s
Fe e st r u ct u r e
global national econom ic fact or s
Local m arket condit ions
Fact or s t o consider I nt erest rat es
6 0 .3 . D e scr ibe d iffe re nt regulat ions
ca t e gor ie s & issue s Due dilig ence
Pr opert y - specif ic r isk s
abilit ies of m anagers
in va luing a nd ca lcula t ing
Addit ional r isk fact or s t o consider
ret urns ( Pa rt 3 ) zoning, perm it t ing, and environm ent al
for dist r essed propert ies inv est ing
and real est at e dev elopm ent consider at ions or rem ediat ion, ...
The com parable sales approach based on recent sales of sim ilar pr opert ies
Est im at es pr oper t y values by calculat ing t he pr esent

value of expect ed f ut ur e cash flows fr om pr oper t y
ownership or by dividing t he net oper at ing incom e
Va lua t ion ( NOI ) for a pr oper t y by a capit alizat ion ( cap) r at e
The incom e appr oach
The cost appr oach estim at es the replacem ent cost of a pr oper t y.
Ex change- tr aded funds ( com m odit y ETFs)

Equit ies t hat ar e direct ly link ed to a com m odit y
Managed futur es funds
Met hods of ex posur es t o com m odit ies
I ndiv idual m anaged account s
Specialized fund s in specific com m odit y sector s
Ret ur ns on com m odit ies lower t han ret urns on global st ocks or bonds
High volat ilit y, especially w hen com bined w it h leverage
Low Shar pe r at ios for com m odit ies giv en low er
r et ur ns and high v olat ilit y of com m odit ies prices
Pot ent ial Benefit s and
Risk s of Com m odit ies Zero real ret urn
Pot ent ial for a posit iv e r eal r et urn w it h liquidit y and
ot her pr em ium s of com m odit y fut ur e cont r act s
Diversificat ion benefit s
Com m odit y spot pr ices depend on supply and dem and

I nelast ic supply in t he short run because of long lead t im es
Com m odit ies
Weat her affect s agr icult ural com m odit ies and oil pr oduct ion
Pr ices a nd I nv est m ent s
Cost s of new supply m ay incr ease ov er t im e
Ant icipat ing dem and from m anufact uring needs
Convenience yield: value of hav ing t he phy sical

com m odit y for use ov er t he per iod of t he fut ur e cont r act
I f t his equat ion does not hold, an ar bit rage t ransact ion is possible
Cont ango: lit t le or no convenience y ield, fut ur es pr ices > spot prices
Back w ar dat ion: high convenience yield is high, fut ures pr ices < spot prices
Com m odit y fut ure s pr icing
Roll yield: t he yield due t o a differ ence bet ween t he
spot pr ice and f ut ur es pr ice or a differ ence bet ween
t wo fut ur es pr ices wit h differ ent expir at ion dat es
Three sources of com m odit ies Collat er al yield: t he int er est ear ned on collat er al
fut ures ret urns r equir ed t o ent er int o a fut ur es cont r act
Change in spot pr ices: spot pr ices ar e
det er m ined by fact or s as discussed ear lier
Tangible collect ibles ar e consi der ed inv est m ent s,

Ot h er a lt e rn a t ive including r ar e w ines, ar t , rare coins and st am ps,
in vest m e n t s val uable j ew el r y and wat ches, and spor t s m em or abilia.
60.3. Describe different categories & issues in valuing and calculating returns (Cont) - CFA Mind Maps Level 1 - 2017 - Copyright by WAY TO FINANCE SUCCESS
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Mind map CFA exam prep 2017-1

Finance (Kedge Business School)

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WAY TO FINANCE SUCCESS

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CFA® MIND MAPSTM 2017 LEVEL 1 BOOK

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3 .5 St a nda r d V. I N V ESTM EN T AN ALYSI S,

3 .4 St a nda r d I V . D UTI ES TO EM PLOYERS 3 .3 St a nda r d I I I . D UTI ES TO CLI EN TS

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All CFA I nst it ut e m em ber s and candidat es ar e

Maint ains ov ersight and responsibilit y

Request ing a w rit t en ex planat ion

2 . Code Of Et hics And Conclude t he inquir y w it h no disciplinary sanct ion

Act w it h in t egrit y , com p et ence, d ilig ence,

Six com ponent s of Care & j udgm ent

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Responsible for violations in w hich they

At t em p t t o stop t he b eh av ior b y b r in g ing it t o t he at t en t io n o f

Maint ain independence and

Fr o m Bu y side clients May t r y t o p r essure sellside analysts

Fr o m t h eir e. g. to issue favorable research reports/

Modest gifts and ent ert ainm ent are

Best practice: rej ect any offer of gifts,

I s fraught w ith conflicts

Protect integrity of opinions

D ef in it ion o f any untrue statem ent or om ission of a fact

qualifications or credentials, services

Writ ten list of available services, description of firm 's qualification

Address conduct related to professional life

Develop and/ or adopt a code of ethics

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it s significant im pact t o t he pr ice

dissem inat ed t o t he m ar ket place and

Dist or t pr ices or ar t ificially inflat e t r ading volum e

pr ohibit legit im at e t r ading st r at egies

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Prudence requi re act wit h care, sk ill, and diligence

Gi ft s i n t he form of r e se a rch sup p or t is any t hing t hat hel p t o m ake

Subm it t o client s at l east quart erl y it em i zed st at em ent s

Do not discrim inat e against any client s

St an dar d I I I ( B) addr esses t he m anner of

should be adv i sed of t he ch anged

RPC Maint ain list of client s and holdings

Be sure t o gat her client info in t he f orm of an I PS and m ak e suit ability

Risk analy sis

Refrai n from m aking t rade or seek

St an dar d I I I ( D) pr ohi bit s m i sr epr esen t at ions of past

I f t he present at ion is brief, m ust m ake av ailable t o

on t he basis of t heir special ability t o conduct a

Avoid disclosi ng inform at ion received from a cl ient ex cept

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Som eone is in t he ser v ice of anot her

I n m at t er s r elat ed t o t heir em p loy m ent , m em ber s and

Abst ain f rom in dependent com pet it ive act ivit y

3 .4 St a n d a rd I V Obt ain writ t en consent from em ploy er before accept ing

Must hav e in dept h k n owledge of t he Code & St andards

prom pt ly init iat e inv est igat ion