CFA #1 Flashcards
A priori probability
A probability based on logical analysis rather than on observation or personal judgement.
Abandonment option
The ability to terminate a project at some future time if the finaicial results are dissapointing.
Abnormal return
The amount by which a security’s actual return differs from its expected return, given the security’s risk and market’s return.
Above full-employment equilibrium
A macroeconomic equilibrium in which real GDP exceeds potential GDP.
Absolute dispersion
The amount of variability present without comparison to any reference point of benchmark.
Absolute frequency
The number of observations in a given interval (for grouped data).
Accelerated book build
An offering of securities by an investment bank acting as principal that is accomplished in only one or two ways.
Accelerated methods of depreciation
Depreciation methods that allocate a relatively large proportion of the cost of an asset to the early years of the asset’s useful life.
Account
With the accounting systems, a formal record of increases and decreases in a specific asset, liability, component of owners’ equity, revenue, or expense.
Account format
A method of presentation of accounting transactions in which effects on assets appear at the left and effects on liablities and equity appear at the right of a central dividing line; also known as T-account format.
Accounting profit (income before taxes or pretax income)
Income as reported on the income statement, in accordance with prevailing accounting standards, before the provisions for income tax expense.
Accounting risk
The risk associated with accounting standards that vary from country to country or with any uncertainty about how certain transactions should be recorded.
Accounts payable
Amounts that a business owes to it’s vendors for goods and sevices that were purchases from them but which have not yet been paid.
Accounts receivable turnover
Ratio of sales on credit to the average balance in accounts receivable.
Accrual basis
Method of accounting in which the effect of transactions on financial condition and income are recorded when they occur, not when they are settled in cash.
Accrued expenses (accrued liabilities)
Liabilities related to expenses that have been incurred but not yet paid as of the end of an accounting period–an example of an accrued expense is rent that has been incurred but not yet paid, resulting in a liability “rent payable.”
Accrued interest
Interested earned but not yet paid.
Accumulated benefit obligation
Under U.S. GAAP, a measure used in estimating a defined-benefit pension plan’s liabitlies, defined as “the actuarial present value of benefits (whether vested or non-vested) attributed by the pension benefit formula to employee service rendered before a specified date and based on employee service and compensation (if aplicable) prior to that date.”
Accumulated depreciation
An offset to property, plant, and equipment (PPE) reflecting the amount of the cost of PPE that has been allocated to current and previous accounting periods.
Acquiring company, or acquirer
The company in a merger or acquisition that is acquiring the target.
Acquisition
The purchase of some portion of one company by another; the purchase may be for asssets, a definable segment of another entity, or the puchase of an entire company.
Acquisition method
A method of accoounting for a business combination where the acquirer is required to measure each identifiable asset and liability at fair value. This method was the result of a joint project of the IASB and FASB aiming at convergence in standards for the accounting of business combinations.
Active factor risk
The contribution to active risk squared resulting from the portfolio’s different-than-benchmark exposures relative to factors specified in the risk model.
Active investment
An approach to investing in which the investor seeks to outperform a given benchmark.
Active return
The return on a portfolio minus the return on the portfolio’s benchmark.
Active risk
The standard deviation of active returns.
Active risk squared
The variance of active returns; active risk raised to the second power.
Active specific risk or asset selection risk
The contribution to active risk squared resulting from the portfolio’s active weights on individual assets as those weights interact with assets’ residual risk.
Active strategy
In reference to short-term cash management, an investment strategy characteriezd by monitoring and attempting to capitalize on market conditions to omptimize the risk and return relationship of short-term investments.
Activity ratios (asset utlization or operating efficiency ratios)
Ratios that measure how efficiently a company performs day-to-day tasks, such as the collection of receivables and management of inventory.
Addition rule for probabilities
A principle stating that the probability that A or B occurs (both occur) equals the probability that A occurs, plus the probability that B occurs, minus the probablity that both A and B occur.
Add-on interest
A procedure for determining the interest on a bond or loan in which the interest is added onto the face value of the contract.
Adjusted beta
Historical beta adjusted to reflect the tendency of beta to be mean reverting.
Adjusted R2
A measure of goodness-of-fit of a regression that is adjusted for degrees of freedom and hence does not automatically increase when another independent variable is added to a regression.
Agency costs
Costs associated with the conflict of interest present when a company is managed by non-owners. Agency costs result from the inherent conflicts of interest between managers and equity owners.
Agency costs of equity
The smaller the stake that managers have in the company, the less is their share in bearing the cost of excessive perquisite consumption or not giving their best efforts in running the company.
Agency problem, or principal-agent problem
A conflict of interest that arises when the agent in an agency relationship has goals and incentives that differ from the principal to whom the agent owes a fiduciary dity.
Agency relationships
An arrangement whereby someone, an agent, acts on behalf of another person, the principal.
Aggregate demand
The relationship between the quantity of real GDP demanded and the price level.
Aggregate hours
The total number of hours worked by all the people employed, both full time and part time, during a year.
Aging schedule
A breakdown of accounts into categories of days outstanding.
Allocationally efficient
Said of a market, a financial system, or an economy that promotes the allocation of resources to their highest value uses.
All-or-nothing (AON) orders
An order that includes the instruction to trade only if the trade fills the entire quantity (size) specified.
Allowance for bad debts
An offset to accounts receivable for the amount of accounts receivable that are estimated to be uncollectible.
Alternative hypothesis
The hypothesis accepted when the null hypthesis is rejected.
Alternative invesment markets
Market for investments other than traditional securities investments (i.e., traditional common and preferred shares and traditional fixed income instruments). The term usually encompasses direct and indirect investment in real estate (including timberland and farmland) and commodities (including precious metals); hedge funds, priate equity, and other investments requiring specialized due diligence.
Alternative trading systems (electronic communications networks or multilateral trading facilities)
Trading venues that function like exchanges but that do not exercise regulatory authority over their subscribers except with respect to the conduct of the subscribers’ trading in their trading systems.
American depository shares
The underlying shares on which American depository receipts are based. They trade in the issuing company’s domestic market.
American depsository receipt
A U.S dollar-denominated secuirity that trades like a commons hare on the U.S. exchanges.
American option
An option that can be exercised at any time until its expiration date.
Amortization
The process of allocating the cost of intangible long-term assets having a finite useful life to accounting periods; the allocation of the amount of a bond premium or discount to the periods remaining until bond maturity.
Amortizing and accreting swaps
A swap in which the notional principal changes according to a formula related to changes in the underlying.
Analysis or variable (ANOVA)
The analysis of the total variability of a dataset (such as observations on a dependent variable in a regression) into components representing different sources of variation; with preference to regression, ANOVA provides the inputs for an F-terst of the significance of the regression as a whole.
Annual percentage rate
The cost of borrowing expressed as a yearly rate.
Annuity
A finite set of level sequential cash flows.
Annuity due
An annuity having a first cash flow that is paid immediately.
Anticipation stock
Excess inventory that is held in anticipation of increased demand, often because of seasonal patters of demand.
Antidilutive
With reference to a transaction or a security, one that would increase earnings per shares (EPS) or result in EPS higher than the company’s basic EPS–antidilutive securities are not included in the calculation of diluted EPS.
Arbitrage
1) The simultaneous purchase of an undervalued asset or portfiolio and sale of an overvalued but equivalent asset or portfolio, in order to obtain a riskless profit on the price differential. Taking advantage of a market inefficiency in a risk-free manner. 2) The condition in a financial market in which equivalent assets or combinations of assets sell for two diffeerent prices, creating an opportunity to profit at no risk with no commitment of money. In a well-functioning financial market, few arbitrage opportunties are possible. 3) A risk-free operation that earns an expected positive net profit but requires no net investment of money.
Arbitrage opportunity
An opportunity to conduct an arbitraage; an opportunity to earn an expected positive net profit without risk and with no net investment of money.
Arbitrage portfolio
The portfolio that exploits an arbitrage opportunity.
Arithmetic mean
The sum of the observations divided by the number of observations.
Arms index, also called TRIN
A flow of funds indicator applied to a broad stock market index to measure the relative extent to which money is moving into or out of rising and declining stocks.
Arrears swap
A type of interest rate swap in which the floating payment is set at the end of the period and the interest is paid at that same time.
Asian call option
A European-style option with a value at maturity equal to the difference between the stock price at maturity and the average stock price during the life of the option, or $0, whichever is greater.
Ask (offer)
The price at which a dealer or trader is willing to sell an asset, typically qualified by a maximum quantity (ask size).
Ask size
The maximum quantity of an asset that pertains to a specific ask price from a trader. For example, if the ask for a share issue is $30 for a size of 1,000 shares, the trader is offering to sell at $30 up to 1,000 shares.
Asset allocation
The process of determining how investment funds should be distributed among asset classes.
Asset beta
The unlevered beta; reflects the business risk of the assets; the asset’s systematic risk.
Asset class
A group of assets that have similar characteristics, attributes, and risk/return relationships.
Asset purchase
An acquisition in which the acquirer pruchases the target company’s asset and payment is made directly to the target company.
Asset retirement obligations (AROs)
The fair value of the estimated costs to be incurred at the end of a tangible asset’s service life. The fair value of the liability is determined on the basis of discounted cash flows.
Asset-based loan
A loan that is secured with company assets.
Asset-based valuation models
Valuation based on estimates of the market value of a company’s assets.
Assets
Resources controlled by an enterpricse as a result of past events and from which future economic benefits to the enterprise are expected to flow.
Assignment of accounts receivable
The use of accounts receivable as collateral for a loan.
Asymmetric information
The differential of information between corporate insiders and outsiders regarding the company’s performance and prospects. Managers typically have more information about the company’s performance and prospects than owners and creditors.
At the money
An option in which the underlying value equals the exercise price.
Autocorrelation
The correlation of a time series with its own past values.
Automated Clearing House
An electronic payment network available to businesses, individuals, and financial institutions in the United States, U.S. Territories, and Canada.
Automatic fiscal policy
A fiscal policy action that is triggered by the state of the economy.
Automatic stabilizers
Mechanisms that stabilize real GDP without explicit action by the government.
Autonomous tax multiplier
The maginification effect of a change in taxes on aggregate demand.
Autoregressive (AR) model
A time series regressed on its own past values, in which the independent variable is a lagged value of the dependent varable.
Available-for-sale investments
Debt and equity securities not classified as either held-to-maturity or held-for-trading securities. The investor is willing to sell but not actively planning to sell. In general, available-for-sale securities are reported at fair value on the balance sheet.
Average cost pricing rule
A rule that sets price to cover cost including normal profit, which means setting the price equal to average total cost.
Average fixed cost
Total fixed cost per unit of output.
Average product
The average product of a factor of production. It equals total product divided by the quantity of the factor employed.
Average total cost
Total cost per unit of outputs.
Averiage variable cost
Total variable cust per unit of output.
Backtesting
With reference to portfolio strategies, the application of a strategy’s portfolio selection rules to historical data to assess what would have been the strategy’s historical performance.
Backward integration
A merger involving the purchase of a target ahead of the acquirer in the value or production chain; for example, to acquire a supplier.
Backwardation
A condition in the futures markets in which the benefits of holding an asset exceed the costs, leaving the futures price less than the spot price.
Balance sheet (statement of financial position or statement of financial condition)
The financial statement that presents an entity’s current financial position by disclosing resources the entity controls (its assets) and the claims on those resources (its liabilities and equity claims), as of a partuclar point in time (the date of the balance sheet).
Balance sheet ratios
Financial ratios involving balance sheet items only.
Balanced budget
A government budget in which tax revenues and outlays are equal.
Balanced budget multiplier
The magnification effect on aggregate demand of a simultaneous change in government expenditure and taxes that leaves the budget balanced.
Balance-sheet-based accruals ratio
The difference between net operating assets at the end and the beginning of the period compared to the average net operating assets over the period.
Balance-sheet-based aggregate accruals
The difference between net operating assets at the end and the beginning of the period.
Bank discount basis
A quoting convention that annualizes, on a 360-day year, the discount as a percentage of face value.
Bar chart
A price chart with four bits of data for each time interval–the high, low, opening, and closing prices. A verticle line connects the high and low. A cross-hatch left indicates the opening price and coross-hatch right indicates the close.
Bargain purchase
When a company is acquired and the purchase price is less than the fair value of the net assets. The current treatment of the excess of fair value over the purchase price is different under IFRS and U.S. GAAP. The excess is never accounted for as negative goodwill.
Barriers to entry
Legal or natural contraints that protect a firm from potential competitors.
Barter
The direct exchange of one good or service for other goods and services.
Basis EPS
Net earnings available to common shareholders (i.e., net income minus preferred dividends) divided by the weighted average number of common shares outstanding.
Basis point value (BPV)
Also called present value of a basis point or price value of a basis point (PVBP), the change in the bond price for a 1 basis point change in the yield.
Basis swap
1) An interest rate swap involving two floating rates. 2) A swap in which both parties pay a floating rate.
Basket of listed depository receips
An exchange-traded fund (ETF) that represents a portfolio of depository receipts.
Bayes’ formula
A method for updating probabilities based on new information.
Bear hug
A tactic used by acquirers to circumvent target management’s objections to a proposed merger by submitting the proposal directly to the target company’s board of directors.
Bear spread
An option strategy that involves selling a put with a lower exercise price and buying a put with a higer exercise price. It can also be executed with calls.
Behavioral finance
A field of finance that examines the psychological variables that affect and often distort the investment decision making of investors, analysts, and porfolio managers.
Behind the market
Said of prices specified in orders that are worse than the best current price; e.g., for a limit buy order, a limit price below the best bid.
Below full-employment equilibrium
A macroeconomic equilibrium in which potential GDP exceeds real GDP.
Benchmark
A comparison portfolio; a point of reference or comparison.
Benchmark error
The use of an inappropriate or incorrect benchmark to assess and compare portfolio returns and management.
Benchmark prtfolio
A comparison portfolio or index that represents the persistent and prominent investment characteristics of the securities in an actual portfolio.
Bernoulli random variable
A random variable having the outcomes 0 and 1.
Bernoulli trial
An experiment that can product one of two outcomes.
Best bid
The highest bid in the market.
Best efforts offering
An offering of a security using an investment bank in which the investment bank, as agent for the issuer, promises to use its best efforts to sell the offering but does not guarantee that a specific amount will be sold.
Best offer
The lowest offer (ask price) in the market.
Beta
A measure of systematic risk that is based on the covariance of an asset’s or portfolio’s return with the return of the overall market.
Bid (bid price)
The price at which a dealer or trader is willing to buy an asset, typically qualified by a maxiumum quantity.
Bid size
The maximum quantity of an asset that pertains to a specific bid price from a trader.
Big tradeoff
The conflit between equality and efficiency.
Bilateral monopoly
A situation in which a single seller (a molopoly) faces a single buyer (a monopsony).
Binomial model
A model of pricing options in which the underlying price can move to only one of two possible new prices.
Binomial random variable
The number fo successes in n Bernoulli trials for which the probability of success is constant for all trials and the trials are independent.
Binomial tree
The graphical representation of a model of asset price dynamics in which, at each period, the asset moves up with probability p or down with probability (1-p).
Black market
An illigal market in which the price exceeds the legally imposed price ceiling.
Block
Orders to buy or sell that are too large for the liquidity ordinarily available in dealer networks or stock exchanges.
Block brokers
A broker (agent) that provides brokerage services for large-size trades.
Blue chip companies
Widely held large market capitalization companies that are considered financially sound and are leaders in their respective industry or local stock market.
Bollinger Bands
A price-based technical analysis indicator consisting of a moving average plus a higher line representing the moving agerage plus a set number of standard deviations from the average price (for the same number of periods as used to calculate the moving average) and a lower line that is a moving average minus the same number of standard deviations.
Bond equivalent yield
A calculation of yield that is annualized using the ratio of 365 to the number of days to maturity. Bond equivalent yield allows for the restatement and comparison of securities with different compounding periods.
Bond optoin
An option in which the underlying is a bond; primarily traded in over-the-counter markets.
Bond yield plus risk premium approach
An estimate of the cost of common equity that is produced by summing the before-tax cost of debt and a risk premium that captures the additional yield on a company’s stock relative to its bonds. The additional yield is often estimated using historical spreads between bond yields and stock yields.
Bond-equivalent basis
A basis for stating an annual yield that annualizes a semiannual yield by doubling it.
Bond-equivalent yield
The yield to maturity on a basis that ignores compounding.
Bonding costs
Costs borne by management to assure owners that they are working in the owners’ best interest (e.g., implicit cost of non-compete agreements).
Book building
Investment bankers’ process of compiling a “book” or list of indications of interest to buy part of an offering.
Book value (or carrying value)
The net amount shown for an asset or liablity on the balance sheet; book value may also refer to the company’s excess of total assets over total liabilities.
Book value equity per share
The amount of book value (also called carrying value) of common equity per share of common stock, calculated by dividing the book value of shareholders’ equity by the number of shares of common stock outstanding.
Bootstrapping earnings
An increase in a company’s earnings that results as a consequence fo the idiosyncrasies of a merger transaction itself rather than because of resulting economic benefits of the combination.
Bottom-up analysis
With reference to investment selection processes, an approach that involves selection from all securities within a specified investment universe, i.e., without prior narrowing of the universe on the basis of macroeconomic or overall market considerations.
Box spread
An option strategy that combines a bull spread and a bear spread having two difffrent exercise prices, which produces a risk-free payoff of the differnece in the exercise prices.
Break point
In the context of the weighted average cost of capital (WACC), a break point is the amount of capital at which the cost of one or more of the sources of capital changes, leading to a change in the WACC.
Breakeven point
The number of units produced and sold at which the copmany’s net income is zero (revenues = total costs).
Breakup value
The value that can be achieved if a company’s assets are divided and sold seprately.
Breusch-Pagan test
A test for conditional heteroskedasticity in the error term of a regression.
Broker
1) An agent who executes orders to buy or sell securities on behalf of a client in exchange for a commission. 2) See Futures commission merchants.
Broker-dealer
A financial intermediary (often a company) that may function as a principal (dealer) or as an agent (broker) depending on the type of trade.
Brokered market
A market in which brokers arrange trades among their clients.
Budget deficit
A government’s budget balance that is negative–outlays exceed tax revenues.
Budget surplus
A government’s budget balance that is positive–tax revenues exceed oulays.
Bull spread
An option strategy that involves buying a call with a lower exercise price and selling a call with a higher exercise price. It can also be executed with puts.
Business risk
The risk associated with operating earnings. Operating earnings are uncertain because total revenues and many of the expenditures contributed to produce those revenues are uncertain.
Butterfly spread
An option strategy that combines two bull or bear spreads and has three exercise prices.
Buy side firm
An investment management company or other investor that uses the services of brokers or dealers (i.e., the client of the sell side firm).
Buyout fund
A fund that buys all the shares of a public company so that, in effect, the company becomes private.
Call
An option that gives the holder the right to buy an underlying asset from another party at a fixed price over a specific period of time.
Call market
A market in which trades occur only at a particular time and place (i.e., when the market is called).
Call money rate
The interest rate that buyers pay for their margin loan.
Callable (or redeemable) common shares
Shares that give the issuing company the option (or right), but not the obligation, to buy back the shares from investors at a call price that is specified when the shares are originally issued.
Candlestick chart
A price chart with four bits fo data for each time interval. A candle indicates the opening and closing price for the interval. The body of the candle is shaded if the opening price was higher than the closing price, and the body is clear if the opening price was lower than the closing price. Verticle lines known as wicks or shadows extend from the top and bottom fo the candle to indicate the high and low price for the interval.
Cannibalization
Cannibalization occurs when an investment takes customers and sales away from another part of the company.
Cap
1) A contract on an interest rate, whereby at periodic payment dates, the writer of the cap pays the difference between the market interest rate and a specified cap rate if, and only if, this difference is positive. This is equivalent to a stream of call options on the interest rate. 2) A combination of interest rate call options designed to hedge a barrower against rate increases on a foating-rate loan.
Capital allocation line (CAL)
A graph line that describes the combinations of expected return and standard deviation of return available to an investor from combining the optimal portfolio of risky assets with the risk-free asset.
Capital asset pricing model (CAPM)
An equation describing the expected return on any asset (or portfolio) as a linear function of its beta relative to the market portfolio.
Capital budgeting
The allocation of funds to relatively long-range projects or investments.
Capital market expectations
An investor’s expectations concerning the risk and return prospets of asset classes.
Capital market line (CML)
The line with an intercept point equal to the risk-free rate that is tangent to the efficient frontier of the risky assets; represents the efficient frontier when a risk-free aset is available for investment.
Capital markets
Financial markets that trade securities of longer duration, such as bonds and equities.
Capital rationing
A capital rationing environment assumes that the company has a fixed amount of funds to invest.
Capital structure
The mix of debt and equity that a compnay uses to finance its business; a company’s specific mixture of long-term financing.
Capitalized inventory costs
Costs of inventories including costs of purchase, costs of conversion, other costs to bring the inventories to their present location and condition, and the allocated portion of fixed production overhead costs.
Caplet
Each component call option in a cap.
Capped swap
A swap in which the floating payments have an upper limt.
Captive finance subsidiary
A wholly-owned subsidiary of a company that is established to provide financing of the sales of the parent company.
Carrying amount (book value)
The amount at which an asset or liability is valued according to accounting principles.
Cartel
A group of firms that has entered into a collusive agreement to restrict output and increase prices and profits.
Cash
In accounting contexts, cash on hand (e.g., petty cash and cash not yet deposited to the bank) and demand deposits held in banks and similar accounts that can be used in payment of obligations.
Cash basis
Accounting method in which the only relevant transactions for the financial statements are those that involve cash.
Cash conversion cycle (net operating cycle)
A financial metric that measures the length of time required for a company to convert cash invested in its operations to cash received as a result of its operations; equal to days of inventory on hand + days of sales outstanding - number of days of payables.
Cash equivalents
Very liquid short-term investments, usually maturing in 90 days of less.
Cash flow additivity priciple
The principle that dollar amounts indexed at the same point in time are additive.
Cash flow at risk (CFAR)
A variation of VAR that reflects the risk of a company’s cash flows instead of its market value.
Cash flow from operations (cash from from operating activities or operating cash flow)
The net amount of cash provided from operating activities.
Cash flow statement (statement of cash flows)
A financial statement that reconciles beginning-of-period and end-of-period balance sheet values of cash; consists of three parts: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities.
Cash offering
A merger or acquisition that is to be paid for with cash; the cash for the merger might come from the acquiring company’s existing assets or from a debt issue.
Cash price or spot price
The price for immediate purchase of the underlying asset.
Cash ratio
A liquidity ratio calculated as (cash + short-term marketable investments) divided by the current liablitiles; measures a company’s ability to meet its current obligations with just the cash and cash equivalents on hand.
Cash settlement
A procedure used in certain derivative transactions that specifies that the long and short parties engage in the equivalent cash value of the delivery transaction.
Cash-flow-statement-based accruals ratio
The difference between reported net income on an accrual basis and the cash flows from operating and investing activities compared to the average net operating assets over the period.
Cash-flow-statement-based aggregate accruals
The difference between reported net income on an accrual basis and the cash flows from operating and investing activities.
CBEO Volatility Index
A measure of near-term market volatility as conveyed by S&P 500 stock index option prices.
Central bank
A bank’s bank and a public authority that regulates the nation’s depository institutions and controls the quantity of money.
Central limit theorem
A result in statistics that states that the sample mean computed from large samples of size n from a pupulation with a finite variance will follow an approximate normal distribution with a mean equal to the population mean and a variance equal to the population variance divided by n.
Centralized risk management or companywide risk management
When a copmany has a single risk maangement group that monitor and controls all of the risk-taking activities of the organization. Centralization permits economics of scale and allows a company to use some of its risks to offset other risks. (See also enterprise risk management.)
