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1
Q

Residual Dividend Model

A
  1. Calc cap needs
  2. Pick cap structure
  3. Calc new cap needs from equity
  4. (Earnings - equity cap investment needed) = div
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2
Q

5 reasons to repurchase shares

A
  1. Tax advantage
  2. Share price support / signaling
  3. Added flexibility (vs. div)
  4. Offsetting dilution from employee stock options
  5. Increasing financial leverage , change cap structure
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3
Q

Is it good to repurchase shares

A
  1. earnings yld = EPS / stock price
  2. EPS after buyback = (earnings - cost of borrowing) / (existing shares - buy back shares)
  3. Is New EPS > old EPS, then repurchase good
  4. Good if borrowing cost < earnings yld
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4
Q
  1. Div payout ratio
  2. Div coverage ration
  3. FCFE coverage ratio
A
  1. Div payout ratio = divs / NI
  2. Div coverage ratio = NI / divs
  3. FCFE coverage ratio = FCFE / (divs + repurchases)
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5
Q

3 Investor div preference theories

A
  1. MM’s div irrelevance
  2. ‘Bird in the hand’
  3. Tax aversion
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6
Q

2 Goals of corporate governance

A
  1. Eliminate/reduce conflicts of interest, especially between management and shareholders
  2. Use company’s assets in best interest of investors and shareholders
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7
Q

4 Elements of a good corporate governance system (core attributes)

A
  1. Defined rights of shareholders/stakeholders
  2. Defined ovesight responibilities of managers/directors
  3. Fair treatment between managers/directors/shareholders
  4. Transparency of operations, risk, performance
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8
Q

Corporations: proportion of all businesses, proportion of revenue

A

20% of businesses
90% of revenue

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9
Q

Board of directors risk as agents of shareholders

A
  1. Lack of independence
  2. Personal relationships w/management
  3. Director has business relationship with firm
  4. Interlinked boards
  5. Over compensation
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10
Q

Good corp governance traits for board (8/14)

A
  1. > 75% BOD are independent
  2. Chairman & CEO split
  3. Good qualifications
  4. Annual, non-staggered elections
  5. BOD self assessments
  6. BOD only meetings (no mng)
  7. Independent audit cmmtt
  8. Independent nominating cmmtt
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11
Q

Good corp governance traits for board (6/14)

A
  1. Compensation cmmtt (?)
  2. Independent BOD legal consel
  3. Statement of governance policies
  4. Disclosure & transparency
  5. Insider transactions approved by BOD
  6. Responsiveness to shareholder proxy votes
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12
Q

4 risks from bad corporate goverance

A
  1. Financial disclosure risk
  2. Asset risk
  3. Liability risk
    4.
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13
Q

M&A | merger

A

one company buys ALL of another company
acquirer and target

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14
Q

2 dimensions of M&A

A
  1. Forms of integration: how companies physically come together
  2. Type of merger: how the companies’ businesse activities relate to each other
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15
Q

M&A | 3 forms of integration

A
  1. Statutory merger: one company ceases to exit
  2. Subsidiary merger: parent + subsidiary
  3. Consolidation: both companies cease to exist >> completely new company
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16
Q

M&A | 3 types of mergers

A
  1. Horizontal: similar businesses
  2. Vertical: along supply chain (raw materitals/backwards, consumer/forwards)
  3. Conglomerate: separate industries
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17
Q

Reasons for M&A

A
  1. Synergy
  2. Rapid growth
  3. Market power
  4. Gain unique capabilities
  5. Diversification
  6. Bootstrapping EPS
  7. Personal benefits to mng
  8. Tax benefits
  9. Hidden value
  10. Int’l business goals
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18
Q

M&A | Bootstrapping

A
  1. Increasing EPS by M&A wo/ increase in earnings
  2. High PE co. buys low PE co.
  3. No new economic value
  4. EPS increase b/c per dollar of mkt cap you get more earnings
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19
Q

M&A and industry life cycle

A
  1. prioneer/dev: congomerate, horizontal
  2. rapid growth: conglomerate, horizontal
  3. mature: horizontal, vertical
  4. stabilization: horizontal
  5. decline: all 3
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20
Q

2 technical forms of acquisition

A
  1. Stock purchase
  2. Asset purchase
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21
Q

M&A | Stock purchase and asset purchase

A

SP|AP - 1. Payment: sharehoder|company

  1. Approval: maj of shareholders|company unless > 50% of assets
  2. Taxes: shareholder pay cap gains| co. pays cap gains
  3. Liabities: buyer assumes liabilities|does not assume liabilities
  4. Notes: buy 100% of co. | buy some assets
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22
Q

M&A | Anti-trust & HHI

A

HHI past merger|Change|Anti-trust action - 1. < 1000 | doesn’t matter | no action

  1. 1000-1500 | > 100 | possible
  2. > 1500 | > 50 | yes
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23
Q

M&A | Post offer defense mechanism

A
  1. Just say no
  2. Litigation
  3. Greenmail
  4. Share repurchase
  5. Leveraged recapitalization
  6. Crown jewel defense: possibly legal
  7. Pac-man
  8. White knight: winner’s curse
  9. White squire
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24
Q

Herfindahl - Hirschmann Index

A
  1. If change > 100, then anti-trust issue
  2. HHI = ∑ (MS x 100)2 from 1 to n, MS = mkt share, n = firms in industry
  3. < 1800 is competitive
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25
Q

M&A| Discounted cash flow (DCF) analysis steps

A

(similar to FCFE), Calc FCF: 1. Decide on FCF mode

  1. Dev pro forma financial estimates
  2. calc FCF using estimates
  3. discount FCF using WACCadjusted
  4. Determine terminal value then discount
  5. Add all PV FCF together
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26
Q

M&A| Discounted cash flow (DCF): calc FCF

A

NI + Net interest after tax | unlevered NI +- deferred tax change | net op profit less adj taxes (NOPLAT) + non-cash charges (NCC) +- ∆NWC - cap ex| FCF, NWC = CA(- cash) - CL(- ST debt)

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27
Q

M&A|Discounted cash flow (DCF): 2 terminal value methods

A
  1. Constant growth: term val = FCFT(1+g) / (WACCadj - g)
  2. Market multiple: term val = FCFT x (P/FCF), P = projected price
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28
Q

M&A| 3 valuation of target company methods

A
  1. Discounted cash flow (DCF) analysis
  2. Comparable company analysis
  3. Comparable transaction analysis
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29
Q

M&A| Comparable transaction analysis for target valuation

A

Similar to comparable company analysis, but only mergers 1. Find comparable companies that were acquired

  1. Calc relative value metrics based on deal price
  2. Create descriptive metrics (avg, median, etc)
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30
Q

M&A | Empirical results

A
  1. Target get 30% premium
  2. Acquirers: ST ↓1-3%, LT after 3yrs ↓ 4% and 60% underperform peer group
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31
Q

PE | committed vs paid-in capital

A

committed = promised
paid-in (invested) = actually received

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32
Q

Convertible bonds: premium payback period

A 
PPP = mkt conv permium / favorable income diff 
fid = (coupon - (conv ratio x div))/conv ratio
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33
Q

PE | corporate governance of PE firm

A
  1. key man clause
  2. performance disclosure & confidentiality
  3. clawback
  4. distribution waterfall
  5. tag along - drag along
  6. no-fault divorce: fire GP w/75% of LP
  7. removal for cause: fire GP
  8. investment restrictions
  9. co-investment
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34
Q

PE | distribution waterfall

A
  1. deal by deal
  2. total return: a.paid back > committed capital b. paid back > invest capital
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35
Q

PE | 6 ways to determine NAV

A
  1. at cost - adj for later financing
  2. at min of cost or mkt
  3. revaluing with each new financing
  4. at cost with no adj until exit
  5. discount factor for restricted securities
  6. illiquidity discounts to comparable public firms
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36
Q

PE | type of investors in PE

A

qualified investors

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37
Q

PE | PE risks

A
  1. liquidity
  2. unquoted
  3. competitive environment
  4. agency
  5. capital
  6. regulatory
  7. tax
  8. valuation
  9. diversification 10. market
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38
Q

PE | PE costs

A
  1. transaction
  2. investment vehicle fund setup
  3. administrative
  4. audit
  5. management (2/20)
  6. dilution
  7. placement (up to 2%)
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39
Q

PE | gross IRR v. net IRR

A

gross: portfolio co. > PE firm
net: PE firm > LPs

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40
Q

PE | quantitative performance measures

A
  1. PIC (paid in capital) - cap utilizied by GP
  2. DPI*(distributed to PIC) - LP’s realized return: aka cash-on-cash return
  3. RVPI*(residual value to PIC) - LP’s unrealized return
  4. TVPI*(total value to PIC) - DPI + RVPI
    * net of mng fee & carried interest
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41
Q

Fixed Asset Turnover

A

Activity Ratio
Rev / Avg Net Fixed Assets
Rev/Ass
Avg Net Fixed Assets = Fixed Assets - Dep

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42
Q

Common Equity Accounts (Balance Sheet)

A

Common stock
Add paid-in capital
Treasury stock
Non-control subsidiary
Retained earnings
Accum other comp income

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43
Q

Common Asset Accounts (Balance Sheet)

A

Cash
Acc Rec
Inv
PPE
Prepaid exp
Investments (bonds)
Intangible
DTA
Pension

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44
Q

Receivables turnover ratio

A

Activity ratio
Rev / Avg acc rec
Rev / Ass

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45
Q

Common Liability Accounts (Balance sheet)

A

Acc pay
Accru exp
Unearned rev
Debt
Captial leases
Pension
DTL

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46
Q

Operating cash flow | Direct vs Indirect Method

A

Direct:
redo income statement based on cash
not accrual
subtract out CFI p/l

Indirect:
start with accrual income statement and net income and adjust for cash basis
subtract CFI p/l

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47
Q

Current Ratio

A

Liquidity ratio
Current Assets / Current Liabilities

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48
Q

Cash to Income Ratio

A

Performance ratio
CFO / Operating Income

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49
Q

Cash return on equity ratio

A

Performance ratio
CFO / Avg total equity

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50
Q

EBIT

A

Operating profit

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51
Q

Multi-step income statement format

A

Rev - COGS = Gross Profit - SGA - Dep = Op Profit - Int = EBT - taxes = EAT - p/l discont ops = Net Income

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52
Q

Operating Cash Flow (CFO)

A

Cash flow that affects net income

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53
Q

Number of days of payables

A

Activity ratio : 365 x avg acct pay / purchases : 365 x liab / exp

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54
Q

total asset turnover

A

activity ratio : rev / avg assets : rev / asset

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55
Q

harmonic mean

A

n / (1/x1 + 1/x2 + 1/x3)

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56
Q

geometric mean

A

[(1 + r1) x (1 + r2) + (1 + r3)] ^ 1/n : less than arithmetic mean

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57
Q

three statistical frequencies

A

absolute, relative, cumulative

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58
Q

NOIR

A

nominal (no particular order), ordinal (ordered), interval (diff equal), ratio (true zero)

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59
Q

Holding period yield/return

A

HPY/HPR : = (end value - begin value) / begin value = (P1 - P0 + D1) / P0 = [BDY x (t/360)] / [1 - BDY x (t/360)]

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60
Q

money weighted return v. time weighted return

A

MWR uses cash flows and IRR : TWR calcs return for each period then multiplies the geometric mean

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61
Q

annual percentage rate APR

A

no compounding : lower than APY : calculator CPT I/Y then multiply by # of periods

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62
Q

annual percentage yield APY

A

yes compounding : higher than APR : ( end value / begin value ) ^ # periods

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63
Q

bond equivalent yield BEY

A

semi-annual rate (compunded if necessary) x 2

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64
Q

money market yield / CD equivalent yield

A

MMY = HPY x (360/dtm) = 360 x BDY / [360 - (dtm x BDY)]

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65
Q

effictive annual yield (EAY)

A

EAY = (1 + HPY) ^ (365/t) - 1

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66
Q

bank discount yield (BDY)

A

’= ( face - price ) / face x 360 / dtm

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67
Q

standards of professional conduct

A

(7) professionalism, integrity of cap mkts, duties to clients, duties to employers, analysis+recommendations+actions, conflict of interest, responsibilities of CFA

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68
Q

standards / resposibilities to CFA

A
  1. conduct
  2. referencing CFA
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69
Q

standards / conflicts of interest

A
  1. disclosure
  2. priority or transactions
  3. referral fees
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70
Q

standards / analysis, recommendations, actions

A
  1. diligence + reasonable basis
  2. comms w clients + prospects
  3. record retention
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71
Q

standards / duties to employers

A

loyalty, outside compensation, surprise well

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72
Q

standards / duties to clients

A

loyalty, fair dealing, suitability, performance presentation, confidentiality

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73
Q

standards / integrity of markets

A

material non-public info, market manipulation

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74
Q

standards / professionalism

A
  1. knowledge of law
  2. independence + objectivity
  3. misrepresentation
  4. misconduct
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75
Q

code of ethics

A

(6) act w integrity w/public,clients,employer, client/profession above self, use care when managing money, practice + encourage, promote integrity of mkts, maintain + improve self

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76
Q

important Z values

A
  1. 59 = 0.5%,
  2. 33 = 1%, 1.96 =
  3. 5%, 1.65 = 5%, 1.28 = 10%
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77
Q

GIPS

A

(9) fundamentals of compliance, input data, calculation methodology, composite construction, disclosures, presentation + reporting, real estate, private equity, wrap fee / separately managed accounts (SMA) portfolios

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78
Q

coefficient of variation

A

standard deviation / mean = s / Xbar

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79
Q

diluted EPS

A

(NI - pref div) + (conv pref divs) + (conv debt int)x(1 - tax) / (weight avg shares) + (conv pref shares) + (conv debt shares) + (stock opt shares)

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80
Q

basic EPS

A

NI - pref divs / weighted avg shares

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81
Q

Dupont equation - original

A

ROE = return on equity = NI/sales x sales/assets x assets/equity = net profit margin x asset turnover x leverage ratio

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82
Q

Dupont equation - extended

A

ROE = return on equity = NI/EBT x EBT/EBIT x EBIT/sales x sales/assets x assets/equity = XXX

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83
Q

common size cash flow ratios

A

basing cash flow statement on % of sales : X/sales

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84
Q

common size balance sheet ratios

A

basing balance sheet accts on % of assets : X/total assets

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85
Q

common size income statement ratios

A

basing income statement accts on % of sales : X/sales

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86
Q

return on equity ROE

A

net income / avg equity

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87
Q

return on total capital

A

net income / (avg debt + avg equity)

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88
Q

return on assets w interest ROA

A

(net income + (int x ( 1 - tr )) / avg assets

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89
Q

return on assets no interest ROA

A

net income / avg assets

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90
Q

pre-tax margin

A

EBT / sales

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91
Q

EBITDA

A

Sales - COGS - SGA

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92
Q

Bayes Formula

A

P(A | B) = P(B | A) x P(A) / P(B)

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93
Q

price index vs return index

A

price index = includes just price, no divs or int : return index = includes div and int

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94
Q

portfolio variance

A

o^2 = Wa^2 x Oa^2 + Wb^2 x Ob^2 + 2WbWaCovab = Wa^2 x Oa^2 + Wb^2 x Ob^2 + 2WbWaPabOaOb

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95
Q

correlation coefficient

A

Pab = Covab / (Oa x Ob) : Pab x Oa x Ob = Covab : -1 <= 1

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96
Q

covariance

A

Covab = Pab x Oa x Ob = E[(Ai - Abar)(Bi - Bbar)] : range is pos to neg infiniti

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97
Q

covariance of A and A

A

Covaa = Oa^2

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98
Q

fact

A

P(A) = P(AB) + P(ABc) where A can only occur if B or Bc, B and Bc are mutually exclusive and exhaustive

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99
Q

probability addition rule

A

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

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100
Q

probability multiplication rule

A

P(AB) = P(A|B) x P(B) = P(B”A) x P(A)

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101
Q

skewness

A

Sk = 1/n x E(Xi - Xbar)^3 / s^3, s=sample std dev : norm dist = 0, right skew > 0, left skew < 0

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102
Q

kurtosis

A

K = 1/n x E(Xi - Xbar)^4 / s^4, s=sample std dev : leptokurtic (more) > 3, norm dist = 3, platykurtic (less) < 3

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103
Q

sharpe ratio

A

S = Ri - Rf / O, O = std dev of portfolio

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104
Q

chebyshev’s inequality

A

percentage of observations that lie within k std devs, regardless of distribution, is at least >= 1 - 1/K^2 for k > 1

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105
Q

variance

A

O^2 = E(Xi - Xbar)^2 / n if Xbar is pop mean OR

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106
Q

mean absolute deviation

A

MAD = E | Xi - Xbar | / n

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107
Q

variance of binomial random variable

A

O^2 = n x p x (1 - p)

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108
Q

probability of x successes in n binomial trials

A

p(x) = n! / [(n - x)! x!] * p^x * (1 - p)^(n - x)

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109
Q

VAR on bonds

A

VAR looks at both how changes in yield affects bond/portfolio values and how yield volatility affects bond/portfolio values

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110
Q

price value of basis point

A

= duration * .0001 * notional : it’s the $ change / 1 bp change

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111
Q

bond valuation with duration and convexity

A

= ( - duration x Δy ) + ( convexity x Δy^2) x 100, where Δy = change in yield in decimal form

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112
Q

portfolio duration

A

= W1D1 + W2D2 + … + WnDn, where W is $ portion of whole portfolio

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113
Q

Macaulay Duration

A

weighted average of time until cash flows arrive, where weights are % of total bond value that cash flow represents : does not work with embedded options :

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114
Q

Modified Duration

A

Macaulay Duration / (1 + YTM) : does not work with embedded options

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115
Q

effective duration

A

(V- - V+) / (2 x V x Δy), where Δy is in decimal form

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116
Q

forward rate notation

A

length of loan ‘f’ years until loan starts : 1 f 2 >> one year loan that starts in 2 years

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117
Q

option adjusted spread

A

z spread if the bond had no options : used to compare to option free bonds : if no options then z spread = OAS

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118
Q

z spread v. YTM spread

A

steeper spot curve >> greater diff between z and YTM spreads : upward sloping spot >> z > YTM : downward sloping z < YTM : earlier principal paid >> wider diff between z and YTM

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119
Q

z spread, zero volatility spread

A

the identical yield that must be added to each risk free spot rate to correctly value a risky bond

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120
Q

5 bond related rates

A

(5) coupon rate, current yield, YTM (= IRR), spot rates, forward rates

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121
Q

arbitrage free bond valuation approach

A

use spot rates : value each cash flow : make sure it sums to bond value : arb by b/s pieces and s/b whole

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122
Q

what is YTM like

A

IRR

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123
Q

spot rate

A

the correct discount rate for a single cash flow in the future

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124
Q

arbitrage CDO vs balance sheet CDO

A

arb CDO done for profit by arb diff between cash inflow and outflow : balance sheet CDO done to reduce risk on balance sheet from loans

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125
Q

what debt maturities are exempt from SEC regulation

A

<= 270 days

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126
Q

what is more risky? Revenue or general obligation bonds

A

revenue

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127
Q

stripped mortgage backed securities & risk

A

PO wins from prepayment : IO losses from prepayment

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128
Q

3 maturity cycles for T-bills

A

30 day, 90 day, 180 day

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129
Q

effect of yield levels on duration and reinvestment risk

A

Yield down > duration up, reinvestment down : yield up > duration down, reinvestment up

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130
Q

different coupon structures

A

zero, step-up, deferred, regular, floating

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131
Q

list of fixed income risk

A

(12) interest rate, yield curve, call, prepayment, reinvestment, credit, liquidity, exchange rate, unexpected inflation, volatility, event, sovereign

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132
Q

bond interest rate sensitivity

A

maturity longer > duration up : coupon up, call, put, yield up > duration down

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133
Q

Is duration calced with %Δyield or Δyield

A

Δyield

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134
Q

variation margin

A

in a futures account, the amount of margin needed to be added when margin falls below maintenance and needs to be increased to initial

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135
Q

3 types of options

A

financial, futures, commodity

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136
Q

features futures for T-bills, T-bonds, stock index

A

T-bills - $1mm denominations : T-bonds - $100k denominations : stock index - S&P most popular ($250 x index value)

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137
Q

forward rate agreement terminology

A

when the loan begins ‘by’ when it ends ‘FRA’ : 2 by 5 FRA starts in 60 days and ends in 150 days and loan length is 90 days (150 - 60)

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138
Q

how are forward contract prices determined for discount bonds, coupon bonds, FRAs

A

discount - % off of face (eg 4% >> (1 + (96% x dtm/360)) x notional : coupon - YTM : forward rate agreement - cash settle, based on rate when loan would BEGIN in the future but discounted by length of loan because the profit wouldn’t occur until the end of the loan

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139
Q

forward rate agreement

A

pl = (realized rate - forward rate) x (dtm/360) x notional / (1 + (realized rate x (dtm/360))

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140
Q

cumulative distribution function (cdf)

A

aka ‘distribution function : sum of probabilities for the outcomes up to and including a specified outcome

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141
Q

of cells in top triangle in matrix

A

n x (n-1) / 2

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142
Q

combination formula

A

nCr = n! / ( (n-r)! x n! ) = ‘n choose r’ : calc n [2nd][nCr] r

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143
Q

permutation formula

A

of permutations of r objects from n objects (order counts) : = n! / (n-r)! : calc n {2nd][nPr] r

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144
Q

label n items with k labels with ni items per label

A

n! / (n1! x n2! x … x nk!)

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145
Q

multiples’ of equity valuation models

A

1) P/E, P/CF, P/S, P/BV : 2) EV/EBITDA

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146
Q

enterprise value

A

all a firm’s outstanding securities (debt + equity) minus cash and short term investments

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147
Q

justified P/E

A

a PE not based on stock price but some other valuation model

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148
Q

discounted cash flow : equity valuation models

A

dividend discount - Gordon constant growth V = D1/(k-g), multi-stage : Free cash flow V = E (FCFEi /(1 + r)^i

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149
Q

Gordon constant growth rate model

A

V = D1 / ( k - g)

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150
Q

infinite return model

A

E X / (1 + r)^i = X / i

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151
Q

3 equity valuation models

A

discounted cash flow model : multiplier model : asset based model

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152
Q

equity valuation model - asset based

A

asset - liabilities - pref stock, where assets and liabilities are valued at fair value

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153
Q

5 external effects on industries

A

(5) macroeconomic, technology, demographic, governmental, social

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154
Q

3 types of market efficiency

A

weak - incorp all past info, no tech analysis : semi-strong - incorp all past + public, includes weak and no fundamental analysis : strong - incorp all past, public and private, includes weak, semi-strong and no active analysis

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155
Q

5 index weighting types

A

(5) price, equal, market cap, float adj mkt cap, fundamental

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156
Q

index - total return vs price return

A

price does not include cash flows (div + int), just index price : total includes all cash flows

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157
Q

complete market efficiency

A

operational efficiency + informational efficiency = allocational efficiency

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158
Q

3 types of secondary markets

A

quote driven - investors w dealers (OTC) : order driven - rules match buyers and sellers (exchanges) : brokered - brokers locate counter parties

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159
Q

margin call price

A

P0 x (1 - initial margin %) / (1 - maintenance margin %) : think of cap structure margin loan = debt, cash = equity, losses go to equity, when equity = maint margin % of capital then margin call

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160
Q

call money rate

A

interest rate charged on margin loan

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161
Q

3 functions of the market

A

allocate capital efficiently, determine returns that put savings and borrowings in equilibrium, allow entities to save, borrow, manage risk, trade assets now and in the future

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162
Q

Markowitz portfolio theory

A

CAPM

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163
Q

IPS - investment guidelines

A

permitted asset types, leverage

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164
Q

IPS - (7) investment constraints

A

(7) risk, return, time horizon, tax situation, liquidity, legal, unique (RRTTLLU)

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165
Q

(9) IPS contents

A

description of client, state of purpose, state of duties/responsibilities, procedures, investment objectives, investment constraints, investment guidelines, eval of performance, appendices

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166
Q

Beta

A

B = Cov(im)/o^2m = corr(im)/o^2m : B is the slope of the least squares line of Ri-Rf vs Rm-Rf : E(Ri) = Rf + B[E(Rm) + Rf)]

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167
Q

Jensen’s Alpha

A

a of portfolio = (Rp - Rf) - Bp(Rm - Rf) : % of the SML line : associated with SML

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168
Q

Treynor’s value

A

(Rp - Rf) / Bp : associated with the SML

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169
Q

CML vs SML statistics

A

CML - Sharpe Ratio, M^2 : SML - Treynor, Jensen’s alpha

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170
Q

M squared risk measure

A

m^2 = (Rp - Rf)Om/Op - (Rm - Rf) : similar to sharpe ratio but % terms : associated with CML

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171
Q

slope of capital markets line (CML line)

A

is the Sharpe ratio = Rm - Rf / om

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172
Q

security market line (SML)

A

systemic risk : E(Ri) vs systemic risk, where systemic risk = Cov(im) : E(Ri) = Rf + Cov(im)/o^2m x [E(Rm) + Rf]

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173
Q

capital market line (CML)

A

total risk : optimal capital allocation : E(Rp) = Rf + [(E(Rm) + Rf) / om] x op

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174
Q

fact

A

concept of systemic risk applies to individual securities as well as portfolios

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175
Q

capital allocation line

A

line of optimal portfolios of risk free + risky assets : theoretically all investors have the same risky asset and CAL

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176
Q

minimum variance portfolio

A

for a given expected return, the portfolio (weights) with the lowest std dev : global min var portfolio = portfolio with the minimum std dev of all portfolios

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177
Q

portfolio variance of two assets

A

O^2p = WaO^2a + WbO^2b + 2WaWbCov(ab) : O^2p = WaO^2a + WbO^2b + 2WaWbCorr(ab)OaOb

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178
Q

covariance

A

Cov(ab) = E (Xa - Xbar a)(Xb - Xbar b) / n - 1 : Cov(ab) = PabOaOb

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179
Q

variance

A

O^2 = E (Xi - Xbar)^2 / n, if population, O^2 = E (Xi - Xbar)^2 / n - 1, if sample

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180
Q

money weighted rate of return

A

= IRR

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181
Q

3 types of lines of credit

A

uncommitted, committed, revolving

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182
Q

Receivables - factoring

A

selling off the receivables through securitization : factor = the buyer of the security

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183
Q

acc pay management - cost of trade credit

A

COTC = (1 + % discount/(1-%discount))^(365/# days paid past discount)

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184
Q

BDY vs MMY vs BEY

A

BDY = (F - P) / F x 360/dtm : MMY = (F - P) / P x 360/dtm : BEY = (F - P) / P x 360/dtm, this is not the normal BEY!

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185
Q

BDY vs MMY

A

Only difference is divisor is face for BDY and price for MMY

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186
Q

operating cycle in days formula

A

days of inventory + days of receivables, this is part of the cash conversion cycle

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187
Q

effect of share repurchase on book value

A

If P > BV, decrease in BV : If P < BV, increase in BV

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188
Q

effect of share repurchase on EPS

A

If E/P = cost of borrowing, no effect on EPS : if E/P > cost of borrowing, EPS will increase : if E/P < cost of borrowing, EPS will decrease

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189
Q

breakeven quantity of sales

A

Qbe = (fixed op cost + fixed financial cost) / (unit price - variable cost per unit) : contribution margin = (unit price - variable cost per unit)

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190
Q

degree of total leverage

A

DTL = DOL x DFL = %ΔEBIT / %Δsales x %ΔEPS / %ΔEBIT =%ΔEPS / %Δsales = Q ( P - V) / (Q (P - V) - F - I) = (S - TVC) / ((S - TVC) - F - I)

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191
Q

degree of financial leverage

A

DFL = %ΔEPS / %ΔEBIT = EBIT / (EBIT - I) ???

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192
Q

degree of operation leverage

A

DOL = %ΔEBIT / %Δsales = ΔEBIT/EBIT / Δsales/sales = Q(P-V) / (Q(P-V) - F) = (S - TVC) / ((S - TVC) - F)

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193
Q

cost of capital - 3 ways to calculate common equity

A

CAPM approach, Kc = Rf - B[E(Rm) - Rf + country risk] : Div discount model, Kc = D1/P0 + g, P0 = D1 / (k -g), g = growth rate = RR X ROE : Bond yield + risk premium (3-5%)

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194
Q

cost of capital - pure play method with B

A

2 step Beq a >> Bass a >>> Beq b : Bass a = Beq a / [1 + (1 -t)debt/equity], then Beq b = Bass a [1 + (1 - t)debt/equity]

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195
Q

leverage - 2 types of risk

A

business risk (sales and operating), financial

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196
Q

leverage - business risk

A

sales, operating

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197
Q

marginal cost of capital break point

A

BP = amount of capital at which the components cost of cap changes / weight of component in capital structure

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198
Q

cost of capital - country risk

A

CRP = sovereign yld spread x (O of developing equity mkt / O of developing bond mkt in foreign currency)

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199
Q

cost of capital - pref stock

A

Kp = Dp / P, Dp = pref div, P = mkt price of pref stock

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200
Q

fact

A

cost of capital - WACC = MCC

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201
Q

NPV IRR PI commonality

A

if one is true, all true - NPV > 0, IRR > RRR, PI > 1

202
Q

profitability index (PI)

A

PI = PV of future cash flows / CF0 = NPV/CF0 + 1

203
Q

credit - 4 Cs and 4 other measures

A

character, collateral, capacity, covenants, scale & diversification, operational efficiency, margin stability, leverage & coverage

204
Q

‘debt’ in ratios exludes…

A

non-interest bearing liabilities - acc pay, acc liabilities, DTL

205
Q

pension costs

A

service cost, interest cost, expected return on plan assets, actuarial p/l, prior service costs

206
Q

2 types of capital leases

A

sales - PV > carrying value, lease rec = PV of lease payments, PV = rev, carrying value = COGS, int = CFO, principal = CFI (same as all amortizing loans) : direct financing/capital - no profit recog, lease rec created, int = CFO, principal = CFI

207
Q

lease payment cash flows and income statement

A

cash flow - int is CFO, prin is CFI : income state for cap lease - depreciation is op exp, int is int exp

208
Q

finance/capital lease

A

is a financial purchase : add to both ass and liab w/dep & int for lessee, for lessor int = CFO, prin = CFI

209
Q

operating lease

A

rental, no balance sheet, rev = PV of cash flow, COGS = carrying value, PV > carrying, for lessor int = CFO, prin = CFI

210
Q

lease is a capital lease if…

A

GAAP, any of these are true - title transferred, bargain purchase option, lease period >= 75% of asset life, PV of lease >= 90% of fair value

211
Q

bond issuing costs

A

GAAP - capitalized as asset (deferred charge), expensed over life of bond, BOND + CHARGE = PROCEEDS: IFRS - reduce bond liability by costs >> increases effective rate

212
Q

bonds on the balance sheet

A

present value of cash flows using effective rate (YTM) : effective rate = mkt rate at purchase : premium - expense + amort = coupon (this reduces liab), discount - exp = coupon + amort (this increases liab)

213
Q

what happens to internally generated intangible assets

A

All expensed except - IFRS - dev costs past R&D capitalized, IFRS&GAAP - software dev past initial stage caped for all uses, GAAP - all software for internal use

214
Q

intangible assets have two characteristics

A

finite/indefinite, identifiable/unidentifiable

215
Q

inventory period costs

A

abnormal waste, storage, admin, selling are expensed not capitalized

216
Q

summary of income statement

A

Net sales - COGS = gross profit - op exp = op profit (EBIT) - interest = EBT - taxes = EAT - below the line items adj for taxes = net income +/- other comp income - pre div = income available to common

217
Q

financial leverage

A

assets / equity

218
Q

ratio pairs

A

rec turnover > days of sales outstanding, pay turnover > number of days of pay, inv turnover > days of inventory on hand

219
Q

types of ratios

A

activity, performance, liquidity, solvency/coverage, profitability, valuation

220
Q

cash flow per share

A

CFO - pref div / weighted avg shares

221
Q

income statement - single step vs multi-step

A

single step - rev and costs aggregated separately, multi - includes gross profit (COGS)

222
Q

interest coverage ratio

A

coverage : CFO + int paid + taxes paid / interest paid

223
Q

cash ratio

A

cash + mkt securities / curr liab

224
Q

financing cash flow

A

cash flow that affects capital structure, issuing/repaying debt, issuing/buying back stock, etc

225
Q

investing cash flow

A

cash flow from purchasing/disposing of long term assets and certain investments (like leases)

226
Q

cash flow to revenue ratio

A

CFO / net revenue

227
Q

inventory turnover ratio

A

COGS / avg inv : exp / asset

228
Q

quick ratio

A

liquidity : cash + mkt securities + rec / curr liab : acid test

229
Q

debt liability interest expense

A

market rate at purchase x balance sheet value of liab at beginning of period

230
Q

deferred taxes

A

DTL is a liab that is what your balance sheet says you SHOULD have paid : DTA is what you should NOT have paid : income tax expense = taxes payable + DTL - DTA : ite is internal, itp is what the govt wants

231
Q

cash return on assets

A

performance : CFO / avg assets

232
Q

defensive interval

A

liquidity : cash + mkt securities + rec / daily expenditures

233
Q

debt coverage ratio

A

coverage : CFO / total debt

234
Q

DDB depreciation

A

double declining : 2 x (cost - accum dep) / useful life

235
Q

fact

A

cost & production - when MP max, MC min : when AP max, AVC min and MP intersects AP

236
Q

fact

A

cost - MC intersects AVC and ATC at each curves minimum point

237
Q

costs - AFC, AVC, ATC

A

AFC = TFC / Q, AVC = TVC / Q, ATC = AFC + AVC

238
Q

marginal cost (MC)

A

ΔTC / ΔQ

239
Q

market concentration - Herfindahl-Hirschman Index (HHI)

A

sum of squared % mkt share of 50 largest firms : > 1800 not competitive

240
Q

market concentration - 4-firm concentration ratio

A

sum of % of industry sales of four largest firms : >40 not competitive

241
Q

fact

A

gov’t multiplier is GREATER than autonomous tax multiplier >> balanced budget multiplier is positive

242
Q

Ricardo-Barro effect

A

bigger gov’t deficit ? People to save more in prep for higher future taxes > people buy the gov’t debt with savings > no crowding out effect

243
Q

Phillips curve

A

Inflation vs UE : long term is 100% elastic, short term slopes down

244
Q

equation of exchange

A

MV = PY

245
Q

Federal Reserve money multiplier

A

1 + c / r + c, c = currency / deposits, r = required reserve ratio

246
Q

debt payment ratio

A

coverage ratio : CFO / cash for long term debt repayment

247
Q

reinvestment ratio

A

coverage ratio : CFO / cash paid for long term assets

248
Q

payable turnover ratio

A

activity ratio : purchases / avg acc pay : exp / ass

249
Q

days of sales outstanding

A

365 / rec turnover : 365 x avg acc rec / sales

250
Q

income statement - unusual or infrequent items v. extraordinary items

A

unusual or infrequent - included in continuing ops and reported before taxes : extraordinary - unusual and infrequent, reported after taxes (net of taxes), not allowed in IFRS

251
Q

cash flow - taxes

A

GAAP - all taxes in CFO : IFRS each tax goes to its section, CFO/CFI/CFF

252
Q

cash flow - interest & dividends

A

GAAP/IFRS : int rec CFO - CFO/CFI, int paid CFO - CFO/CFF, div rec CFO - CFO/CFI, div paid CFF - CFO/CFF

253
Q

items on cash flow statement come from…

A

1) income statement items 2) changes in balance sheet accounts

254
Q

change of accounting method or estimate requires

A

method - retro : error - retro : estimate - pro

255
Q

comprehensive income

A

net income + other comp income (unreal pl from currrency, pension adj, hedges, unreal pl from avail for sale securities), NO DIVS (pref or common) included

256
Q

held to maturity

A

debt, reported at amort cost (initial proceeds), amort cost = face - unamort discount or + unamort premium, fair value ignored subsequently, realized pl on income statement

257
Q

available for sale securities

A

debt & equity, reported on balance sheet at fair value, unrealized pl reported in other comp income, realized pl on income statement

258
Q

trading securities

A

debt & equity, reported on balance sheet at fair value, unrealized pl reported in income statement, realized pl on income statement

259
Q

gross revenue reporting vs net revenue reporting

A

gross = all rev + all costs, net = rev - costs : can use gross if primary obligator, bear investment + credit risk, able to choose supplier, latitude to establish price

260
Q

installment sales

A

revenue is recognized 1) immediately - very certain payment 2) as cash comes in - % rev = % profit 3) cost recovery - profit when accum cash > accum cost

261
Q

IASB vs FASB

A

IASB more emphasis on going concern : FASB - relevance, reliability, IASB - comparability, understandability : FASB0 bi adj of asset values upwards

262
Q

accounting boards & standards

A

FASB > GAAP : IASB > IFRS

263
Q

flow of accounting information

A

journal entries (in a general journal) > general ledger > initial trial balance (end of period) > adjusted trial balance > financial statements

264
Q

main accounting equation

A

A = L + E : A = L + contributed cap + beginning retain earn + revenue - expenses - dividends

265
Q

4 types of revenue and expense accruals

A

unearned rev (L), accrued exp (L), accrued rev (A), prepaid exp (A)

266
Q

are financial statement notes audited

A

yes

267
Q

McCallums monetary fed rul

A

something to do with monetarism and MV = PY

268
Q

Taylor’s fed funds rate rule

A

Fed funds rate = 2% + actual inflation + .5*(actual inflation - 2%) + .5(output gap)

269
Q

technology efficiency vs economic efficiency

A 
technology = fewest inputs 
economic = lowest cost
270
Q

economic profit

A

includes explicit & implicit opportunity cost

271
Q

normal profit of an individual

A

an individual’s opportunity cost

272
Q

opportunity cost

A

the return on a resource that could have been earned in its next most valuable use

273
Q

marginal benefit & marginal cost

A 
marginal benefit (MB) = demand curve 
marginal cost (MC) = supply curve
274
Q

price elasticity of supply

A

%Δ quantity supplied / %Δ price of good

275
Q

inelastic vs elastic

A

inelastic < 1
elastic > 1
perfect inelastic = 0
perfect elasticity = infinity

276
Q

income elasticity of demand

A

%Δ quantity demanded / %Δ income
normal necessity 0-1
normal luxury > 1
inferior < 0

277
Q

elasticity & greatest total revenue

A

when elasticity = -1, P*Q = max;
total revenue test:
if ΔPup > Δ(P*Q)up, then demand is inelastic
ΔPup > Δ(P*Q)down, then demand is elastic

278
Q

cross elasticity of demand

A

%ΔQ / %ΔPsubstitute
if positive > substitute
if negative > compliment

279
Q

price elasticity of demand

A

%ΔQ / %ΔP where %Δ = (Xt - X0) / [(Xt - X0)/2]
vertical demand line = inelastic
horizontal demand line = elastic

280
Q

elasticity

A

%ΔX / %ΔY

281
Q

technical analysis - change in polarity

A

breached resistence > support and vice versa

282
Q

technical analysis - non price based

A
  1. put/call ratio
  2. VIX
  3. margin debt
  4. short interest ratio
  5. flow of funds
  6. mutual fund cash position
  7. equity issuance
283
Q

technical analysis oscillators

A
  1. rate of change, Pt - P0
  2. relative strength, Pup/Pdown
  3. moving avg, 2 moving avg lines
  4. stochastic, Pt vs high/low prices in last X days
284
Q

technical analysis - moving average and Bollinger bands

A
  1. moving avg = avg of last X closing prices
  2. Bollinger bands = std dev of X closing prices around moving avg
285
Q

technical analysis - chart

A
  1. bar chart
  2. candlestick chart
  3. point and figure chart
  4. volume chart
286
Q

parametric and non-parametric

A
  1. parametric: more assumptions regarding distribution of population
  2. non-parametric: few assumptions about population (Spearman rank correlation test)
287
Q

variance testing - equality of 2 normally dist populations

A

are the two variances the same? both normal, independent : F test statistic, F = s1^2/s2^2, where s1^2 > s2^2 and df = n1 - 1 and n2 - 1 (2 dfs)

288
Q

variance testing - variance of norm dist population

A

is variance same as null hypo variance? normal, Chi-square statistic : X2n-1 = (n-1) x s^2 / O2o, where O2o = null hypo value and df = n-1

289
Q

mean difference test

A

are the means of two pops diff? both normal, DEPENDENT, remember returns of 2 steel companies : t statistic = (dbar - pop mean) / std error of d, where dbar = 1/n*E di, where di = difference in means

290
Q

equality of pop means test with unknown but assumed unequal variances

A

are the pop means the same? Both norm, independent : t stat = (x1bar - x2bar) / (s1^2/n1 + s2^2/n2)^1/2 where df is really complicated

291
Q

equality of pop means test with unknown but assumed equal variances

A

are the pop means the same? Both norm, independent : t stat = (x1bar - x2bar) / (sp^2/n1 + sp^2/n2)^1/2 where sp^2 = ((n1 -1)s1^2 + (n2-1)s2^2) / (n1 + n2 -2)

292
Q

hypothesis test p-value

A

probability of obtaining a test statistic that rejects the null hypothesis when it is true, use Z table to find it

293
Q

critical value

A

z,t,X,F value (eg 1.96)

294
Q

power of hypothesis test

A

probabilty of correctly rejecting the null hypothesis when it is false : often decreases when alpha is small : = 1 - P(type II error)

295
Q

hypo test - type I and type II error

A
  1. type 1: reject the null when true = significance level = alpha
  2. type II: failure to reject null when false
296
Q

test statistic

A

(sample statistic - null hypo value) / standard error

297
Q

hypopothesis testing procedure (7)

A
  1. state hypothesis
  2. select test statistic
  3. specify sig level
  4. state decision (rejection) rule
  5. collect sample and calc sample statistic
  6. make a decision re hypo
  7. make a decision based on test results
298
Q

z vs t test statistic

A
  1. normal, known var = z
  2. normal, unknown var = t, non-norm, known 30 z
  3. non-norm, unknown: 30 t
299
Q

the 2 n-1s

A

sample variance and degrees of freedom

300
Q

roys safety first criterion (SF ratio)

A

max (E(Rp) - Rl) / Op OR min P(Rp<Rl), where Rl is the minimum threshold

301
Q

continuous compounding formula

A

e^r where r is rate of return (eg 0.06)

302
Q

working capital turnover

A

activity ratio = rev / (avg curr ass - avg curr liab)

303
Q

days of inventory on hand

A

365 / inventory turnover = 365 x avg inv / COGS

304
Q

bond sinking fund provisions

A
  1. repayment of principle through series of repayments
  2. cash payment: borrower pays cash > trustee > retires at par
  3. delivery of securities: borrower buys bonds > trustee > retires those bonds (worse when bonds over par)
305
Q

free cash flow to equity

A

= CFO - FCI + net borrowing

306
Q

free cash flow to firm

A

= CFO - FCI + int exp(1 - t) = NI + non cash charges + int exp(1-t) - FCI - working capital

307
Q

investing and financing ratio

A

coverage ratio : CFO / cash outflows from investing and financing activities

308
Q

bonds - calls & puts

A
  1. call: good for issuer/borrower, call protection > currently calleable, refundable vs non-refundable, rates down
  2. put: good for lender/buyer, rates up
309
Q

bullet vs amortizing security

A
  1. bullet: principle repaid at end
  2. amortizing: principle paid along side interest
310
Q

what happens when a bold is sold inbetween coupon payments

A
  1. cum coupon (normal) = seller will receive accrued interest for buyer up to sale date
  2. dirty price (full price) = clean price + accured int, if bond is in default trades without accrued interest : ex-coupon - next coupon goes to seller
311
Q

dividend payment ratio

A

coverage ratio = CFO / dividends paid

312
Q

cash flow stucture

A

Operating + investing + financial = change in cash balance + beginning cash balance = ending cash balance

313
Q

cash conversion cycle

A

days of sales outstanding + days of inventory on hand - days of payables

314
Q

split rate corporate tax

A

corporate retained earnings are taxed at a higher rate than earnings paid out as dividend

315
Q

old prudent man vs new prudent investor rule

A
  1. total return old: income + preserve principle, new: income + cap growth
  2. risk old: no risk, new: risk vs return
  3. portfolio old: each investment by itself, new: investment part of portfolio
  4. security restrictions old: yes, new: no
  5. delegation of duty old: no, new: duty to delegate
316
Q

new prudent investor: main points

A
  1. economic conditions
  2. inflation + deflation
  3. investments + tax liability
  4. investment effect on portfolio
  5. total return (income + cap growth)
  6. other resources of beneficiary
  7. liquidity, income, cap preservation
  8. special relationship of assets to beneficiary
317
Q

PE | NAV after distribution

A

= NAVbefore - carried int - distributions

318
Q

PE | VC post money value

A

= PV(exit value) = pre + inv

319
Q

PE | VC ownership calc at time of investment

A
  1. f = inv/post = PV(inv)/exit value
  2. VC shares / other shares = f / 1-f
  3. price = inv / VC shares
320
Q

PE | adjusting discount rate for probability of failure

A

r* = (1+r / 1-q) - 1, r* = adj, r = unadj

321
Q

EV | residual income model

A
  1. aka economic profit for equity
  2. = NI - equity charge, equity charge = equity x rr
  3. equity charge measures shareholders opportunity cost
322
Q

cash flow accrual ratio

A
  1. NI - CFO - CFI = accrual
  2. accrual / net op assets = cash flow accrual ratio
323
Q

** EV | Four Valuation Models**

A
  1. dividend discount (DDM)
  2. free cash flow (FCF)
  3. market multiple models
  4. residual income model
324
Q

EV | economic value added

A
  1. EVA = NOPAT - (wacc x invested cap)
  2. inv cap = NWC + fixed assets = book debt + book equity
  3. NOPAT = EBIT(1-t)
  4. EVA = economic profit to debt + equity
325
Q

ABS | early amort trigger

A
  • protects lender from credit quality decline
  • eg. 3 months avg excess spread = 0 >> trigger
326
Q

ABS | CDO

A

• 3 layers
senior: variable rate: 70-80% of CDO
mezzanine: fixed rate
subordinate (equity tranche)

• pool contains mix of variable + fixed rate but not in same proportion as investor layers. Swaps are used to adjust

327
Q

ABS | Cash flow CDO

A
  • goal is to repay senior + mezz
  • 3 phases

1) ramp up: 1-2 mo: put together portfolio
2) reinvest: reinvest payments
3) paydown: 3-5 yrs: get paid

  • if ‘coverage test’ is passed then mezz and equity get paid interest, otherwise all to senior
  • principal >> senior >> mezz >> equity
328
Q

ABS | Market Value CDO

A

more freedom to manager than cash flow CDO

329
Q

ABS | Synthetic CDO

A
  • contract, not asset
  • senior + junior ‘sections’
  • junior pays in as protection for senior
  • then sell a credit default swap (CDS) on a notional amount tied to some other instrument
  • derivative: after junior is depleted, senior is on the hook
330
Q

ABS | CDO motivations

A
  1. arbitrage (majority)
    2.balance sheet
    ◎ sell an asset without selling it and same with buying
331
Q

Mortgages | SMM & prepayment calculation

A

prepayment(m) = SMM(m) x (mortgage balance at beginning of month - scheduled principal repayment)

332
Q

Mortgages | prevailing mortgage rates

A
  1. spread between current rate and original mortgage rate
  2. path of mortgages
    ◎ refinancing burnout when rates go up and down and everyone has refied already
333
Q

Mortgages | 3 factors of prepayment

A
  1. prevailing mortgages rates
  2. housing turnover
  3. characteristics of mortgage
334
Q

Mortgages | 2 types of prepayment risk

A
  1. contraction risk
    ◎ negatie convexity (call)
    ◎ reinvestment risk
  2. extension risk
335
Q

Mortgages | CMO

A

collateralized mortgage obligation
◎ tranches

336
Q

Mortgages | CMO tranche types

A
  1. sequential pay tranche
  2. accrual tranche
  3. planned amort class tranche
  4. support tranche
337
Q

Mortgages | principal pay down window

A

• in a CMO, the time it takes to pay down the principal in a particular tranche

338
Q

Mortgages | Z - tranche

A
  • aka accrual tranche
  • last tranche to receive principal
  • interest goes to paying off other tranches. Z-tranche balance increases (accrues)
  • Z or Accrual bond
339
Q

ABS | CDO debt includes:

A
  1. junk bonds
  2. MBS & ABS (structured)
  3. emerging mkt bonds
  4. corp loans made by commercial banks
  5. special situation loans
340
Q

Mortgages | PAC tranche

A

• ‘planned amortization class’
• amorted based on sinking fund schedule
• initial PAC collar: prepay speed
• guaranteed lower PSA schedule
◎ min of 2 payment speeds
• PAC window: principal repay time
• a prepay collar

341
Q

Mortgages | support tranche

A
  • paired with a PAC tranche
  • more guaranteed PAC >> more risky the support
  • support takes excess or provides when too little
  • if support is paid off then PAC no longer supported >> ‘busted’ PAC
342
Q

Mortgages | effective collar

A

a PAC’s PSA range

343
Q

Mortgages | PAC I and PAC II

A

• PAC I is normal PAC
• PAC II (aka scheduled tranche)
◎ support for PAC I
◎ also has a schedule
◎ higher prepay risk, but more prepay protection than support wo/schedule

344
Q

Mortgages | why were CMO’s set up?

A

to redistribute contraction & extension risk

345
Q

Mortgages | PAC I, PAC II, Support prepay risk

A

PAC I
PAC I
PAC I
PAC I
PAC II
PAC II
Support (no schedule)

346
Q

Mortgages | pass through

A

the worst basic MBS with no bells or whistles

347
Q

Mortgages | stripped MBS

A
  1. principal only (PO)
    ◎ prepay good
  2. interest-only strips (IO)
    ◎ prepay pad
348
Q

Mortgages | IO, PO, pass through: price volatility

A

price vol (PO,IO) > price vol (pass through)

349
Q

Mortgages | 3 factors of agency underwriting standards

A
  1. max loan to value (LTV)
  2. payment to income
  3. loan amount
350
Q

Mortgages | agency v non-agency CMO path

A
  • agency: whole loan >> pass through >> CMO
  • non-agency: whole loan >> whole loan CMO
351
Q

Credit | treasuries used to create the theoretical spot rate curve

A
  1. all on the run
    ◎ most accurate priced issues
    ◎ large maturity gaps after 5 yrs
  2. most on-the-run, some off
    ◎ reduces maturity gap
    ◎ repo mkt may distort prices
  3. all treasuries
    ◎ includes all information
  4. treasury strips (zero coupon)
    ◎ reduce maturity gap, rate = spot rate
    ◎ less liquid premium, diff taxes
352
Q

Credit | par coupon curve

A

on-run-run yld curve

353
Q

Credit | what does duration measure?

A

bond price sensitivity to parallel changes in interest rates

354
Q

Credit | 3 factors that affect treasury securities returns

A
  1. changes in interest rate levels (90%)
  2. slope changes (8.5%)
  3. curvature changes (1.5%)
355
Q

Volatility

A
  • var = Σ (X1 - Xbar)^2 / T - 1
  • sd = sqrt(var)
  • Xt = ln(Yt / Yt-1)
  • Xbar = avg yld from 1 > T and is optional
  • *sqrt(time) to change time period (day > annual = *16)
356
Q

Credit | what does bond yld volatility mean?

A
  • if annual vol = .1 and yld = .08
  • then 69% prob that yld will be .08 +- .008 a year from now
357
Q

Bonds | 3 spread measures

A
  1. nominal yield: YTMbond - YTMgovt
  2. Z-spread
    ◎ spread at each spot rate so that CFpv = Po
    ◎ includes cost of imbedded option
    ◎ Z is constant across all spot rates
    ◎ exp: 104.12 = 8/(1+.04+Z) + 108/(1+.05+Z)…
  3. OAS: spread once option cost is removed = Z - opt cost
358
Q

Bonds | backward induction

A
  • used to calc Po of bond
  • start calcing at nodes N (end of tree) back node 0
359
Q

Bonds | option value

A
  • Pcall = Pnon-call bond - Pcall bond
  • Pput = Pput bond - Pnon-put bond
360
Q

Bonds | OAS

A
  • aka option-adjusted spread
  • rate that must be added to all of the non-option spot rates so that CFpv = Po
  • rate that once added makes the binomial tree arbitrage free
  • removes cost of embedded option
361
Q

Credit | S&P’s debt service coverage

A

= (free op cash flow + interest) / (interest + annual principal repayment)

362
Q

Credit | free operating cash flow

A

= FCFF - int(1- tr)
• does not add back in interest exp as does FCFF

363
Q

Credit | operating cash flow

A

= CFO = NI + dep + decrease non-cash assets + increase non-cash debt +- non-cash charges

364
Q

CF

A

= NI + dep +- other non-cash charges
• aka earning plus non-cash charges
• aka funds from operations (credit term)

365
Q

Credit | financial ratios

A
  1. current (ST solvency)
  2. acid test (ST solvency)
  3. LT dept-cap (capitalization: financial leverage)
  4. total debt-cap (capitalization)
  5. EBIT - int (coverage)
  6. EBITDA - int (coverage)
    • all ratios are better when higher
366
Q

Asset Manager Code of Professional Conduct (AMCPC)

A
  1. loyalty to clients
  2. investment process and actions
  3. trading
  4. risk management, compliance, support
  5. performance & valuation
  6. disclosures
367
Q

Asset Manager Ethics Responsibilities

A
  1. always act ethically & professionally
  2. acit in the best interest of the client
  3. act in an objective and independent manner
  4. perform actions using skill, competence and diligence
  5. communicate accurately with clients on a regular basis
  6. comply with legal and regulatory reqs regarding capital mkts
368
Q

AMCPC | Loyalty to Clients policies (3B1 p 123)

A
  1. align incentives (no undue risk)
  2. client confidential info
  3. AML
  4. def of a token gift
369
Q

AMCPC | Investment Process and Actions (3B1 p 124)

A
  1. never manipulate mkt prices
  2. deal fairly when doing ARA
  3. reasonable basis
  4. diff levels of service
  5. explainable strategies
  6. ability to cash out
  7. IPS
370
Q

AMCPC | Trading (3B1 p 125)

A
  1. no insider trading
  2. priority of transactions
  3. soft dollars use
  4. best execution
  5. equitable share allocation
371
Q

AMCPC | Risk management, Compliance, Support (3B1 p 125)

A
  1. Policies/procedures for AMCPC, SPC, regs, law
  2. firm-wide risk system
  3. compliance officer
  4. portfolio info is correct & reviewed by 3rd party
  5. record retention 7 yrs
  6. sufficient, qualified staff
  7. disaster recovery plan
372
Q

AACPC | Performance & Valuation (3B1 p 126)

A
  1. see GIPS
  2. 3rd party valuations
373
Q

AMCPC | Disclosure (3B1 p 127)

A

Absolutely EVERYTHING

374
Q

3 Behavioral models

A
  1. Barnewall 2 way model
  2. Bailard, Biehl, Kaiser 5 way model
  3. Pompain model
375
Q

Behavior models | Barnewall 2 way model

A

2 investor categories: active and passive

376
Q

Behavior models | Bailard, Biehl, Kaiser 5 way model

A

• 2 investeror dimensions:
◎ confidence: confident (C) to anxious (A)
◎ method of action: careful (F) to impetuous (I)
• 5 investor categories:
◎ straigt arrow (middle)
◎ Individualist (CF)
◎ Adventurer (CI)
◎ Guardian (AF)
◎ Celebrity (AI)

377
Q

Behavior models | Pompian model

A

• 4 step assesment
• 2 dimensions: risk tolerance / investment style
• 4 Behavior Investor Types (BITs):
◎ passive preserver
◎ friendly follower
◎ independent individualist
◎ active acumulator

378
Q

Behavior models | Pompian model - 4 step assessment

A
  1. active/passive
  2. risk tolerance scale
  3. behaviorial biases
  4. classify investor in BITS
379
Q

Behavior models | Pompian model - BITs

A

Behavior Investor Types: Risk tolerance (low > high) & Investment style (conservative > aggressive):
◎ Least: Passive preserver (emotional: bad)
◎ Moderate low: Friendly follower (cognative: good)
◎ Moderate high: Independent individualist (cognative: good)
◎ Most: Active accumulator (emotional: bad)

380
Q

Behavior models | Pompian model biases - Passive preserver

A
  • Emotional: endowment, loss aversion, status quo, regret aversion
  • Cognative: mental accouting, anchoring and adjustment
381
Q

Behavior models | Pompian model biases - Friendly follower

A
  • Emotional: regret aversion
  • Cognative: availability, hindsight, framing
382
Q

Behavior models | Pompian model biases - Independent individualist

A
  • Emotional: overconfidence, self-attribution
  • Cognative: conservatism, availability, confirmation, representativeness
383
Q

Behavior models | Pompian model biases - Active accumulator

A
  • Emotional: overconfidence, self-control
  • Cognative: illusion of control
384
Q

Client / Adviser success measure

A
  1. Adviser understands long term financial goals of client
  2. Adviser maintains consistent approach with client
  3. Adviser acts as client expects
  4. Both client and advisor benefit
385
Q

Analyst behavioral biases

A
  1. overconfidence
  2. way management presents information
  3. biased research
386
Q

Analyst behavioral biases | self calibration

A
  • Mitigate overconfidence
  • accurately remembering forecasts and accurate self-evaluations
387
Q

Analyst behavioral biases | Company management influence

A
  1. framing
  2. anchoring and adjustment
  3. availablity
388
Q

Investment committee behavioral biases

A
  • Often no better than individual
  • All individual + social proof bias: person follows the group
  • To counteract, need independence
389
Q

Excess return anomolies that are not

A
  • Excess return before, but not after expenses
  • Excess return with too low associated risk
390
Q

Behavioral bias | Disposition effect

A

more willing to sell winners than losers

391
Q

Behavioral bias | Biases creating excess returns

A
  1. Momentum effect
    ◎ Herding
  2. Bubble and crash: panic buying/selling
  3. Value vs Growth
    ◎ Halo effect
392
Q

Behavioral bias | Biases that contribute to overconfidence

A
  1. illusion of knowledge
  2. self-attribution
  3. representativeness
  4. availability
  5. illusion of control
  6. hindsight
393
Q

Behavioral bias | Methods to avoid bias

A
  1. seek counter evidence/opinions
  2. defined systematic decision process
  3. verifiable data
  4. correct framing
  5. documenting decisions
  6. bayes formula
394
Q

Behavioral bias | Quantitative indication of bubbles/crashes

A
  • Bubble: 2 std dev from mean price
  • Crash: 30% drop in a few months
395
Q

Behavioral bias | Bubble/Crash biases

A
  1. overconfidence
  2. confirmation
  3. self-attribution
  4. hindsight
  5. regret aversion
  6. disposition effect
396
Q

Behavioral finance | macro vs micro

A
  • macro: mkt deviaition from traditional finance theory
  • micro: individuals’ decision making process deviation from traditional finance (REM: rational economic men)
397
Q

Rational economic men (REM)

A

The rational actor assumption in traditional finance theory

398
Q

Bayes formula

A

P(A|B) = P(B|A) * P(A) / P(B)

399
Q

Behavioral finance | Utility theory

A

• Foundation of traditional finance theory
• diminishing marginal utility return
◎ >> concave risk averse utility function
◎ >> convex indifference curves

400
Q

Behavioral finance | Satisfice

A
  • sufficient satisfaction, but not optimal, are sufficient
  • satis+ficent = satisfice
401
Q

Behavioral finance | Decision theory

A

• associated with traditional finance theory • process of making optimal decision when decision maker is informed, math able, rational (REM)

402
Q

Behavioral finance | Bounded rationality

A
  • associated with behavioral finance theory
  • Knowledge and cognative limitations of decision maker
  • Satisfice
  • More constrained that prospect theory
403
Q

Behavioral finance | Prospect theory

A
  • associated with behavioral finance theory
  • similar to bounded theory
  • risk aversion is replaced by loss aversion
  • 2 phases: Editing phase, then Evaluation phase
404
Q

Behavioral finance | Prospect theory : Editing phase

A

First three steps

  1. Codification: gain/loss & prob
  2. Combination: Combines similar outcomes
  3. Segregation: separation of risk-free and risky aspect of each outcome
405
Q

Behavioral finance | Prospect theory: Evaluation phase

A
  1. assign weights and prob
    ◎ weights and prob are based on behavioral biases
    ◎ >>gains < losses, large prob < tail events
  2. calc expected utility
406
Q

IPS | Situational profiling and risk tolerance

A
  1. source of wealth
    ◎ active (entrepreneurial) vs passive (steady accum & inherit)
  2. measure of wealth
    ◎ perceived wealth vs needs >> percieved risk tolerance
  3. stage of life
    ◎ foundation, accumulation, maintenance, distribution
407
Q

IPS | Situational profiling: Source of wealth

A
  • Active: more risk tol, but possible business risk vs investment risk difference
  • Passive: less risk tol
408
Q

IPS | Situational profiling: Stage of life

A
  1. Foundation (mod risk)
  2. Accumulation (highest risk)
  3. Maintenance [retirement] (low-mod risk)
  4. Distribution: old wealthy giving to others (low - high risk)
409
Q

Traditional finance assumes investors have 3 traits

A
  1. risk aversion: min risk; risk is volatility
  2. rational expectations: unbiased view of the world
  3. asset integration: all investments are correlated
410
Q

Traditional vs Behavioral investor traits

A
  1. risk aversion vs loss aversion
  2. rational expectations vs biased expectiations
  3. asset integration vs ass segregation
411
Q

IPS | 4 Personality types

A
  1. cautious: low risk, indecisive, difficult
  2. methodical: conservative, lots of data
  3. confident, decisive
  4. spontaneous: high portfolio turnover, chase fads, doubt self and others
412
Q

IPS | for exam, IPS = O&C (objectives & constraint section of IPS)

A

*only front of card*

413
Q

IPS | IPS benefits to clients

A
  1. id’s and documents objectives/constraints
  2. dynamic in response to changes w/client or mkt
  3. easy to understand
  4. education about self and investing
  5. understand manager’s actions
  6. transferable across managers
414
Q

IPS | IPS benefits to manager

A
  1. knowledge of client
  2. guidance for investment decisions
  3. resolution of disputes (signed documentation)
415
Q

IPS | RRTTLLU breakdown by O&C

A
  • O: RR
  • C: TTLLU
416
Q

IPS | arrving at RRTTLLU

A

TTLLU >> risk >> return

417
Q

IPS | SAA must conform to IPS

A

*only front of card*

418
Q

IPS | RRTTLLU abbrev for notes in test

A
  • return: rn
  • risk: rs
  • time horizon: tm
  • taxes: tx
  • liquidity: lq
  • legal: ll
  • unique: u
419
Q

IPS | calcing returns with inflation

A

add inflation in initially so that you include the inflated numbers when calcing taxes

420
Q

IPS | are residences included in investment calculations?

A

no

421
Q

IPS | remember to watch for…

A
  • pre vs after tax
  • real vs nominal
422
Q

IPS | Return objective: 2 categories

A

required vs desired return

423
Q

IPS | Risk objective: 2 categories

A
  • ability (time horizon, wealth & outflow) vs willingness to take risk
  • always state conclusion
  • if they differ, pick conservative choice
424
Q

IPS | assessing clients’ preferences

A

look at actions as well as statements

425
Q

IPS | 4 Risk objective factors

A
  1. time horizon
  2. critical goals/expenditures
  3. liquidity needs
  4. portfolios proportion of overall wealth
426
Q

IPS | Time horizon constraint assessment

A
  1. state:
    ◎ number of stages
    ◎ each stage objective
    ◎ # yrs in each stage
  2. other involved people (eg giving/receiving inheritance)
  3. multi-generational horizon
  4. retirement time horizon default: 20-25 yrs
427
Q

IPS | 4 Tax constraint: tax types

A
  1. income
  2. capital gains
  3. wealth transfer
  4. personal property (eg car, house)
428
Q

IPS | 4 Tax mitigation strategies

A
  1. Tax deferral (eg cap gain investment, loss harvesting, low turnover)
  2. Tax avoidance: tax free securities
  3. Tax reduction: investments with lower tax rates (eg cap gains vs income)
  4. Wealth transfer timing: (eg. no sales)
429
Q

IPS | Complicated tax situation

A

state that tax situation is complex and manager should seek qualified tax advice

430
Q

IPS | 5 Liquidity constraints

A
  1. ongoing, known expense (or in return jbj)
  2. emergnecy reserves (if requested)
  3. one-off, infrequent outflows (college falls under time horizon)
  4. one off positive inflows
  5. illiquid assets: restricted from sale, illiquid (eg house)(or in unique), large tax cost (or in unique or tax)
431
Q

IPS | Legal: 2 common issues

A
  1. Trust: revocable vs irrevocable
  2. Family foundation
432
Q

IPS | Legal: notes

A
  1. If no big legal issues state there are none beyond normal Code & Standards responsibilities
  2. manager must follow the trust document; weigh needs of different stakeholders
  3. mention other legal issues or lack of
  4. if complex issues, state manager will seek qualified expert advice
433
Q

IPS | Unique constraints

A
  1. Special investment concerns (eg social)
  2. Special instructions (liquidate holdings)
  3. Restrictions on sales
  4. Forbidden asset / asset classes
  5. Assets outside of portfolio (eg. houses)
  6. Bequests
  7. Unattainable objectives
434
Q

IPS | General notes

A
  • State what is there and what is NOT there
  • Complex issues, seek qualified expert
  • Re-state all the facts
  • point out conflicting factors
435
Q

Strategic Asset Allocation (SAA)

A

is the mix of asset classes that will meet the IPS objectives and constraints

436
Q

IPS & SAA | important return is pre or after tax?

A

after tax

437
Q

SAA process

A
  1. eliminate portfolios that violate stated or appropriate constraints
  2. assess return to risk ranking
    ◎ sharpe ratio
    ◎ most often you will never need to get to this stage bc/only one portfolio remains
438
Q

SAA portfolio elimination process

A
  1. excess/insufficient cash equivalents
  2. hold/fail to hold assets specified in constraints
  3. violates risk constraints
    4.generate insuffient return (after-tax)
    5.inappropriate asset classes or weightings (even if not specificed)
    ◎ 60 equity/40 bond&cash is default
    ◎ do not ignore home ownership >> too much real estate holdings
    • address concentration issues (eg. low-basis inheritance, former employer stock)
439
Q

IPS & SAA | monte carlo simulation pro/cons vs deterministic method

A

• Pros:
1. path dependency
2. better display of risk/return by providing multiple possible outcomes
3. better tax analysis
4. better display of short-term & long-term performance (eg more ST vol, but better LT return)
5. better analysis of multi-period effects
6. can look at different points in timeline (major decision/event points)
• Cons:
1. if simplistic model of returns is used
2. if generalized asset class returns are used rather than specific investments (w/costs)
3. if simplistic tax model is used

440
Q

Taxes | 3 types of taxes

A
  1. income
  2. wealth: assets and asset transfers
  3. consumption: sales & VAT
441
Q

Taxes | marginal tax rate

A

tax rate paid on the last dollar of income

442
Q

Taxes | how US taxes work in regards to different tax rates over a single income

A
  • every one pays same rate on 1st dollar
  • each dollar after is taxed on whichever tax rate basket that dollar falls into
  • for example: $20K income: first $8,350 is taxed at 10%, remaining is taxed at 15%
  • the overall rate (avg tax rate) is the weighted average of the different rates * the amount taxed at that rate
443
Q

Taxes | 2 most common tax regimes

A 
#1: common progressive (progressive, light on all investment) 
#2: LIght capital gains tax (progressive, light on cap gains)
444
Q

Taxes | accrual taxes

A

• paid periodically (eg annually)

445
Q

Taxes | FVIF - accrual tax

A

FVIF = [1 + R*(1 - T)]^N
R = pre-tax return
◎ or FVIF = (1 + Rart)^N
T = tax rate
N = number of investment periods
• = after-tax value of each dollar invested

446
Q

Taxes | accrual (annual) tax drag % is less/more than tax rate

A

more, due to effect on compounding

447
Q

Taxes | tax drag

A
  • gain lost to taxes
  • stated as a dollar value or %
448
Q

Taxes | FVIF - deferred tax

A 
FVIF = [(1 - T) \* (1 + R)^N + T\*B] 
R = investment return 
N = # periods 
T = tax rate 
B = % of original investment ALREADY taxed
449
Q

Taxes | Tax drag: deferred vs accrual

A
  • accrual $ and % > deferred
  • deferred is constant % of total gain (horizon and return do not affect it) and equal to tax rate
  • accrual $ and % grow with return and horizon
450
Q

Taxes | FVIF - wealth based

A 
FVIF = [(1 + R) \* (1 - T)]^N 
R = investment return 
N = # periods 
T = tax rate
451
Q

Taxes | wealth tax attributes

A
  • tax drag > tax rate
  • horizon increase >> greater $ and % tax drag
  • return increase >> greater $ lower % tax drag
452
Q

Taxes | accrual tax attributes

A
  • tax drag > tax rate
  • horizon or return increase >> greater $ and % tax drag
453
Q

Taxes | deferred tax attributes

A

constant % tax drag regardless of horizon or return
• tax drag % = tax rate

454
Q

Taxes | annual return after realized (cummulative) taxes sans deferred taxes

A

Rart = R(1 - Trealized) = R[1 - (PiTi + PdTd + PcgTcg)]
Pi, Pd, Pcg = % of gain attributed to interest, div, realized cap gains
Ti, Td, Tcg = tax rate on interest, div, realized cap gains

455
Q

Taxes | Tax loss harvesting

A
  • using investment loses ot offset investment gains
  • main gain reducing tax bill in near term and those saving can be invested
456
Q

Taxes | HIFO

A
  • Highest In (basis), First Out
  • allowed by some govts
  • Also LIFO if you believe taxes will rise
457
Q

Taxes | trading activity and taxes

A

usually the frequent trader falls under a higher tax rate, which leads to lower returns, especially over longer horizons and higher return rates

458
Q

Taxes | year end sales

A
  • if gain, wait until next year
  • if loss, sell this year to harvest the loss
459
Q

Taxes | Mean variance optimization

A

Optimizing portfolio allocation should be done on an after tax basis using equivalent after-tax returns and risk on an after tax basis

460
Q

Taxes | effective unrealized cap gains tax rate adjusting for annual taxes

A

Tecg = Tcg*[1 - (Pi + Pd + Pcg)] / [1 - (PiTi + PdTd + PcgTcg)]

461
Q

Taxes | FVIF - all taxes

A

FVIFt = (1 - Tecg) * (1 + Rart)^N + Tecg - (1-B)*Tcg
• Tecg = effective cap gains adj for annual taxes
• Rart = return after realized taxes

462
Q

Taxes | accrual equivalent (after tax) return

A

Rae = (ending balance after all taxes / beginning balance)^N
N = number of periods
• as horizon or amount deferred increases Rae approaches pre-tax return

463
Q

Taxes | accrual equivalent tax rate

A

Tae = 1 - (Rae / Rpre-tax)

464
Q

Taxes | tax deferred account (TDA)

A
  • pre-tax income
  • entire balance when withdrawn
  • FVIFtda = (1 + R)^N * (1 - Tfuture)
465
Q

Taxes | tax-exempt account (TEA)

A
  • not Tea (equivalent accrual tax rate)
  • after-tax income
  • no tax upon withdrawl
  • FVIFtea = (1 + R)^N * (1 - Tnow)
466
Q

Taxes | TDA vs TEA

A
  • if Tfuture < Tnow, then TDA is better
  • if Tfuture > Tnow, then TEA is better
  • if Tfuture = Tnow, then no difference
  • if $ amounts are restricted and equal then compare FV’s of each, but remember to include extra taxed $ for TDA
467
Q

Taxes | FVIF

A

Future Value Interest Factor

468
Q

Taxes | List of FVIF’s

A
  1. tax deferred acct
  2. tax exempt acct
  3. all taxes
  4. accrued annual tax
  5. wealth tax
  6. deferred cap gains
469
Q

Taxes | FVIF - deferred capital gains

A

FVIFcgt = (1 - Tcg)*(1 + R)^N + Tcg * B
• Tcg = cap gains tax rate
• B = cost basis PERCENT
• R = annual return

470
Q

Taxes | Taxes and investment risk (volatility)

A

after tax risk = stan dev * (1 - T)
• govt absorbs part of variability
• tax exempt accts (TDA & TEA): investor bears all risk

471
Q

Taxes | asset location

A

type of acct asset is located (eg tax advantaged acct)

472
Q

Taxes | tax alpha

A

value created by effective tax management

473
Q

Taxes | Taxes and trading behavior

A
  1. Traders: high turn-over, ST cap gains >> bad
  2. Active investors: med-turn-over, LT cap gains >> so-so
  3. Passive investors: LT cap gains over many years >> good
  4. Exempt investors: hold assets in tax-exempt accts
474
Q

Estate

A

Every thing a person owns
• financial
• real estate (aka immovable property)
• collections (eg art)
• businesses
• non-tangible (eg trademarks, patents

475
Q

Estate planning

A

Planning of transfer of person’s estate to other during lifetime or at death

476
Q

Will

A
  • aka testament
  • legal doc that states rights of others to person’s estate
477
Q

Probate

A

• Legal process that takes place at death
• court determines
◎ will validity
◎ decedent’s property inventory
◎ claims against decedent
◎ distributes property according to will

478
Q

Intestate

A

Dying without a valid will

479
Q

Avoiding probate

A

• There are ways to avoid probate
◎ joint ownership w rights of survivorship
◎ living trusts
◎ retirement plans
◎ life insurance

480
Q

Estate | gifts

A
  • aka lifetime gratuitous transfer or inter vivos transfer
  • given while living
  • subject to gift taxes; who pays is up to govt law
481
Q

Estate | wealth transfer methods

A
  1. gifts
  2. bequests
482
Q

Estate | bequests

A
  • testamentary gratuitous transfer
  • given after death
  • estate taxe (paid by grantor/transferor); inheritance tax (paid by recipient); who pays is up to govt law
  • taxes can vary based on relationship to decedent
483
Q

Roman law

A

civil law system based on old Roman law; top down system where laws are handed down from legislative body

484
Q

English law

A

common law system; bottom up; judges create precedents that are applied in future cases

485
Q

Estate | forced heirship

A
  • children or spouse have a right to a portion of parent’s estate
  • all assets are usually included
486
Q

Estate | community property rights

A
  • each spouse entitled to half of the estate earned during mariage
  • gift and inheritence can be held separately
  • part of forced heirship
487
Q

Estate | separate property rights

A
  • each spouse owns their property separately
  • common in civil law countries
488
Q

Human capital

A
  • aka net employment
  • PV of net employment income over lifetime
489
Q

Individual balance sheet

A
  • Assets: all tangible and intangible assets including human capital and any other future income
  • Liabilities: all current and future liabilities incurred by living life plus any required reserve fund (Core capital)
  • Equity is anything left over (Excess capital)
490
Q

Core capital

A

equals liabilities on Individual Balance Sheet
• sum product of expected annual spending x prob of living that long

491
Q

Excess capital

A

equals equity on Individual Balance Sheet

492
Q

Mortality table

A

death table (fun)
• combined prob: prob either one is alive next year
• real annual spending: living exp for coming year
• exp real spending: real annual spending * combined prob
• present value:PV of real annual spending
• total: PV of core capital required to meeting exp THROUGH the given year (row)
• 0 prob to live past 100 in table

493
Q

monte carlo simulation advantage

A

gives a distribution of outcomes vs just a mean

494
Q

longevity risk

A
  • risk of running out of money in retirement prior to death (ruin)
  • generally, retiree should spend <= 3% of assets to have 95% confidence of not outliving assets
495
Q

Estate | giver and givee terms before and after death

A
  • before death: donor, recipient
  • after death: testator, beneficiary
496
Q

Estate | return and tax rate symbols

A
  • Rg, Tig = investment return and annual tax rate of recipient
  • Re, Tie = investment return and annual tax rate of giver
  • Te = estate tax rate paid by the estate
  • Tg = gift tax rate paid by either giver, receiver
497
Q

Estate | relative value of gift / bequest

A 
RV = FVgift / FVbequest 
◎ = (1 - Tg)\*(1 + Rg\*(1 - Tig))^N / (1 - Te)\*(1 + Re\*(1 - Tie))^N 
F = future vale
498
Q

Estate | relative value of gift when donor pays gift tax

A
  • add in + Tg*Te due to reduced estate taxes
  • RVg = (1 - Tg + Tg*Te)*(1 + Rg*(1 - Tig))^N / (1 - Te)*(1 + Re*(1 - Tie))^N
499
Q

Estate | relative value: generation skipping

A 
RV = 1 / 1 - T 
T = wealth transfer tax
500
Q

Estate | calcing generation skipping

A
  1. calc excess above core capital requirements for giver and next generation
  2. give excess to third generaiton

CFA (11 decks)

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