CFA II Flashcards
1
Q
What are the three approaches to estimating VaR?
A
- Parametric method
- Historical simulation
- Monte Carlo simulation
2
Q
What are the three steps when estimating VaR of a portfolio?
A
- Decompose risk factors
- Collect historical data
- Third step depends on approach used
3
Q
How many trading days are there in one year?
A
250
4
Q
What is the z-score for a one-tailed test with a 5% significance level?
A
1.645
5
Q
What is the z-score for a two-tailed test with a 5% significance level?
A
1.96
6
Q
What is surplus at risk cause by?
A
A mismatch between the duration of the assets and the duration of the liabilities
7
Q
Leverage for banks (formula)
A
RWAs
———
Equity
8
Q
Information Ratio (formula)
A
Information Coefficient x (Breadth)^0.5 (x Transfer Coefficient)
Or
Active Return
——————— (x Transfer Coefficient)
Active Risk
9
Q
Optimum Level of Active Risk
A
IR
——— x sd(b)
SR(b)
10
Q
Sharpe Ratio of Actively Managed Portfolio (formula)
A
SR(p)^2 = SR(b)^2 + IR^2
11
Q
Risk Neutral Probability (Formula)
A
1 + r - d
————
u - d
12
Q
What view does a positive delta signify?
A
Bullish
13
Q
What view does a negative delta signify?
A
Bearish
14
Q
When is gamma at its highest?
A
When it is ATM and near to expiry
15
Q
What accounting method(s) is used for <20% ownership in a company?
A
Cost or FV
16
Q
What accounting method is used for 20-50% ownership in a company?
A
Equity method
17
Q
What accounting method(s) is used for >50% ownership in a company?
A
Consolidation method
18
Q
R^2
A
RSS
——
SST
19
Q
Standard deviation of the residuals (SEE)
A
(MSE)^0.5
20
Q
Adjusted R^2 (formula)
A
n - 1
1 - [(————) x (1 - R^2)]
n - k - 1
21
Q
How do you correct for serial correlation? (2 methods)
A
- Adjust the coefficient standard errors using the Hansen method
- Improve the specification of the model
22
Q
How to detect serial correlation? (Two methods)
A
- Scatter plot with residuals
- Durbin-Watson test
23
Q
How do you detect heteroskedasticity? (Two methods)
A
- Scatter plot
- Breusch-Pagan Chi-Squared test
24
Q
Breusch-Pagan test statistic (formula)
A
n x R^2(resid)
25
How do you correct for heteroskedasticity?
Use White-corrected standard errors
26
How do you correct for multicollinearity?
Drop one of the correlated variables
27
How do you detect multicollinearity? (Two methods)
- Conflicting t and F statistics
| - Correlations among independent variables (if k = 2)
28
Mean-reverting level
b(0)
————
1 - b(1)
29
Standard error of estimated autocorrelation (Formula)
1
———
T^0.5
30
How do you detect serial correlation for AR models?
Test the autocorrelations of the residuals using the t-test (NOT the Durbin-Watson test, which is only for trend models)
31
What are two advantages of simulations?
- Promote better input quality
| - Provide a distribution of expected values rather than a single point estimate
32
Fisher relation (Formula)
R(nom) = R(real) + E(inflation)
33
Covered interest rate parity (Forward)
1 + R(price)
F = S x ——————
1 + R(base)
34
Uncovered interest rate parity (Formula)
E(%ΔS) = R(price) - R(base)
35
Absolute purchasing power parity (Formula)
CPI(price)
S = —————
CPI(base)
36
Relative purchasing power parity (Formula)
%ΔS = Inflation(price) - Inflation(base)
37
International Fisher effect (Formula)
R(price) - R(base) = E(infl,price) - E(infl,base)
38
Slope coefficient (Formula)
cov(x,y)
b(1) = ————
var(x)
39
Accuracy (Formula)
TP + TN
—————————
TP + TN + FP + FN
40
F1 score (Formula)
2 x P x R
————
P + R
41
True positive rate (Formula)
TP
————
TP + FN
42
False positive rate (Formula)
FP
————
FP + TN
43
Normalised X(i)
X(i) - X(min)
————————
X(max) - X(min)
44
Standardised X(i)
X(i) - X̄
————
sd
45
F-statistic (Formula)
MSR
———
MSE
46
Value of forward contract prior to expiration (Formula)
[FP(t) - FP] x (contract size)
—————————————
[1 + r(days/360)]
47
Sustainable growth rate of output per capita (Formula)
θ
g* = ———
1 - α
48
Sustainable growth rate of output (Formula)
θ
G* = ——— + ΔL
1 - α
49
Output per worker
Y/L = T(K/L)^(α)
50
Growth rate in potential GDP (Formula 1)
Long-term growth rate in technology + α(long-term growth rate of capital) + (1 - α)(long-term growth rate in labour)
51
Growth rate in potential GDP (Formula 2)
Long-term growth rate of labour force + long-term growth rate of labour productivity
52
How is in-process R&D recognised?
As an intangible asset under both IFRS and US GAAP
53
Plan assets at end of period (Formula)
Plan assets at beginning of period + employer contributions + actual return - benefits paid
54
PBO at end of period
PBO at beginning of period + service cost + interest cost + past service cost +/- actuarial losses/gains - benefits paid
55
Funded status (Formula)
Plan assets - PBO
56
Total periodic pension cost (Formula 1)
Employer contributions - (ending funded status - beginning funded status)
57
Total periodic pension cost (Formula 2)
Current service cost + interest cost - actual return of plan assets +/- actuarial losses/gains + prior service cost
58
IFRS periodic pension cost on income statement(Formula)
Current service cost + prior service cost +/- net interest cost/income
59
US GAAP periodic pension cost on income statement (Formula)
Current service cost + interest cost - expected return on plan assets +/- amortisation of actuarial losses/gains* +/- amortisation of prior service cost/benefit
60
Which method do you use if the functional and presentation currency are different?
The current rate method
61
Which method do you use if the functional and presentation currency are the same?
The temporal method
62
Underwriting loss ratio (Formula)
Claims paid + Δ loss reserves
——————————————
Net premium earned
63
Expense ratio (P&C company) (Formula)
Underwriting expenses
———————————
Net premium written
64
Combined ratio (Formula 1)
Total insurance expenses
————————————
Net premium earned
65
Combined ratio (Formula 2)
Underwriting loss ratio + expense ratio
66
Loss and loss adjustment ratio (Formula)
Loss expense and loss adjustment expense
————————————————
Net premium earned
67
Dividends to policyholders ratio (P&C companies) (Formula)
Dividends to policy holders
—————————————
Net premium earned
68
Combined ratio after dividends (CRAD) (Formula)
Combined ratio + dividends to policyholders ratio
69
Receivables turnover
Net annual sales
—————————
Average receivables
70
Days of sales outstanding (Formula)
365
——————————
Receivables turnover
71
What do you do with subsidiaries in hyper inflationary economies under IFRS?
Restate financial statements for inflation and convert at current rate
72
What do you do with subsidiaries in hyper inflationary economies under US GAAP?
Use temporal method
73
Dividend/interest income and interest expense classification under IFRS?
Operating or financing cash flows
74
Dividend/interest income and interest expense classification under US GAAP?
Operating cash flows only
75
Modigliani and Miller proposition I (No taxes)
Capital structure is irrelevant and the value of the firm is not affected
76
Modigliani and Miller proposition II (No taxes)
The cost of equity increases linearly as a company increases its proportion of debt financing, exactly offsetting the benefits of debt financing and resulting in no change to the WACC
77
Modigliani and Miller proposition I (with taxes)
Value is maximised at 100%, as the tax shield provided by debt causes the WACC to decline as leverage increases
78
Modigliani and Miller proposition II (with taxes)
WACC is minimised at 100% debt as the tax shield provided by debt causes the WACC to decline as leverage increases
79
Accruals (balance sheet approach)
Net operating assets (end) - net operating assets (beg)
80
Accruals ratio (Formula)
NOA(end) - NOA(beg)
————————————
(NOA(end) + NOA(beg))/2
81
Accruals (cash flow approach)
Net income - CFO - CFI
82
Estimated cash flow (Formula)
EBIT + depreciation/amortisation
83
What does a ratio of proportional CapEx to proportional assets greater than 1 signify?
The firm is growing that business segment
84
Cash generated from operations (Formula)
CFO + cash interest paid + cash taxes paid
85
How do you adjust operating income for pension items?
Add back reported pension expense (difference formulas depending on IFRS or US GAAP)
86
What is pecking order theory?
Managers prefer financing choices that send the least visible sign to investors (internal capital, then debt financing, then equity financing)
87
What is static trade-off theory?
Managers will try to balance the benefits of debt with the costs of financial distress, and thus there is an optimal level of debt
88
Initial outlay for an expansion project (Formula)
FCInv + NWCInv
89
After-tax operating cash flows for an expansion project (Formula)
(S - C)(1 - T) + TD
90
Terminal-year non-operating cash flows for an expansion project (Formula)
Sal(t) + NWCInv - T[Sal(t) - B(t)]
91
Impairment of goodwill under IFRS
Single step approach; impairment exists when the carrying amount is greater than the recoverable value; impairment loss is carrying amount - recoverable value
92
Impairment of goodwill under US GAAP
Two step approach; impairment exists if carrying value exceeds the fair value; impairment loss is the difference between the carrying value of goodwill and the implied fair value of goodwill
93
Economic profit (Formula)
NOPAT - $WACC
94
Market Value Added (Formula)
Economic profit(t)
Sum of ————————
(1 + WACC)^t
95
Economic income (Formula 1)
Cash flow + (ending market value - beginning market value)
96
Economic income (Formula 2)
Cash flow - economic depreciation
97
Residual income
Net income - equity charge (using beginning of period book value of equity)
98
NOPAT (Formula)
EBIT(1 - tax rate)
99
FCFE (NI Formula)
NI + non-cash charges - FCInv - WCInv + net borrowing
100
FCFE (CFO Formula)
CFO - FCInv + net borrowing
101
FCFE coverage ratio (Formula)
FCFE
————————————
(Div. + share repurchases)
102
Dividend coverage ratio (Formula)
Net income
——————
Dividends
103
Dividend payout ratio (Formula)
Dividends
——————
Net income
104
Equity method on balance sheet (Formula)
Share of net assets + share of net income - share of dividends - share of extra depreciation - share of derecognised profits
105
Equity method on income statement (Formula)
Share of net income - share of extra depreciation - share of derecognised profits
106
Porter’s Five Forces
- Threat of new entrants
- Threat of substitutes
- Bargaining power of buyers
- Bargaining power of suppliers
- Rivalry among existing competition
107
What discount rate should be used for an FCFF model?
The WACC of the firm
108
What discount rate should be used for an FCFE model?
The cost of equity of the firm
109
Justified leading P/E (Formula)
P(0) 1 - b
—— = ———
E(1) r - g
110
Justified trailing P/E (Formula)
P(0) (1 - b)(1 +g)
—— = ——————
E(0) r - g
111
What does the remeasurement component of periodic pension cost include?
Actuarial gains and losses on pension obligation and the net return on plan assets
112
Single-stage residual income model (Formula)
(ROE - r) x B(0)
V(0) = B(0) + ———————
r - g
113
WCInv (Formula)
Accounts receivable + inventory - accounts payable
114
FCFF (EBIT Formula)
EBIT(1 - tax rate) + Dep - FCInv - WCInv
115
FCFF (EBITDA Formula)
EBITDA(1 - tax rate) + Dep x (tax rate) - FCInv - WCInv
116
FCFF (CFO Formula)
CFO + [Int x (1 - tax rate)] - FCInv
117
FCFE (DR Formula)
NI - [(1 - DR) x (FCInv - Dep)] - [(1 - DR) x WCInv]
118
Justified P/B ratio (Formula)
ROE - g
————
r - g
119
Discount for lack of control (Formula)
1
1 - (——————————)
1 + control premium
120
Total discount with DLOC and DLOM (Formula)
1 - [(1 - DLOC)(1 - DLOM)]
121
Present value of growth opportunities (Formula)
E(1)
V(0) = —— + PVGO
r
122
Value of perpetual preferred shares (Formula)
D(p)
V(p) = ——
r(p)
123
H-model (Formula)
D(0) x [1 + g(l)]
———————— +
r - g(l)
D(0) x H x [g(s) - g(l)]
———————————
r - g(l)
124
PEG ratio (Formula)
P/E ratio
————
g
125
Justified dividend yield (Formula)
D(0) r - g
—— = ———
P(0) 1 + g
126
Justified P/S multiple (Formula)
Net profit margin x trailing P/E ratio
127
Residual income valuation (Formula)
[ROE - r] x B(0)
B(0) + (———————)
r - g
128
PV of continuing residual income in year T-1 (using persistence factor formula)
RI(t)
————
1 + r - w
129
PV of continuing residual income in year T-1 (using decline to long-run rate formula)
[P(t) - B(t)] + RI(t)
—————————
1 + r
130
Clean surplus relation (Formula)
B(t) = B(t - 1) + E(t) - D(t)
131
Unlevered beta (Formula)
Beta(L)
—————
1 + D/E
132
Where are actuarial assumptions included in the financial statements?
Notes to financial statements
133
What is the day basis for an FRA contract?
360
134
What is the day basis for foreign currency contracts?
365
135
Fixed swap rate (Formula)
1 - final discount factor
———————————
Sum of discount factors
136
Value of an interest rate swap (Formula)
ΣZ x [SFR(new) - SFR(old)]
days
x ——— x notional principal
360
137
N(-d1) (Formula)
1 - N(d1)
138
N(-d2) (Formula)
1 - N(d2)
139
BSM Model call option (Formula)
S(0)N(d1) - e^(-rT)XN(d2)
140
BSM Model put option (Formula)
e^(-rT)XN(-d2) - S(0)N(-d1)
141
Capitalisation rate (Formula)
NOI
———————
Property value
142
Property value (cap rate Formula)
NOI
————
Cap rate
143
FFO (Formula)
Accounting net earnings + depreciation and amortisation expense - gains from sales of property + losses from sales of property
144
AFFO (Formula)
FFO - non-cash rent adjustment - recurring maintenance-type capital expenditures and leasing commission
145
How can you value REITs and REOCs? (Three methods)
- NAVPS
- Relative value (price-to-FFO and price-to-AFFO)
- Discounted cash flow
146
NAV before distributions (Formula)
NAV after distributions in prior year + capital called down - management fees + operating results
147
NAV after distributions (Formula)
NAV before distributions - carried interest - distributions
148
What does a ratchet do within private equity?
Enables the management team to increase its equity allocation depending on the company’s actual performance and the return achieved by the PE firm
149
Per-share effective spread transaction cost
Side x (transaction cost - misquote price)
150
Effective spread
2 x per-share effective spread transaction cost
151
Linear regression assumptions (x6)
1. There is a linear relationship between the dependent and independent variable
2. Independent variable is uncorrelated with the residuals
3. Expected value of the residual term is zero
4. The variance of the residual term is constant for all observations
5. Residual term is independently distributed
6. The residual term is normally distributed
152
How many tails does an F-Test have?
One
153
Three conditions of being covariance stationary?
1. Constant and finite expected value
2. Constant and finite variance
3. Constant and finite covariance between values at any given leg
154
What criterion is used to compte the accuracy of AR models in forecasting out-of-sample values?
Root mean squared error (RMSE)
155
How do data scientists reduce overfitting? (Two methods)
- Complexity reduction
| - Cross validation
156
What is complexity reduction?
Method that adds a penalty to exclude features that do not meaningfully contribute to model
157
What is cross validation?
Estimates out-of-sample error rates directly from the validation sample
158
What is k-fold cross validation?
- Sample divides into k parts
- Training sample = k-1; validation sample = 1
- Repeat k times
- Compile average in-sample and out-of-sample error rates
159
Least absolute shrinkage and selection operator (LASSO)
Minimises SSE and the sum of the absolute values of the slope coefficients
160
Support vector machine
Linear classification algorithm that separates data into one of two possible classifieds by determining a boundary farthest away from all observations
161
K-nearest neighbour (KNN)
Technique used to classify an observation based on nearness to observations in the training data (k is hyperparameter, and algorithm looks for the ‘k’ nearest neighbours)
162
What does principal component analysis (PCA) produce?
Eigenvectors, each with an eigenvalue
163
What does an eigenvalue tell us?
The proportion of data explained by the eigenvector
164
What types of hierarchical clustering are there?
- Agglomerative (each data point starts as a cluster)
| - Divisive (start with one giant cluster)
165
How many hidden layers does a deep neural network (DNN) have?
Often more than 20
166
Data analysis steps (5)
1. Conceptualisation
2. Data collection
3. Data preparation and wrangling
4. Data exploration
5. Model training
167
What is Winsorisation?
Replacing extreme values by the maximum value allowable for that variable
168
Bag-of-words procedure
Collects all words and a document term matrix puts them into structured data
169
N-grams
Used to represent word sequences (e.g. bigrams, trigrams)
170
What is an FX carry trade a bet against?
Uncovered interest rate parity
171
Preconditions for economic growth (6 preconditions)
1. Savings and investment
2. Financial markets and intermediaries
3. Political stability, rule of law, and property rights
4. Investment in human capital
5. Tax and regulatory systems
6. Free trade and unrestricted capital flows
172
Equity price correlation to GDP (short-term)
ΔP = ΔGDP + Δ(E/GDP) + Δ(P/E)
173
Equity price correlation to GDP (long-term)
ΔP = ΔGDP
174
Cobb-Douglas production function (formula)
Y = TK^(α)L^(α-1)
175
Growth accounting relation (growth rate in potential GDP)
ΔY/Y = ΔA/A + α x (ΔK/K) + (1-α) x (ΔL/L)
176
What is “Dutch disease”?
When natural resource-rich countries see their currency appreciate heavily due to demand for those natural resources, making all exports more expensive and other domestic industries less competitive
177
Absolute convergence hypothesis
Less developed countries will achieve equal living standards over time
178
Conditional convergence hypothesis
States that convergence in living standards will only occur for countries with the same savings rates, population growth rates, and production functions
179
Club convergence hypothesis
Countries may be part of a club (with similar institutional features) and able to rapidly catch up to richer peers within that club
180
Classical growth theory
Growth in real GDP per capita is temporary - when the GDP per capita rises above the subsistence level, a population explosion occurs, driving GDP per capita back to the subsistence level
181
Neoclassical growth theory
Sustainable growth rate of GDP is a function of population growth, labour’s share of income, and the rate of technological advancement. Growth gains from other means are only temporary
182
Endogenous growth theory
Investment in capital can have constant returns (unlike neoclassical theory), which allows for a permanent increase in growth rate attributable to an increase in savings rate
183
What are self-regulatory bodies (SRBs)?
Private organisations that represent as well as regulate their members
184
What are self-regulating organisations (SROs)?
SRBs that are recognised by the government. They are independently funded
185
Regulatory capture
A regulatory body will, at some point in time, be influenced or even possibly controlled by the industry that is being regulated
186
Regulatory competition
Where regulators compete to provide the most business-friendly regulatory environment
187
Regulatory arbitrage
Where businesses shop for a country that allows a specific behaviour rather than changing the behaviour
188
Regulatory tools (three)
1. Price mechanisms (taxes / subsidies)
2. Restricting or requiring certain activities
3. Provision of public goods or financing of private projects
189
Regulatory burden
Refers to the cost of compliance for the regulated entity
190
Net regulatory burden
Regulatory burden minus the private benefits of regulation
191
What accounting treatment do joint ventures require?
Equity method (almost always) under both IFRS and US GAAP
192
Two criteria for amortised cost (debt securities only) for investments in financial assets?
1. Business model test - debt securities being held to collect contractual cash flows
2. Cash flow characteristic test - cash flows are either principal, or interest in principal, only
193
Can you reclassify equity securities once classified as FVPL or FVOCI?
No
194
Goodwill created in purchase (equity method)
Excess of purchase price less excess allocated to equipment
195
What values are the two coefficients in the Taylor equation?
0.5
196
How do you account for a variable interest entity (VIE)?
It must be consolidated by the primary beneficiary
197
What are the characteristics of a VIE?
1. At-risk equity that is insufficient to fianance the entity’s activities without additional financial support
2. Equity investors that lack any of the following:
- Decision making rights
- Obligation to absorb expected losses
- Right to receive expected residual returns
198
Where is remeasurement (temporal method) gain or loss recognised?
Income statement
199
Where is translation (current rate method) gain or loss recognised?
Shareholder’s equity
200
Three pillars of the Basel III framework?
The maintenance of minimum levels of:
1. Capital
2. Liquidity
3. Stable funding
201
What does the CAMELS approach entail?
```
C - Capital adequacy
A - Asset quality
M - Management
E - Earnings
L - Liquidity
S - Sensitivity
```
202
Liquidity coverage ratio (LCR)
Highly liquid assets
———————————
Exp. cash outflows (1-month stress)
203
Net stable funding ratio (NSFR)
Available stable funding
———————————
Required stable funding
204
What is a soft pricing period?
When P&C insurers cut prices during periods of heightened competition
205
What is a hard pricing period?
After insurers leave the industry following soft pricing periods, the industry enters a healthier pricing environment and fatter margins
206
What does Basel III recommend for LCR and NSFR ratios?
100%
207
What is the Beneish Model?
A pro it regression model estimating the probability of earnings manipulation using 8 dependent variables. A higher M-score indicates higher probability of manipulation
208
What is the Altman model?
A Z-score model developed to assess the probability that a firm will file for bankruptcy
209
What are three characteristics of high-quality financial balance sheet reporting?
1. Completeness
2. Unbiased measurement
3. Clarity of presentation
210
6-step process for financial statement analysis?
1. Establish the objectives
2. Collect data
3. Process data
4. Analyse data
5. Develop and communicate conclusions
6. Follow up
211
Cash generated from operations (CGO) (formula 1)
EBIT + non-cash charges - increase in working capital
212
Cash generated from operations (CGO) (formula 2)
CFO + cash taxes paid + cash interest paid
213
Which of sunk costs, externalities, and opportunity costs should be included in capital budgeting analysis?
Sunk costs - no
Externalities - yes
Opportunity costs - yes
214
NWCInv (formula)
Δnon-cash current assets - Δnon-debt current liabilities
215
Replacement project initial outlay (formula)
FCInv + NWCInv - Sal(0) + T[Sal(0) - B(0)]
216
Replacement project incremental operating cash flows (formula)
(ΔS - ΔC)(1-T) + ΔDT
217
Replacement project terminal year non-operating cash flow (formula)
[Sal(TNew) - Sal(TOld)] + NWCInv - T[(Sal(TNew) - B(TNew) - (Sal(TOld) - B(TOld)]
218
What option is an abandonment option the equivalent of?
Put option
219
What option is an expansion option the equivalent of?
Call option
220
Required rate of return on equity from MM proposition II no taxes (Formula)
D
r(0) + — [r(0) - r(d)]
E
221
Amount of capital gains required if differential in tax rates between capital gains and dividends (formula)
[1 - T(d)]
D x —————
[1 - T(cg)]
222
What six factors affect a company’s dividend payout policy?
1. Investment opportunities
2. Expected volatility of future earnings
3. Financial flexibility
4. Tax considerations
5. Flotation costs
6. Contractual and legal restrictions
223
Effective tax rate under a double-taxation system (formula)
Corporate tax rate + (1 - corporate tax rate)(individual tax rate)
224
What is a split-rate corporate tax system?
A system where corporate earnings paid out as dividends are taxed as a lower rate than corporate earnings otherwise
225
Imputation tax system
Taxes are paid at the corporate level but are attributed to the shareholder so that all taxes are paid at the shareholder’s rate (shareholder pays [shareholder tax rate - corporate tax rate] in tax)
226
Expected increase in dividends under target payout adjustment model
[(expected earnings x target payout ratio) - previous dividend] x adjustment factor
227
What is the residual dividend model?
Dividends are paid from residual earnings after the optimal capital structure has been financed
228
What are the four common methods for share buybacks?
1. Open market transactions
2. Fixed price tender offer
3. Dutch auction
4. Repurchase by direct negotiation
229
Five common rationales for share repurchases (versus dividends)
1. Potential tax advantages
2. Share price support / signalling
3. Added flexibility
4. Offsetting dilution from employee stock options
5. Increasing financial leverage
230
When will EPS increase if share repurchases are financed by borrowing?
When the after-tax cost of borrowing is less than the initial earnings yield of the shares
231
Five major ownership structure factors impacting corporate governance
1. Director independence
2. Board structure
3. Special voting arrangements
4. Corporate governance codes, laws , and listing requirements
5. Stewardship codes
232
What is a statutory merger?
Where the acquiring company acquired all of the targets assets / liabilities and the target company ceases to exist
233
What is a subsidiary merger?
Where the target company becomes a subsidiary of the acquirer
234
What is a consolidation (merger)?
Where both companies cease to exist and they form a new company
235
What is a horizontal merger?
Both companies operate in the same or similar industries
236
What is a vertical merger?
Acquiring company seeks to move up or down the supply chains
237
What is a conglomerate merger?
Both companies operate in completely separate industries
238
What are the two forms of acquisition?
Stock purchase and asset purchase
239
What is a poison pill (pre-offer defence)?
Gives current shareholders the right to purchase additional shares at attractive prices, increasing the cost to the acquirer
240
What is a poison out (pre-offer defence)?
Gives bondholders the right to demand immediate repayment in the case of a merger
241
What are golden parachutes (pre-offer defence)?
Compensation agreements between the target and its senior management for lucrative payouts if they leave following a merger
242
What is greenmail (post-offer defence)?
Payoff to the potential acquirer to terminate a hostile takeover attempt
243
What is a crown jewel defense (post-offer defence)?
Selling a key asset
244
What is a pac-man defense (post-offer defence)?
Target acquired the acquirer
245
What is a white knight defense (post-offer defence)?
Friendly third party acquires the target
246
What is a white squire defense (post-offer defence)?
Friendly third party acquires a minority interest in target
247
FCFF (corporate finance topic formula)
Net income + net interest after tax + change in deferred taxes + net no cash charges - change in net working capital - capital expenditures
248
Post-merger value (formula)
Pre-merger value of acquirer + pre-merger value of target + synergies - cash paid to target shareholders
249
Gain accrued to target (formula)
Price paid to target - pre-merger value of target (this overall equals takeover premium)
250
Gains accrued to acquirer (formula)
Synergies - takeover premium
251
PRAT model (formula)
Profit margin x retention rate x asset turnover x financial leverage
252
FCInv (formula assuming no long-term assets have been sold)
Ending net PP&E - beginning net PP&E + depreciation
253
FCInv (formula assuming long-term assets were sold)
Ending net PP&E - beginning net PP&E + depreciation - gain on sale of long-term assets
254
What is the difference between Total Invested Capital (TIC) and EV?
TIC includes cash and short-term investments
255
Conversion value of convertible bond
Market price of stock x conversion ratio
256
Market conversion price of convertible bond
Market price of convertible
—————————————
Conversion ratio
257
Market conversion premium per share for convertible bond
Market conversion price - stock’s market price
258
Value of noncallable, nonputable convertible bond
Straight value + value of call option on stock
259
Value of callable convertible bond
Straight value + value of call option on stock - value of call option on bond
260
CDS upfront payment (by protection buyer)
PV(protection leg) - PV(premium leg)
261
Upfront CDS premium %
(CDS spread - CDS coupon) x duration
262
Profit for CDS protection buyer
Change in spread x duration x notional principal
263
Forward price (if no storage costs)
S(0) x (1 + R(f))^T
264
Forward price of an equity security with dividends
(S(0) - PVD) x (1 + R(f))^T
265
Forward price on an equity index (continuous dividends)
S(0) x e^[(R(cf) - D(c)) x T]
266
Forward price of a coupon-paying fixed income security
(S(0) - PVC) x (1 + R(f))^T
267
Quoted futures price of a bond
[(full price)(1 + R(f))^T - AI(T) - FVC)
1
x ——
CF
268
Value to payer in interest rate swap
Sum of discounts x (SFR(new) - SFR(old)) x settlement period days/360 x notional principal
269
Hedge ratio (formula)
C(+) - C(-)
—————
S(+) - S(-)
270
BSM call value
S(0) x N(d1) - e^(-rT) x X x N(d2)
271
BSM put value
e^(-rT) x X x N(-d2) - S(0) x N(-d1)
272
BSM call value (dividend-paying stock)
S(0) x e^(-dT)x N(d1) - e^(-rT) x X x N(d2)
273
BSM put value (dividend-paying stock)
e^(-rT) x X x N(-d2) - S(0) x e^(-dT)x N(-d1)
274
Black Model call value
e^(-RcfT) x [(Ft x N(d1)) - (X x N(d2)]
275
How do you replicate a long FRA using options?
Long interest rate call and short interest rate put
276
How do you replicate a short FRA?
Short interest rate call and long interest rate put
277
How do you replicate an interest rate cap?
Series of interest rate call options with different maturities and the same exercise price
278
How do you replicate an interest rate floor?
A series of interest rate put options
279
How to replicate a payer swap?
Long interest rate cap and short interest rate floor with the same exercise rate
280
How do you replicate a receiver swap?
Short interest rate cap and long interest rate floor with same exercise rate
281
Number of short call options to delta hedge
Number of shares hedged
————————————
Delta of call option
282
Number of long put options to delta hedge
Number of shares hedged
- ————————————
Delta of put option
283
Three sources of value creation in PE
1. Re-engineering portfolio company so that it operates more efficiently
2. Obtain debt financing on more advantageous terms
3. Superior alignment of interests between management and owners
284
r* (adjusted for failure of VC firm)
1 + r
—— - 1
1 - q
285
What factor does the Carhart model extend the Fama and French model by?
Momentum
286
Information coefficient for market timer (formula)
2 x (% correct) - 1
287
Breadth for correlated decisions (formula)
N
——————
1 + (N - 1)r
288
Modigliani and Miller value of leverage company (formula)
EBIT(1 - t)
—————
WACC
289
What type of banks generally use swaps?
Wholesale banks
290
Common adjustments when calculating EVA
1. R&D expenses should be capitalised and amortised
2. Eliminate deferred taxes (only recognise cash taxes)
3. Convert LIFO to FIFO (add LIFO reserve)
4. Treat operating leases as capital leases
5. Adjust for non-recurring items
291
What is the intercept and slope of the security market line?
```
Intercept = risk free rate (Rf)
Slope = equity risk premium (Rf - Rm)
```
292
Intercept for fundamental factor model
Not necessarily the risk-free rate due to standardised betas
293
Ibbotsen-Chen formula
[(1 + expected inflation) x (1 + expected growth in real earnings per share) x (1 + expected growth in P/E)] + expected income component - risk-free rate (+ other risk premiums)
294
CDS upfront premium
(Credit spread - Fixed coupon) x CDS duration
295
CDS price (per 100 notional)
100 - upfront premium
296
What are one’s positions on credit risk if you buy or sell a CDS?
Buy: short credit risk (pay premiums)
Sell: long credit risk (receive premiums)
297
Is one allowed to impact market price if trading solely for tax purposes?
Yes
298
How to check whether an autoregressive model is correctly specified?
Check there is no autocorrelation between the residuals
299
Covariance formula
E[x(i) - x(avg)][y(i) - y(avg)]
———————————————
n - 1
300
Sample Variance formula
E[x(i) - x(avg)]^2
—————————
n - 1
301
Currency spread formula
Ask - Bid
—————
Ask
302
What companies is the capitalised cash flow method suitable for?
Small private companies (not large private or public companies)
303
Information coefficient (correlation formula)
E(Ra) Ra
Corr[——— , ———]
sd sd
304
Transfer coefficient (correlation formula)
E(Ra)
Corr[——— , Δw x sd]
sd
