CFA Level 2 Flashcards
(150 cards)
1
Q
Explain Durbin watson test
A
Durbin watson is used testing first order autocorrelation (serial correlation).
DW < 2 indicates positive serial correlation
DW = 2(1-r)
If you have an autoregressive model, then you cannot use DW, then you will have to use Breusch godfrey.
2
Q
Write down the solows growth accounting equation
A
Solows Growth account equation: growth rate of output = rate of technological change + alpha x growth rate of capital + (1-alpha) x growth rate of labor
It comes from the Cobb douglas production function:
y = A * K^alpha * L ^ (1-alpha) which gives the
3
Q
Write down the labor productivity growth accounting equation
A
Labor productivity growth account equation:
growth rate in potential gpd = Growth rate of the labor force + growth rate of labor productivity
4
Q
Explain conditional convergence, club convergence
A
Conditional convergence => convergence is conditional on the countries having the same saving rate, population growth rate and production function.
Club convergence => a group of high and middle income countries, where the middle income countries will converge. Low income can also join the club if the y do the appropriate institutional changes.
5
Q
What is the cash flow based accrual ratio?
A
Cash-flow-based accruals ratio = [NI - (CFO + CFI)] / [(NOA_t1 + NOA_t2)/2]
6
Q
Describe the different ownership structures: Horizontal, vertical, dispersed and concentrated
A
Horizontal ownership -> companies with mutual business interests have cross-holding share arrangements with each other
Vertical ownership -> a company or a group owns a holding company who owns operating companies
Dispersed ownership -> many shareholders, none of which has the ability to individually exercise the control of the corporation.
Concentrated ownership -> controlling shareholders can exercise power of the company
7
Q
What are stewardship codes?
A
Stewardship codes are voluntary codes introduced by a country that encourages investors to use their legal rights as shareholders to increase corporate governance engagement
8
Q
What is shareholder activism?
A
Shareholder activism refers to strategies used by shareholders to attempt to force a company to act in a desired manner?
9
Q
What are special voting arrangements?
A
Special voting arrangements is a requirement designed to improve the position of minority shareholders
10
Q
What should you do with non-operating assets when using FCFF?
A
In valuing a company with FCFF, if there exist non-operating assets (like excess cash or mkt. Securities), then you add those to the valuation. The FCFF valuation creates a valuation of operating assets.
Non-operating assets, such as excess cash and marketable securities, noncurrent investment securities, and nonperforming assets, are usually segregated from the company’s operating assets. They are valued separately and then added to the value of the company’s operating assets to find total firm value.
11
Q
What is pathwise valuation?
A
Pathwise valuation involves discounting a bond’s cash flows for each likely interest rate path and calculating the average of these values across all paths
12
Q
What is backward induction?
A
That is what we use to value bonds. We start at the maturity and work our way back to the start, discounting with the forward rates.
13
Q
Describe Ho-lee model
A
Ho-lee (holy shit unique)
Is the only arbitrage free model.
dr = theta x dt + sigma x dw
Good for options and more accurate. Can be negative together with Vasicek
14
Q
Describe Vasicek
A
Vasicek is mean reverting and has constant volatility.
dr = alpha (mu - r)dt + sigma x dw
can be negative
15
Q
Describe CR, Cox Ingersoll
A
COX kaxig, går uppåt
It is mean reverting and do not have constant volatility
dr = alpha (mu - r)dt + sigma x sqrt(r) x dw
since we take the sqrt(r), the interest rate cannot be negative
16
Q
Ethics - ipo approval
A
Employers should require prior approval for employees participating in ipos. ipo allocations should be done
17
Q
How do you hedge a forward poisition?
A
When you value a forward currency contract you take the opposite position. So if you went in as “sell AUD against USD”, then the oppostive should be “sell USD against AUD”. When you sell the BASE you do it at Bid, when you buy the BASE you do it at the offer).
18
Q
Name some indicators of a potential currency crisis
A
- The ratio of exports to imports usually drops before a currency crisis (reduced exports)
- Broad money growth (maybe indicated as M2 / to bank reserves) is an indicator of a potential currency crisis.
- Foreign exchange reserves tend to decline steeply when a crisis is approaching
- A banking crisis usually comes before or coincides with a currency crisis
- Countries with fixed or partly fixed exchange rates are more rpone to crises compared to counties that have floating exchange rates.
19
Q
What is the Grinold-kroner model?
A
Grinold-kroner model is a macro model used to find the ERP.
Grinold-Kroner (a macro model) says: ERP = Dividend yield + Expected Capital gains +inf - risk free rate.
where Expected capital gains = expected repricing (P/E) + earnings growth per share (g)
so Grinold-Kroner: ERP = DY + Delta(P/E) + i + g + delta(S) - rf
20
Q
How do you calculate the CDS upfront payment? What are the two fixed rates?
A
CDS upfront payment = (fixed coupon rate - credit spread) * duration * nominal
5% for non-investment grade
1% for investment grade
21
Q
When do you use FCFF instead of FCFE?
A
FCFF is preferred over FCFE when the capital structure is expected to change. FCFF is often use for levered companies with negative FCFE and levered companies with changing capital structure). You also use FCFF to get a control perspective
If the company’s capital structure is relatively stable, using FCFE to value equity is more direct and simpler.
22
Q
What is a busted convertible?
A
A busted convertible is a converitble bond that is far out of the money, it behaves more like an option-free bond
23
Q
What is the J-curve effect?
A
P/E firms usually exhibit J-curve effect, where the returns will be done after some years of negative or 0 returns
24
Q
What is the formula for VWAP?
Volume weighted average price
A
For buy-orders:
VWAP transaction cost estimate = trade size * (Trade VWAP - Benchmark VWAP)
For sell orders it is reversed.
25
What is the formula for effective spread?
For buy orders:
Effective spread cost estimate = trade size * (trade price - mid-point)
26
What is the covered interest rate parity?
Covered interest rate parity is an arbitrage relation and says that forward rates follow interest rate parity. So nominal interest rate spread equals the percentage forward premium.
27
What is the uncovered interest rate parity?
Uncovered interest rate parity says that the expected future exchange rate follows interest rate parity. It is forecasting EXPECTED FUTURE SPOT RATES. It states that the expected future spot rate is a function of the current spot rate and the interest rates of each currency
28
What happens when both uncovered interest and covered interest rate parity holds?
The forward exchange rate would serve as an unbiased predictor of the future spot exchange rate.
29
What is the international fischer effect?
The internation fisher effect occurs when the nominal yield spread between domestic and foreign markets equals the domestic-foreign **expected** inflation differential. This assumes that real interest rates are broadly the same across all markets.
So international fischer effect => expected inflation differential.
Exante PPE => expected change in spot rates.
| assumes real interest rate is the same, delta i = delta expected inflati
30
What is exante PPE?
Ex ante PPE occurs when the expected change in the spot exchange rate should equal the expected difference between domestic and foreign inflation rates
31
Contrast P/E, P/CFO and EV/EBITDA in terms of vulnerability to manipulation
P/E and EV/EBITDA are generally more affected by manipulation. P/CFO is more stable.
But EV/EBITDA should be used when there is a lot of financial leverage (EV) and financial leverage -> high interest costs so good to look at EBITDA
32
What do you do with preferred shares in P/B?
In P/B, the denominator BVPS is calculated by removing preferred shares.
so B = common shareholder's equity
33
What does a 3x9 FRA mean? And what happens to the long side when the floating rate increases?
3x9 -> begins in 3 months, ends in 9 months so it covers 6 months. When we calculate the value of a FRA sometime later, we need to discount it back from the maturity of the FRA to the current period.
The long side of the FRA, fixed-rate payer (floating-rate receiver), incurs a gain when rates increase.
34
Contrast IFRS to US GAAP when it comes to contingent liabilities?
US GAAP - the contingent liability must be both probable and reasonably estimated.
IFRS - the contingent liability just need to be reliable estimated
35
Describe how impairment of goodwill is done in US GAAP and IFRS.
IFRS is simple:
You write it down to the recoverable amount. So if carrying value is 2,500 and recoverable amount is 2,300, the impairment is 2,300-2,500 = -200
If impairment is greated than goodwill, you allocate on a prorata basis to the other
non-cash assets **within** the unit.
US GAAP:
1. First look if write down is needed. Is the fair value of unit < carrying value? If yes, move on=>
2. calculate new good will. Goodwilll = fair value of unit - identifiable net assets.
Example: carrying value 2,500. Goodwill = 400. Fair value of unit 2,300 and net identifiable assets = 2,000. Then 2,300 < 2,500, new goodwill = 2,300-2,000, impairment = 400-300
In US Gaap you cannot do impairment more than the good will.
36
How do you calculate FFO?
Funds from operations, FFO = NI + dep + deferred tax expense +/- loss/gain on sale
37
How do you calculate AFFO?
AFFO = FFO - non-cash rent - recurring maintenance capex
38
How do you calculate NAVPS?
First you take the NOI and cap rate to value the operating assets.
Op. assets = NOI / cap rate (this is the direct capitalization method, cap rate = r- g)
Then you add all non-operating assets to get NAV (and deduct liabilities) and then divide by # of shares.
| Usually you remove non cash rent from NOI
39
Elaborate on the five theories that explain the term structure of interest rates:
**Unbiased expectations theory**
**Local expectations theory**
**Liquidity expectations theory**
**Preferred habitat theory**
**Market segmentation theory**
**Unbiased expectations theory** - Every maturity strategy leads to the same expected returns over a given investment horizon. So yield curve are only impacted by the market expectation of future interest rates, no risk premiums for longer maturities.
**Local expectations theory** - a narrow interpretation of unbiased expectations theory. LEE asserts that expected returns on bonds with varying maturities is the same only over short time periods.
**Liquidity expectations theory** - Borrowers prefer to borrow long term and lenders prefer to borrow short term, so upward sloping yield curve.
**Preferred habitat theory** - Different market participants have different maturity preferences, will seek different maturities if extra returns are good enough
**Market segmentation theory** - Different market participants have different maturity preferences, so supply and demand affect the shape of the yield curve. However, the market participants are unwilling or unable to make any other investments.
40
What are judicial law, statues and administrative law?
Judicial law => courts enforce regulation (tänk usa)
Statues are laws enacted by legislative bodies
Administrative laws are rules issued by government agencies
41
Explain the Mundell-Fleming models when it comes to government policies impact on the exchange rate
In the Mundell-Fleming model, monetary policy is transmitted to the exchange rate through its impact on **interest rates** and **output**. Changes in the price level and/or the inflation rate play no role.
42
Draw out the table what happens with the fx under High capital mobility.
top row (left to right) expansionary monetary, restrictive monetary
first column (top to bottom) expansionary fiscal, restrictive fiscal
restrictive monetary and expansionary fiscal is currency appreciation
43
Explain tax imputation system, double taxation system and split-rate taxation system
Tax imputation system -> tax is calculated for the individual, so if the company had a higher tax rate than the individuals tax on income, the individual may get a tax credit
Double taxation system -> first corporate tax, then additional tax on dividend income
Split-rate taxation system -> different tax on capital gains and dividends
44
Name a few good governance practice when it comes to:
- audit committe / renumeration
- tenure
- # of independent directs in the board
- what can cause a director to not be independent
* Audit committee / Renumeration committee => all should be outside directors
* Good corporate governance means that board members should not have too long tenure, >10 years may be bad, it can affect the independence!
* At least 1 and 3 members as a minimum or somewhere between 20% and 50%.
* Independent directors on the board that get appointed to advisors to the CEO are no longer independent.
* Having private / business relationship, being an owner, have worked at the company. Renumeration per say doesn't have to be a factor, or political involvement.
45
What is the FCFE coverage ratio?
FCFE / (dividends + share repurchases)
46
Name the three returns in a future contract
Price return = (current price - old price) / old price
Roll return = (near term - further term) / near term * % rolled
collateral return = risk free rate * time
47
What is negative calendar spread?
Negative calendar spread is when the futures market is in contango, current price is lower than the future price.
It cannot be explained by the hedging hypothesis which rationalizes backwardation.
48
What is the formula for adjusted R-squared?
adj R2 = 1 - (n-1)/(n-k-1) * (1 - R2)
49
What is the rate of growth of output in the steady state?
delta y / y = theta / (1-alpha) + n
where n = delta L / L, which is the growth of labor
50
What are some strenghtes with the residual income model?
- You can use it when you have negative cash flows.
- The model gives less weight to terminal value.
- RI models use readily available accounting data.
- It can be used to value non-dividend paying companies.
51
Write out the formula for PV of terminal value in a RI model with persistence factor
[ E_t - rB_T-1] / [(1+r - w) x (1+r)^(T-1)]
you have ^(T-1) in the other term of the denominator.
Leading market position and low dividend payout usually mean a high persistence factor when it comes to RoE in the residual income model.
52
How does the Economic value added model work?
EVA = NOPAT - wacc x TC
NOPAT is EBIT after tax, or EBIT x (1-tax) and use beginning book value of total capital.
53
What is the market value added?
MVA = Market value of the company - book value of total company = MVe + MVd - accounting value equity - accounting value debt
54
What is the Excess Earnings Method?
This method basically values a company in two pieces - the tangible value and the intangible value.
The tangible value of the company is simply calculated as the value of the company's net worth (i.e., working capital + fixed assets).
The intangible part is calculated by capitalizing those earnings that are calculated to be in "excess" of what a reasonable amount of earnings would be on the company's tangible net worth.
Adding the tangible and intangible values of the company together results in the value of the entire company.
55
What is the G-spread and what does it measure?
G-spread is the bonds YTM - government YTMs
It measure general credit risk for the bond
56
What is the TED-spread?
TED spread is the MRR - treasury bill, it measure the overall credit risk
57
What is the MRR-OIS spread?
It is a perception of the money markets, MRR is up to 1 year (money market) and OIS is just 1 day
58
What is the swap spread?
Yield on swap - government bond yields, it measure counterparty credit risk since the swap is hedged for interest rate risk but you still have some counterparty risk
59
What is the I-spread?
I-spread stands for interpolated spread and it is the yield on a bond - interpolated swap spread.
60
What is the break even inflation rate?
The difference between the yield on non-inflation adjusted (nominal) and inflation-indexed bonds with the same maturity is called the break-even inflation (BEI) rate. The inflation expectations, θ, and the risk premium demanded by investors as compensation for the uncertainty of future inflation, π
, determine the break-even inflation rate. So BEI = θ + π
61
Explain insurance theory, hedging pressure hypothesis & theory of storage when it comes to the future curve
**Insurance theory** is also called "normal backwardation". Sellers (commodity producers) want to hedge and can accept a lower price.
**Hedging pressure hypothesis** - markets can be in both contango and backwardation depending on buyers or sellers have greater wish to remove price uncertainty.
**Theory of storage** - Commodity futures prices are affected by the cost of storage and convenience yield. Futures price = Spot price + storage costs - convenience yield
Convenience yield is inversely related to general availability of the commodity. So very rare => much convenience yield.
62
Write the formula for OAS and what happens to it when volatility increase?
OAS = Z-spread - option cost
13 10 -3
For putable, OAS >z-spread (the price is lower for the bond without the option)
option value increase with volatility, so for a putable bond the OAS will increase if volatility increase
63
What are some assumptions of the BSM model?
- BSM are used for equities and currency options
- BSM assumes that returns are lognormally distributed
- There are no risk-arbitrage opportunities
- Short selling is permitted
- Risk free rate is constant
- volatility of returns are constant
- Early exercise is not allowed, so BSM only for european options
64
When is the Black option model used?
The Black options valuation model is a modified version of the BSM model used for options on underlying securities **that are costless to carry**, including options on **futures** and forward contracts.
65
What is the Dickey-fuller test?
It is a test for an unit root. g = b - 1 and then test if g = 0 (which means b = 1)
Unit root testing involves checking whether the time series is covariance stationary.
A time series with a unit root problem can be modeled by modeling the first differenced series with an autoregressive time series.
66
How can you calculate the periodic pension cost?
Periodic pension cost = Ending Funded Status - Beginning Funded Status + Employer Contributions (contributions increases assets so we need to remove the effect from those)
Periodic pension cost = Current service cost + Interest cost + Past service cost - Actuarial gains/losses - actual return on plan assets
67
What is the NSFR?
NSFR = Net Stable Funding Ratio is calculated as:
Available stable funds / required stable funds and should be >=100%
68
What is the LCR?
LCR = Liquidity coverage ratio
LCR = High quality liquid assets (HQLA) / one month liquidity needs in a stress scenario and should be >= 100%
69
What is the loss and adjustment ratio, underwriting expense ratio and the combined ratio?
* Loss and loss adjustment expense ratio = (loss expense + loss adjustment expense) / net premiums earned
* Underwriting expense ratio = underwriting expense / net premiums written
* combined ratio = loss and loss adjustment expense ratio + underwriting expense ratio
we want the combined ratio < 100%, then we have an underwriting profit.
70
What is greenmail? Dutch auction and open market purchase?
* **Greenmail** is an effort by the target company to prevent a takeover attempt by offering a substantial premium above the market price to the corporate shareholder trying to take control of the company
* In a **Dutch action**, the company makes tender offer to its shareholders by stipulating a price range that it will pay per share for a given number of shares. It is a descending price auction in which an auctioneer starts with a very high price, incrementally lowering the price until someone places a bid.
* In an **open market purchase**, the company simply repurchases its shares at the market price as they become available and as the company believes the conditions for a purchase are favorable.
71
Write out the put-call parity
S0 + p = c + PV(X)
72
What is the formula for conversion adjusted fixed income future price?
Q0 = 1/CF * [FV(B0 + AI_0) - AI_T - FVCI]
| The fixed income forward price is the Qo * CF, used for CTD
73
When do you use temporal vs current rate method?
Temporal = same functional currency
Current = different functional currency
74
How do you get to retained earnings in current vs temporal method?
**Retained earnings in Current rate** => Först beräknas i PnL => Net Income – dividends (at date of declaration) = Retained Earnings
**Retained earnings in Temporal** => Beräknas i Balance Sheet så att TA = Liabilities + Equity. Retained earnings används sen i PnL för att ta fram translation adjustment
75
Explain how the balance sheet is translated in current rate and temporal method
- For both methods, equity accounts are translated in historical rates
- Current rate => everything (assets + liabilities) is current rate
- Temporal => monetary assets/liabilities is current, non-monetary are historical (wa for inventory)
76
Explain how the PnL is translated in current rate and temporal method
Current rate => everything at average
Temporal => most stuff at average, but dep (historical) and inventory (weighted average historical)
In temporal we also have a translation gain in the PnL. For current it is only in OCI.
77
What do you do in hyperinflation for IFRS / US Gaap?
Hyperinflation if cumulative inflation over 3 years is >100%.
- IFRS, restate for inflation and then use current rate
- US GAAP, just use temporal
78
How do we report foreign transactions that has not been realized?
We report unrealized gain in PnL if we have bought something on credit or have an accounts receivable in a foreign currency as of reporting balance sheet date. (One of the few times we report unrealized gains)
79
Give details on Gamma
Gamma is the highest for at-the-money options and always positive for long puts and calls (it is actually the same)
Gamma can hence be decreased by taking short position.
80
Give details on option Theta
Theta is negative for long positions in options (the decrease in value is more severe for nearly dated options)
Theta is positive for short positions in options
81
Give details on option Vega
Vega (sensitivity to volatility) is always positive and the same for long puts and call.
Vega is high for at or near the money options and when there is long time to maturity
82
Give details on option Rho
Rho (sensitivity to interest rates), positive for call options (you can invest money in the bank), negative for put options
Rho is lower as the experation date nears since interest rates lose much imporance then
83
What does advanced set and settled mean?
**Advanced set** => reference interest rate is set at the time money is deposited
**Advanced settled =>** settlement is made when the FRA expires so it has to be discounted
84
Explaind Conditional Var, Incremental VaR, Marginal VaR, Relative VaR
**Conditional VaR** (CVaR / Expected Shortfall) is a tail risk metric that quantifies the amount of the expected losses **beyond** the VaR cutoff point at a specific confidence level. CVaR is a weighted average of the losses in the tail of the return’s distribution beyond the VaR level.
**Incremental VaR** is the change in VaR given that you change a position in your portfolio but the size is stayed the same, you just re-weight
**Marginal VaR** is the change in VaR from removing a position.
**Relative VaR** measures the risk resulting from the underperformance of a portfolio relative to a benchmark portfolio. Assuming a 95% confidence level, a 1-day relative VaR of $5,000 for portfolio B implies that, on average, the portfolio would underperform only for five days in a hundred days, relative to the benchmark by more than $5,000 due to market changes.
85
What is the delta for a call option?
delta = [0, e^(-dividend yield x t)
so if dividend yield = 0, then delta [0, 1]
| for a put option, it is just reversed and you have "-" infront of e^...
86
Write down the hieararchy of quality of financial reports
The hierarchy of quality of financial reports (from high to low):
1. Gaap, decision-useful, sustainable and adequate returns
2. Gaap, decision-useful but unstainable, questionable low earnings
3. Within GAAP, but biased choices
4. Withing GAAP, but earnings management (earnings management below biased choices)
5. Non-compliant accounting
6. Fictitious transactions
| earnings management is worse than biased choicses
87
What is one condition needed to make money on a carry trade?
That the uncovered interest rate parity do not hold
88
Elaborate on US Gaap vs IFRS when it comes to goodwill, full/partial?
US GAAP requires full goodwill
IFRS allows both partial and full goodwill
89
Elaborate on differences between principal-principal and principal-agent problems?
* Principal-principal can arise when you have concentrated ownership, the minority may get run over
* Principal-agent can arise when you have dispersed ownership, the management may act in their best interest.
| In private companies, overlap in man. and ownership, less agency costs
90
Which two options are used for finding cost of equity for private companies?
1. Expanded CAPM = normal CAPM + size premium + industry premium + company specific premium
2. Build up approach (note Beta=1) = rf + ERP + Size premium + company specific premium
| A bit subjective on what premia to add. Dont add IP if already eq. beta
91
What are the three ways of calculating a cost of equity?
* DDMs,
* The bond yield plus risk premium build-up method
* risk-based models.
92
Describe the Bond-yield plus risk premium approach?
Bond yield plus risk premium (BYPRP): re = YTM on company's long term debt + risk premium
A prerequisite is that the company has public traded debt with YTM available
93
Describe the five factor Fama-French model for calculating the cost of equity
re = rf + β1ERP + β2SMB + β3HML + β4RMW + β5CMA
ERP = equity risk premium
SMB = Small / big, risk premium for small companies (Size premium)
HML = value premium (high vs low)
RMW = Profitable vs least profitable premium (robust vs weak profitability)
CMA = Investment premium, conservative vs agressive investments
The beta for the ERP typically is different between CAPM and the Fama-French five factor model. This is because of the additional factors in the five-factor model that impacts the regression
94
What is the formula for justified trailing P/E?
How do you find justified P/S from justified P/E?
trailing just. P/E = payout ratio (1+g) / (r - g)
If you have justified trailing P/E, you can find justified trailing P/S = P/E * NPM, where NPM is net profit margin)
95
Contrast structural models with reduced form credit risk models
Structural models, they are based on the structure of a company's balance sheet. In a structural model, owning a (risky) bond is equivalent to owning the company's assets and having a short position in a call option on the company's assets. If the value of the assets is higher than the value of the bond, the equity owners will call the assets and the bondholder will be paid the face value
Reduced-form models in credit risk analysis uses historical variables like financial ratios to estimate default intensity.
96
Write the three formula for active return, optimal amount of active risk and best Sharpe ratio
E(Ra) = IC x TC x sqrt(BR) x sigma_a
Optimal amount of active risk sigma_a = TC x IR / SR_b x sigma_b
Optimal SR^2 = SR^2_b + TC^2 x IR^2
97
Explain how to use BIC and AIC
The model with the lowest BIC is the most "parsimonious", best fitting model
The model with the lowest AIC is the best model for prediction
Individual AIC and BIC stats are meaningless, they are only useful relative to each other.
98
What impact does the savings rate have on growth rate in GDP in endogenoues vs neoclassical model?
In the endogenous model, an increase in the savings rate leads to a permanent increase in the growth rate.
In the neoclassical model, the savings rate has no impact on the steady-state growth rate.
99
What does the credit spread in a bond capture?
The credit spread captures expected loss from default, differences in taxation between corproate and benchmark bonds, liquidity, and uncertainty about these factors
The benchmark yield already captures the expected real return, expected inflation and uncertainty about inflation.
100
Contrast statistical based approach with portfolio based and loan-by-loan when it comes to ABS.
A statistical based approach is appropriate for short-term structured finance vehicles. An ABS backed by a pool of 100,000 consumer credit cards = statistics based approach, they are homogenous and **static**
Portfolio approach, fewer, higher value assets that are unique and have idiosyncratic risks. If it is not static you have to use the portfolio approach,
Loan by loan, if there are very high value loans and very idiosyncratic
101
Elaborate on key characteristics for appraisal-based indexes
Appraisal-based indexes are often critized for having appraisal lag, which results from appraised valeus tending to lag when there are sudden shifts in the market.
In a down market, the appraised values would not be falling as quick as the transaction prices. So appraisal lag tends to smooth the index, it has less volatility and this in turn overstates sharpe ratios.
102
Write down the key convertible bond ratios:
* conversion price
* Market conversion price
* Market conversion premium
* Market conversion premium ratio
* Conversion value
* conversion price = convertible bond par / converstion ratio
* Market conversion price = convertible bond price / conversion ratio
* Market conversion price premium = market conversion price - underlying share price
* Market conversion price premium ratio = (market conversion price - underlying share price ) / underlying share price
* Conversion value = Underlying share price × Conversion ratio
103
What is the effective duration for a floating rate bond?
The effective duration of a floating-rate bond is close to the time to next reset. If the reset is annual, the effective duration of the bond would be close to 1.
104
Compare divise to agglomorative clustering,
* Divisive hierarchical clustering (top-down) all observations belong to a single cluster in the beginning.
* Agglomerative hierarchical clustering (bottom up), each observation is its own cluster in the beginning.
105
When should you add capital, MPK > r, or MPK < r and what happens in the steady state?
If MPK > r, then you should continue to add capital to you stock
In steady state, MPK = r (rentral price of capital)
| MPK stands for marginal productivity of capital
106
What is easier to estimate, health insurance costs or future retirement benefits?
In general, estimating future health care costs (health insurance) is harder than future retirement benefits
Funding of defined benefit pension plans is common and required by law. Funding of other post-retirement benefits are much less common (like post-retirement life insurance and health insurance)
107
What adjustment to CFF and CFO should you do if contribution to the plan is less than the total periodic pension cost?
If the total periodic pension cost is greater than the contribution to the plan, you can make an adjustment to decrease CFO and increase CFF. It is a source of funding. Remember to do after-tax!
108
What is meant with grant date in share based compensation?
Grant date is when the clock starts ticking for vesting, it is also the date at which the fair value of the equity award is often determined for accounting purpose
Share-based compensation expense impacts shareholders' equity and not the company's liabilities. It reduced retained earnings and increases paid-in-capital.
109
When does EPS and BVPS increase in share buybacks?
EPS increase if the earnings yield is greater than the after tax cost of funding, so if E/P > after tax cost of debt
BVPS increase is P/B < 1
110
Should you use average book value of equity when calcualtion RoE?
Yes, when calculating RoE (like g= RoE * RR) then use average shareholders equity!
111
What are hedonic and repeat sales indices? How do they compare to repeat sales index?
**Hedonic index **- A hedonic index does not require repeat sales of the same property. It requires only one sale and instead includes variables in the regression that control for differences in the characteristics of the property such as size, age, quality and location
**Repeat sales index** - focuses on recurring sales of the same property
Both hedonic and repeat sales are "Transaction based indices"
**Appraisal-based index **- based on periodic estimates of property values made by experts. The appraisal based index tends to delay actual transactions so it has lag and it reduces volatility
112
What are **net** and **gross** leases?
A **gross** lease requires the owner to pay for operating expenses
A **net** lease requires the tentant to be responsible for paying operating expenses.
Triple **net** leases (NNN leases) are common in US and Canada and require each tentat to pay: 1) common area maintenance, 2) property taxes and 3) building insurance cost
113
What are **percentage lease**?
A percentage lease means that the tenant have to pay additional rent once their sales reach a certain level.
114
Give a few examples on how the bid-ask spreads for ETF can be kept tight:
- Low creation / redemption fees
- The presence of hedging securities for the AP (authorized participant)
- No underlying securities in other markets
- A higher number of market makers
- A high degree of order flow
115
When can the ETF price be more accurate than NAV or iNAV?
ETF prices may be more accurate reflection than NAVs or iNAVs when:
- the underlying securities are less actively traded
- the underlying market is closed or has time lags
| iNAV is the intraday net asset value.
116
How do SROs differ compared to Self Regulation Bodies?
Self-regulatory organizations (SRO) differs from industry self regulatory bodies in that they are given recognition and authority (including enforcement power) by a government body
Self-regulatory bodies obtain their power from constituent members who agree to operate within an organization's rules and standards. However, the authority of these organizations is not attached to the rule of law, but they can expel the members who breach their rules.
117
Contrats regulatory capture, competition and arbitrage
Regulatory capture -> we capture the good, regulation leads to better environment for companies already in the industry-
Regulatory competition -> regulators compete with eachother trying to make it more beneficial for companies in other countries to relocate
Regulatory arbitrage -> companies trying to exploit differences in regulatory burden, like locating funds in countries with lower reporting requirements.
118
What does dividends irrelevance theory say? And Bird in the hand? Tax theory?
Dividends irrelevance theory => dividends do matter but in what whey they are paid does not, so the dividend policy is irrelevant. "homemade" dividends can replace actual dividends (doesn't work in reality)
Bird in the hand => better to pay out earnings than invest (since earnings paid out are less risky)
Tax theory => sometimes dividends are taxed higher than capital gains, then the dividend policy do not become irrelevant.
119
To what curve is the Z-spread added?
Z-spread is added to the spot curve.
For a callable or putable bond, the Z-spread is the same as the option-adjusted spread (OAS) in a tree with 0% interest rate volatility (The option cost is 0 in the formula OAS = Z-spread - option cost when voltatility is 0%)
120
# 1.
Name 4 characteristics of takeover targets in a LBO.
Takeover targets in an LBO usually have:
- Significant physical assets
- Low Debt to equity
- High and strong cash flow
- Undervalued stock
121
What is a fundamental factor model and a macroeconomic factor model?
In a **fundamental factor **model, the factors are attributes of companies or stocks, such as market capitalization or various accounting ratios. So we first specify the factor sensitivies and then the factor returns through regression. The factor betas are calculated directly.
In a **macroeconomic factor** model, the factors are typically surprises in macroeconomic variables like GDP. In a macroeconomic factor model we develop the factor (surpirses) first and then estimate factor sensitivies (the betas)through regression, so normal way.
fundamental => sensitivities/betas first, then returns (weird)
macroeconomic => factor surprise returns first, then sensitivities (normal)
122
What is the relation between growth rate of potential GDP and real interest rate?
A high growth rate of potential GDP usually means high real interest rate. Faster growth of potential GDP means that consumers expect their real income to rise more rapidly, future consumption is less valuable so you need higher interest rate to be willing to save.
123
What is the relation between a putable bonds value and volatility, exercise price and dividends on stock?
Lower volatility => lower value of put
Lower exercise price => lower value of put
low dividend => lower value of put
124
How is past service cost recognized in IFRS and US GAAP?
Defined benefit plan, US GAAP, is past service costs always OCI and always amortized
In IFRS, past service cost is recognized in PnL!
125
Elaborate on how the profit is bookefd in an intercompany transaction for both up- and downstream sales.
In an upstream sale, the profit on the intercompany transaction is recorded on the associate's income (PnL) statement. The investor’s share of the unrealized profit is thus included in equity income on the investor’s income statement which must be removed.
In a downstream sale, the profit is recorded on the investor's income statement.
So in both upstream and downstream, we need to remove the unrealized profit from the equity line of the associate
126
Member with residence in "more strict" and does business in "less strict", but it states that law of locality where business is conducted governs. To what should you adhere to?
Law of locaility => "less strict", but we always compare to the code and standards, so the member must adhere to Code and Standards.
127
What do you do in a carry arbitrage?
You buy the underlying and sell a forward contract. Hence you **carry** the underlying which get sold when the forward expires
128
When should you use a barbell vs a bullet portfolio?
Barbells fall down, bullets shoot up” is how I remember it. Barbell portfolios do better in a flattening yield curve environment. Bullet portfolios do better in a rising yield environment.
129
What are stock appreciation rights?
Stock appreciation rights or phantom stock, compensate an employee on the basis of changes in the value of shares without requiring the employee to hold the shares.
130
What is the formula for effective duration? and one-sided effective duration?
Effective duration = (PV- - PV+) / (2*delta_yield * PV0)
(Down )One-sided effective duration = (PV- - PV0) / (delta_yield * PV0)
(UP) One-sided effective duration = (PV0 - PV+) / (delta_yield * PV0)
131
How does key rate duration differ to effective duration?
Effective duration is calculated by assuming parallel shifts in the benchmark yield curve. Key rate durations reflect the sensitivity of a bond's price to changes in specific maturities
132
What are one benefit of REITs compared to REOC?
REIT avoids double taxation on dividends received by investors. It does this by avoiding corporate income taxation, leaving the investor to pay taxes on dividends received.
Both REIT and REOCs are publicly traded equity investments and require little Real estate investment knowledge.
133
What are Type 1 and Type 2 errors?
Type 1 error are false positive, you predict 1 but it should have been 0.
Type 2 error are false negative, you predict 0 but it should have been 1.
134
What is precision?
Precision = TP / (TP + FP)
Out of all that we predicited true, how many were actually true?
135
What is recall?
Recall = TP / (TP + FN)
Recall is the True positive rate. Out of all that was true, how many did we get?
136
What is the F1-score?
F1-score is the harmonic mean of precision and recall and is a good accuracy measure when there are class imbalances.
137
Are reclassification of equity or debt investments permitted?
Reclassification of equity instruments is not permitted, the intial classification is irrevocable.
Reclassification for debt instruments is permitted and there is no restatement of prior methods. And reclassification only permitted if the business model / objective of holding the financial asset has changed.
138
If you want to hedge a small change in the stock price, do you add or subtract the call option gamma?
To fully hedge a small change in the stock price, the proper strategy is use call option delta and **add** the call option gamma,
139
Is implied volatility forward- or backward-looking?
Implied volatility is a measure of estimated future volatility, not historical volatility.
140
What is the F-statistic for testing multiple variables at a time?
F-test statistic for testing multiple variables at a time, e.g. null hypothesis: x3 = x4 = 0
F = (SSE of restricted model - SSE of unrestricted model)/q / [ SSE of restricted model / (n-k-1)]
It is a one-tailed rightside test.
141
What is the Braush Pagan test used for? And what is the test statistic?
BP = n * R2
Tests conditional heteroskedasticity
142
What is the Braush Godfrey test used for? And what is the test statistic?
Breusch Godfrey is for testing serial correlation. It is used for autoregression and can test any lag, we use p-values?
143
What is VIF and what are the thumbrules?
Variance inflation factor (VIF) is a measure for quantifying multicollinearity
* VIF > 10 indicates serious multicollinearity issues requiring correction
* VIF > 5 warrant further investigation
* VIF = 1 means that there are no multicollinearity.
144
What is leverage and outliers?
Leverage means that the point is on a very different X-level and its presence impacts the output. If leverage > 3(k+1)/n then it is potentially influential
Outliers means that the point is on a very different Y-level. If the studentized residuals are greater than the t-statistic then it is potentially influential
145
What are influential points?
Outliers and high-leverage points are not necessarily influential. An observation is considered influential if its exclusion from the sample causes substantial changes in the estimated regression function. Cook's distance or Cook's D is a metric for identifying influential data points. If Di > 2 * sqrt(K/n) then it is highly likely to be influential.
146
Is there a cap for the surplus in a Defined Benefit obligation?
When a company has a surplus in a DB pension plan, the amount of assets that can be reported is the lower of the surplus or the present value of future economic benefits.
147
What are the two adjustments you can do to pension expense in US Gaap?
In US GAAP, you can do two adjustments to reclassifying pension components.
Operating income can be adjusted to include only current service cost, the **interest component** is reclassified as interest expense
The actual return on plan asset can be added as investment income.
148
What does the remeasurement component of the periodic pension cost represent?
The remeasurement component of the periodic pension cost includes both actuarial gains and losses on the pension obligation and the net return on plan assets.
IFRS, it is recognized in OCI
US Gaap, either immediately PnL or more commonly in OCI and amortized to PnL using corridor approach
149
What are credit unions?
Credit unions are depository institutions that function like banks and offer many of the same services, but they are owned by their members rather than being publicly traded as many banks are.
150
What is the benish model?
It produces a M-score which indicates the probability of earnings manipulation. The higher number, >-1.78 the higher probability for earnings manipulation.
