CFA Level 2 Flashcards - 2
1
Q
Financial contagion
A
A situation in which financial shocks spread from their place of origin to other locales. In essence, a faltering economy infects other, healthier economies.
2
Q
Independent regulators
A
Regulators recognized and granted authority by a government body or agency. They are not government agencies per se and typically do not rely on government funding.
3
Q
Informational frictions
A
Forces that restrict availability, quality, and/or flow of information and its use.
4
Q
Judicial law
A
Interpretations of courts.
5
Q
Net regulatory burden
A
The private costs of regulation less the private benefits of regulation.
6
Q
Procedural law
A
The body of law that focuses on the protection and enforcement of the substantive laws.
7
Q
Prudential supervision
A
Regulation and monitoring of the safety and soundness of financial institutions to promote financial stability, reduce system-wide risks, and protect customers of financial institutions.
8
Q
Regulatory arbitrage
A
Entities identify and use some aspect of regulations that allows them to exploit differences in economic substance and regulatory interpretation or in foreign and domestic regulatory regimes to their (the entities’) advantage.
9
Q
Regulatory burden
A
The costs of regulation for the regulated entity.
10
Q
Regulatory capture
A
Theory that regulation often arises to enhance the interests of the regulated.
11
Q
Regulatory competition
A
Regulators may compete to provide a regulatory environment designed to attract certain entities.
12
Q
Self-regulating organizations (SROs)
A
Self-regulating bodies that are given recognition and authority, including enforcement power, by a government body or agency.
13
Q
Self-regulatory bodies
A
Private, non-governmental organizations that both represent and regulate their members. Some self-regulating organizations are also independent regulators.
14
Q
Statutes
A
Laws enacted by legislative bodies.
15
Q
Substantive law
A
The body of law that focuses on the rights and responsibilities of entities and relationships among entities.
16
Q
Systemic risk
A
Refers to risks supervisory authorities believe are likely to have broad impact across the financial market infrastructure and affect a wide swath of market participants.
17
Q
Downstream
A
A transaction between two related companies, an investor company (or a parent company) and an associate company (or a subsidiary) such that the investor company records a profit on its income statement. An example is a sale of inventory by the investor company to the associate or by a parent to a subsidiary company.
18
Q
Upstream
A
A transaction between two related companies, an investor company (or a parent company) and an associate company (or a subsidiary company) such that the associate company records a profit on its income statement. An example is a sale of inventory by the associate to the investor company or by a subsidiary to a parent company.
19
Q
Defined benefit pension plans
A
Plans in which the company promises to pay a certain annual amount (defined benefit) to the employee after retirement. The company bears the investment risk of the plan assets.
20
Q
Defined contribution pension plans
A
Individual accounts to which an employee and typically the employer makes contributions during their working years and expect to draw on the accumulated funds at retirement. The employee bears the investment and inflation risk of the plan assets.
21
Q
Exercise date
A
The date when employees actually exercise stock options and convert them to stock.
22
Q
Grant date
A
The day that stock options are granted to employees.
23
Q
Other post-employment benefits
A
Promises by the company to pay benefits in the future, such as life insurance premiums and all or part of health care insurance for its retirees.
24
Q
Pension obligation
A
The present value of future benefits earned by employees for service provided to date.
25
Service period
For employee stock options, usually the period between the grant date and the vesting date.
26
Vesting date
The date that employees can first exercise stock options.
27
Current exchange rate
For accounting purposes, the spot exchange rate on the balance sheet date.
28
Current rate method
Approach to translating foreign currency financial statements for consolidation in which all assets and liabilities are translated at the current exchange rate. The current rate method is the prevalent method of translation.
29
Exposure to foreign exchange risk
The risk of a change in value of an asset or liability denominated in a foreign currency due to a change in exchange rates.
30
Foreign currency transactions
Transactions that are denominated in a currency other than a company's functional currency.
31
Functional currency
The currency of the primary economic environment in which an entity operates.
32
Historical exchange rates
For accounting purposes, the exchange rates that existed when the assets and liabilities were initially recorded.
33
Local currency
The currency of the country where a company is located.
34
Monetary assets and liabilities
Assets and liabilities with value equal to the amount of currency contracted for, a fixed amount of currency. Examples are cash, accounts receivable, accounts payable, bonds payable, and mortgages payable. Inventory is not a monetary asset. Most liabilities are monetary.
35
Monetary/non-monetary method
Approach to translating foreign currency financial statements for consolidation in which monetary assets and liabilities are translated at the current exchange rate. Non-monetary assets and liabilities are translated at historical exchange rates (the exchange rates that existed when the assets and liabilities were acquired).
36
Net asset balance sheet exposure
When assets translated at the current exchange rate are greater in amount than liabilities translated at the current exchange rate. Assets exposed to translation gains or losses exceed the exposed liabilities.
37
Net liability balance sheet exposure
When liabilities translated at the current exchange rate are greater assets translated at the current exchange rate. Liabilities exposed to translation gains or losses exceed the exposed assets.
38
Non-monetary assets and liabilities
Assets and liabilities that are not monetary assets and liabilities. Non-monetary assets include inventory, fixed assets, and intangibles, and non-monetary liabilities include deferred revenue.
39
Presentation currency
The currency in which financial statement amounts are presented.
40
Purchasing power gain
A gain in value caused by changes in price levels. Monetary liabilities experience purchasing power gains during periods of inflation.
41
Purchasing power loss
A loss in value caused by changes in price levels. Monetary assets experience purchasing power loss during periods of inflation.
42
Temporal method
A variation of the monetary/non-monetary translation method that requires not only monetary assets and liabilities, but also non-monetary assets and liabilities that are measured at their current value on the balance sheet date to be translated at the current exchange rate. Assets and liabilities are translated at rates consistent with the timing of their measurement value. This method is typically used when the functional currency is other than the local currency.
43
Transaction exposure
The risk of a change in value between the transaction date and the settlement date of an asset of liability denominated in a foreign currency.
44
Allowance for loan losses
A balance sheet account; it is a contra asset account to loans.
45
Float
Amounts collected as premium and not yet paid out as benefits.
46
Premiums
Amounts paid by the purchaser of insurance products.
47
Provision for loan losses
An income statement expense account that increases the amount of the allowance for loan losses.
48
Bottom-up approach
With respect to forecasting, an approach that usually begins at the level of the individual company or a unit within the company.
49
Economies of scale
A situation in which average costs per unit of good or service produced fall as volume rises. In reference to mergers, the savings achieved through the consolidation of operations and elimination of duplicate resources.
50
Growth capital expenditures
Capital expenditures needed for expansion.
51
Hybrid approach
With respect to forecasting, an approach that combines elements of both top-down and bottom-up analyses.
52
Maintenance capital expenditures
Capital expenditures needed to maintain operations at the current level.
53
Scenario analysis
A technique for exploring the performance and risk of investment strategies in different structural regimes.
54
Top-down approach
With respect to forecasting, an approach that usually begins at the level of the overall economy. Forecasts are then made at more narrowly defined levels, such as sector, industry, and market for a specific product.
55
Bonus issue of shares
A type of dividend in which a company distributes additional shares of its common stock to shareholders instead of cash.
56
Buyback
A transaction in which a company buys back its own shares. Unlike stock dividends and stock splits, share repurchases use corporate cash.
57
Canceled shares
Shares that were issued, subsequently repurchased by the company, and then retired (cannot be reissued).
58
Constant dividend payout ratio policy
A policy in which a constant percentage of net income is paid out in dividends.
59
Dividend
A distribution paid to shareholders based on the number of shares owned.
60
Dividend coverage ratio
The ratio of net income to dividends.
61
Dividend imputation tax system
A taxation system that effectively assures corporate profits distributed as dividends are taxed just once and at the shareholder's tax rate.
62
Dividend payout ratio
The ratio of cash dividends paid to earnings for a period.
63
Dividend policy
The strategy a company follows with regard to the amount and timing of dividend payments.
64
Dividend yield
Annual dividends per share divided by share price.
65
Double taxation system
Corporate earnings are taxed twice when paid out as dividends. First, corporate pretax earnings are taxed regardless of whether they will be distributed as dividends or retained at the corporate level. Second, dividends are taxed again at the individual shareholder level
66
Ex-dividend
Trading ex-dividend refers to shares that no longer carry the right to the next dividend payment.
67
Ex-dividend date
The first date that a share trades without (i.e., "ex") the right to receive the declared dividend for the period.
68
Extra dividend
A dividend paid by a company that does not pay dividends on a regular schedule, or a dividend that supplements regular cash dividends with an extra payment.
69
Fixed price tender offer
Offer made by a company to repurchase a specific number of shares at a fixed price that is typically at a premium to the current market price.
70
Flotation cost
Fees charged to companies by investment bankers and other costs associated with raising new capital.
71
Franking credit
A tax credit received by shareholders for the taxes that a corporation paid on its distributed earnings.
72
Greenmail
The purchase of the accumulated shares of a hostile investor by a company that is targeted for takeover by that investor, usually at a substantial premium over market price.
73
Impairment of capital rule
A legal restriction that dividends cannot exceed retained earnings.
74
Indenture
A written contract between a lender and borrower that specifies the terms of the loan, such as interest rate, interest payment schedule, or maturity.
75
Liquidating dividend
A dividend that is a return of capital rather than a distribution from earnings or retained earnings.
76
Payout policy
The principles by which a company distributes cash to common shareholders by means of cash dividends and/or share repurchases.
77
Payouts
Cash dividends and the value of shares repurchased in any given year.
78
Perfect capital markets
Markets in which, by assumption, there are no taxes, transaction costs, or bankruptcy costs and in which all investors have equal ("symmetric") information.
79
Price-to-earnings ratio
(P/E) The ratio of share price to earnings per share.
80
Reverse stock split
A reduction in the number of shares outstanding with a corresponding increase in share price, but no change to the company's underlying fundamentals.
81
Share repurchase
A transaction in which a company buys back its own shares. Unlike stock dividends and stock splits, share repurchases use corporate cash.
82
Special dividend
A dividend paid by a company that does not pay dividends on a regular schedule, or a dividend that supplements regular cash dividends with an extra payment.
83
Split-rate tax system
In reference to corporate taxes, a split-rate system taxes earnings to be distributed as dividends at a different rate than earnings to be retained. Corporate profits distributed as dividends are taxed at a lower rate than those retained in the business.
84
Stable dividend policy
A policy in which regular dividends are paid that reflect long-run expected earnings. In contrast to a constant dividend payout ratio policy, a stable dividend policy does not reflect short-term volatility in earnings.
85
Stock dividend
A type of dividend in which a company distributes additional shares of its common stock to shareholders instead of cash.
86
Target payout ratio
A strategic corporate goal representing the long-term proportion of earnings that the company intends to distribute to shareholders as dividends.
87
Treasury shares/stock
Shares that were issued and subsequently repurchased by the company.
88
Concentrated ownership
Ownership structure consisting of an individual shareholder or a group (controlling shareholders) with the ability to exercise control over the corporation.
89
Dispersed ownership
Ownership structure consisting of many shareholders, none of which has the ability to individually exercise control over the corporation.
90
Dual-class shares
Shares that grant one share class superior or even sole voting rights, whereas the other share class has inferior or no voting rights.
91
ESG integration
An ESG investment approach that focuses on systematic consideration of material ESG factors in asset allocation, security selection, and portfolio construction decisions for the purpose of achieving the product's stated investment objectives. Used interchangeably with ESG investing.
92
Green bond
Bonds in which the proceeds are designated by issuers to fund a specific project or portfolio of projects that have environmental or climate benefits.
93
Greenwashing
The risk that a green bond's proceeds are not actually used for a beneficial environmental or climate-related project.
94
Horizontal ownership
Companies with mutual business interests (e.g., key customers or suppliers) that have cross-holding share arrangements with each other.
95
Independent board directors
Directors with no material relationship with the company with regard to employment, ownership, or remuneration.
96
Insiders
Corporate managers and board directors who are also shareholders of a company.
97
Interlocking directorates
Corporate structure in which individuals serve on the board of directors of multiple corporations.
98
Majority shareholders
Shareholders that own more than 50% of a corporation's shares.
99
Minority shareholders
Particular shareholders or a block of shareholders holding a small proportion of a company's outstanding shares, resulting in a limited ability to exercise control in voting activities.
100
One-tier board
Board structure consisting of a single board of directors, composed of executive (internal) and non-executive (external) directors.
101
Shareholder activism
Strategies used by shareholders to attempt to compel a company to act in a desired manner.
102
Straight voting
A shareholder voting process in which shareholders receive one vote for each share owned.
103
Stranded assets
Assets that are obsolete or not economically viable.
104
Two-tier board
Board structure consisting of a supervisory board that oversees a management board.
105
Vertical ownership
Ownership structure in which a company or group that has a controlling interest in two or more holding companies, which in turn have controlling interests in various operating companies.
106
Voting caps
Legal restrictions on the voting rights of large share positions.
107
Bond yield plus risk premium (BYPRP) approach
An estimate of the cost of common equity that is produced by summing the before-tax cost of debt and a risk premium that captures the additional yield on a company's stock relative to its bonds.
108
Capital asset pricing model (CAPM)
A single factor model such that excess returns on a stock are a function of the returns on a market index.
109
Confirmation bias
A belief perseverance bias in which people tend to look for and notice what confirms their beliefs, to ignore or undervalue what contradicts their beliefs, and to misinterpret information as support for their beliefs.
110
Cost of debt
The required return on debt financing to a company, such as when it issues a bond, takes out a bank loan, or leases an asset through a finance lease.
111
Cost of equity
The return required by equity investors to compensate for both the time value of money and the risk. Also referred to as the required rate of return on common stock or the required return on equity.
112
Country risk premium (CRP)
The additional return required by investors to compensate for the risk associated with investing in a foreign country relative to the investor's domestic market.
113
Country risk rating (CRR)
The rating of a country based on many risk factors, including economic prosperity, political risk, and ESG risk.
114
Credit spread
The compensation for the risk inherent in a company's debt security.
115
Cumulative preferred stock
Preferred stock that requires that the dividends be paid in full to preferred stock owners for any missed dividends prior to any payment of dividends to common stock owners.
116
Customer concentration risk
The risk associated with sales dependent on a few customers.
117
Dividend discount model (DDM)
The model of the value of stock that is the present value of all future dividends, discounted at the required return on equity.
118
Equity risk premium (ERP)
Compensation for bearing market risk.
119
Factor betas
An asset's sensitivity to a particular factor; a measure of the response of return to each unit of increase in a factor, holding all other factors constant.
120
Factor risk premiums
The expected return in excess of the risk-free rate for a portfolio with a sensitivity of 1 to one factor and a sensitivity of 0 to all other factors. Also called factor price.
121
Fama–French models
Factor models that explain the drivers of returns related to three, four, or five factors.
122
Finance (or capital) lease
A lease that is viewed as a financing arrangement.
123
Financial leverage
The use of fixed sources of capital, such as debt, relative to sources without fixed costs, such as equity
124
Forward-looking estimates
Estimates based on current and expectations. Also referred to as ex ante estimates.
125
Global CAPM (GCAPM)
A single-factor model with a global index representing the single factor.
126
Gordon growth model
A DDM that assumes dividends grow at a constant rate into the future.
127
Idiosyncratic risk premium (IRP)
The additional return required for bearing company-specific risks.
128
Incremental borrowing rate (IBR)
The rate of interest that the lessee would have to pay to borrow using a collateralized loan over the same term as a lease.
129
Industry risk premium (IP)
The additional return that is required to bear industry -specific risk.
130
Intangible assets
Assets without a physical form, such as patents and trademarks.
131
International CAPM (ICAPM)
A two-factor model with a global index and a wealth-weighted currency index.
132
Market conditions
Interest rates, inflation rates, and other economic characteristics that comprise the macroeconomic environment.
133
Market model
A regression model with the return on a stock as the dependent variable and the returns on a market index as the independent variable.
134
Rate implicit in the lease (RIIL)
The discount rate that equates the present value of the lease payment with the fair value of the leased asset, considering also the lessor's direct costs and the present value of the leased asset's residual value.
135
Recency bias
The behavioral tendency to place more relevance on recent events.
136
Required rate of return on equity
The minimum rate of return required by an investor to invest in an asset, given the asset's riskiness. Also known as the required return on equity.
137
Risk-based models
Models of the return on equity that identify risk factors or drivers and sensitivities of the return to these factors.
138
Risk-free rate
The minimum rate of return expected on a security that has no default risk.
139
Sales risk
The uncertainty regarding the price and number of units sold of a company's products.
140
Shadow banking
Lending by financial institutions that are not regulated as banks.
141
Size premium (SP)
Additional return compensation for bearing the additional risk associated with smaller companies.
142
Sovereign yield spread
The spread between the yield on a foreign country's sovereign bond and a similar-maturity domestic sovereign bond.
143
Specific-company risk premium (SCRP)
Additional return required by investors for bearing non-diversifiable company-specific risk.
144
Straight debt
Debt with no embedded options.
145
Tangible assets
Identifiable, physical assets such as property, plant, and equipment.
146
Target capital structure
A company's chosen proportions of debt and equity.
147
Weighted average cost of capital (WACC)
A weighted average of the after-tax required rates of return on a company's common stock, preferred stock, and long-term debt, where the weights are the fraction of each source of financing in the company's target capital structure.
148
Acquisition
When one company, the acquirer, purchases from the seller most or all of another company's (the target) shares to gain control of either an entire company, a segment of another company, or a specific group of assets in exchange for cash, stock, or the assumption of liabilities, alone or in combination. Once an acquisition is complete, the acquirer and target merge into a single entity and consolidate management, operations, and resources.
149
Balance sheet restructuring
Altering the composition of the balance sheet by either shifting the asset composition, changing the capital structure, or both.
150
Conglomerate discount
When an issuer is trading at a valuation lower than the sum of its parts, which is generally the result of diseconomies of scale or scope or the result of the capital markets having overlooked the business and its prospects.
151
Cost restructuring
Actions to reduce costs by improving operational efficiency and profitability, often to raise margins to a historical level or to those of comparable industry peers.
152
Divestiture
When a seller sells a company, segment of a company, or group of assets to an acquirer. Once complete, control of the target is transferred to the acquirer.
153
Dividend recapitalization
Restructuring the mix of debt and equity, typically shifting the capital structure from equity to debt through debt-financed share repurchases. The objective is to reduce the issuer's weighted average cost of capital by replacing expensive equity with cheaper debt by purchasing equity from shareholders using newly issued debt.
154
Equity investment
A company purchasing another company's equity but less than 50% of its shares. The two companies maintain their independence, but the investor company has investment exposure to the investee and, in some cases depending on the size of the investment, can have representation on the investee's board of directors to influence operations.
155
Franchising
An owner of an asset and associated intellectual property divests the asset and licenses intellectual property to a third-party operator (franchisee) in exchange for royalties. Franchisees operate under the constraints of a franchise agreement.
156
Industry shocks
Unexpected changes to an industry from regulations or the legal environment, technology, or changes in the growth rate of the industry.
157
Joint venture
Two or more companies form and control a new, separate company to achieve a business objective. Each participant contributes assets, employees, know-how, or other resources to the joint venture company. The participants maintain their independence otherwise and continue to do business apart from the joint venture, but they share in the joint venture's profits or losses.
158
Leveraged buyout (LBO)
An acquirer (typically an investment fund specializing in LBOs) uses a significant amount of debt to finance the acquisition of a target and then pursues restructuring actions, with the goal of exiting the target with a sale or public listing.
159
Offshoring
Refers to relocating operations from one country to another, mainly to reduce costs through lower labor costs or to achieve economies of scale through centralization, but still maintaining operations within the corporation.
160
Outsourcing
Shifting internal business services to a subcontractor that can offer services at lower costs by scaling to serve many clients.
161
Pro forma financial statements
Financial statements that include the effect of a corporate restructuring.
162
Reorganization
A court-supervised restructuring process available in some jurisdictions for companies facing insolvency from burdensome debt levels. A bankruptcy court assumes control of the company and oversees an orderly negotiation process between the company and its creditors for asset sales, conversion of debt to equity, refinancing, and so on.
163
Sale-leaseback
A situation in which a company sells the building it owns and occupies to a real estate investor and the company then signs a long-term lease with the buyer to continue to occupy the building. At the end of the lease, use of the property reverts to the landlord.
164
Spin off
When a company separates a distinct part of its business into a new, independent company. The term is used to describe both the transaction and the separated component, while the company that conducts the transaction and formerly owned the spin off is known as the parent.
165
Synergies
The combination of two companies being more valuable than the sum of the parts. Generally, synergies take the form of lower costs ("cost synergies") or increased revenues ("revenue synergies") through combinations that generate lower costs or higher revenues, respectively.
166
Takeover premium
The amount by which the per-share takeover price exceeds the unaffected price expressed as a percentage of the unaffected price. It reflects the amount shareholders require to relinquish their control of the company to the acquirer.
167
Abnormal return
The amount by which a security's actual return differs from its expected return, given the security's risk and the market's return.
168
Absolute valuation model
A model that specifies an asset's intrinsic value.
169
Alpha
The return on an asset in excess of the asset's required rate of return; the risk-adjusted return.
170
Asset-based valuation
An approach to valuing natural resource companies that estimates company value on the basis of the market value of the natural resources the company controls.
171
Blockage factor
An illiquidity discount that occurs when an investor sells a large amount of stock relative to its trading volume (assuming it is not large enough to constitute a controlling ownership).
172
Bond indenture
A legal contract specifying the terms of a bond issue.
173
Breakup value
The value derived using a sum-of-the-parts valuation.
174
Buy-side analysts
Analysts who work for investment management firms, trusts, bank trust departments, and similar institutions.
175
Catalyst
An event or piece of information that causes the marketplace to re-evaluate the prospects of a company.
176
Control premium
An increment or premium to value associated with a controlling ownership interest in a company.
177
Discounted cash flow model
A model of intrinsic value that views the value of an asset as the present value of the asset's expected future cash flows.
178
Dividend discount model
(DDM) A present value model of stock value that views the intrinsic value of a stock as present value of the stock's expected future dividends.
179
Due diligence
Investigation and analysis in support of an investment action, decision, or recommendation.
180
Fair market value
The price, expressed in terms of cash equivalents, at which a property (asset) would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at "arm's length" in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. Fair market value is most often used in a tax reporting context in the United States
181
Fair value
The amount at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's-length transaction; the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.
182
Free cash flow to equity model
A model of stock valuation that views a stock's intrinsic value as the present value of expected future free cash flows to equity.
183
Free cash flow to the firm model
A model of stock valuation that views the value of a firm as the present value of expected future free cash flows to the firm.
184
Fundamentals
Economic characteristics of a business, such as profitability, financial strength, and risk.
185
Going-concern assumption
The assumption that the business will maintain its business activities into the foreseeable future.
186
Going-concern value
A business's value under a going-concern assumption.
187
Illiquidity discount
A reduction or discount to value that reflects the lack of depth of trading or liquidity in that asset's market.
188
Industry structure
An industry's underlying economic and technical characteristics.
189
Intrinsic value
The amount gained (per unit) by an option buyer if an option is exercised at any given point in time. May be referred to as the exercise value of the option.
190
Investment value
The value to a specific buyer, taking account of potential synergies based on the investor's requirements and expectations.
191
Lack of marketability discount
An extra return to investors to compensate for lack of a public market or lack of marketability.
192
Liquidation value
The value of a company if the company were dissolved and its assets sold individually.
193
Market efficiency
A finance perspective on capital markets that deals with the relationship of price to intrinsic value. The traditional efficient markets formulation asserts that an asset's price is the best available estimate of its intrinsic value. The rational efficient markets formulation asserts that investors should expect to be rewarded for the costs of information gathering and analysis by higher gross returns.
194
Mispricing
Any departure of the market price of an asset from the asset's estimated intrinsic value.
195
Orderly liquidation value
The estimated gross amount of money that could be realized from the liquidation sale of an asset or assets, given a reasonable amount of time to find a purchaser or purchasers.
196
Pairs trading
An approach to trading that uses pairs of closely related stocks, buying the relatively undervalued stock and selling short the relatively overvalued stock.
197
Present value model
A model of intrinsic value that views the value of an asset as the present value of the asset's expected future cash flows.
198
Private market value
The value derived using a sum-of-the-parts valuation.
199
Quality of earnings analysis
The investigation of issues relating to the accuracy of reported accounting results as reflections of economic performance. Quality of earnings analysis is broadly understood to include not only earnings management but also balance sheet management.
200
Rational efficient markets formulation
A finance perspective on capital markets that deals with the relationship of price to intrinsic value. The traditional efficient markets formulation asserts that an asset's price is the best available estimate of its intrinsic value. The rational efficient markets formulation asserts that investors should expect to be rewarded for the costs of information gathering and analysis by higher gross returns.
