Concepts Flashcards
Front-running by employee
Front-running is the purchase or sale of securities in advance of client trades to take advantage of knowledge of client activity and should be completely prohibited, not simply limited.
Is verbal consent enough if receiving additional compensation from client
Members and candidates shall obtain written consent from their employers to enter into the agreement for additional contingent compensation from a client.
Statement a firm can indicate compliance with GPIS standard
American Securities has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS®).
Can candidate use knowledge from the previous work for his own purpose?
The use in new employment, of knowledge and experience gained in previous employment, is not prohibited.
If a candidate overhear non-public information, which is meaningless on its own, and combines with other information to make recommendation, does he violate CFA standard?
No, the use of security analysis combined with nonmaterial nonpublic information to arrive at significant conclusions is allowable under the mosaic theory. He should disclose the details of the information and methodology they used to arrive at recommendation.
What is the trend if converging trend lines form a triangle pattern
The trend will continue in the same direction it was going when the triangle pattern formed
What does Relative Strength Index (RSI) above 70 tell you about trend
An RSI above 70 is thought to indicate an overbought condition, which can be a warning sign that the current uptrend is not sustainable.
If a strategy indicated statistical significant return, even including the transaction costs, should we implement it?
No, should also consider risk. Although the mean abnormal return is positive, returns for various sub-periods may be highly variable. Client might not be able to take the risk
Neglecting statistical discrepancy, should the income and expenditure approaches to calculating GDP yield same value for economic output?
Yes
J Curve Effect (trade deficit)
When domestic currency depreciates (the foreign currency appreciates), the trade deficit gets worse initially but improves over time.
- Higher exchange rate will at first correspond to more costly imports and less valuable exports, leading to a bigger initial deficit or a smaller surplus.
- Later, a country’s exports will start to increase due to lower price
- Local consumers will also purchase less expensive imports and focus on local goods. The trade balance eventually improves to better levels compared to before devaluation.
Conventional fixed peg aggrement
A country pegs its currency within a margin of ±1% versus another currency or a basket that includes the currencies of its major trading or financial partners.
Formal dollarization
Use currency of another country
Monetary union
Several countries use a common currency
Currency board aggrement
Exchange currency at a fixed rate
Pegged exchange rates within horizontal bands/target zone
Wider fluctuations than conventional fixed peg, (±2%)
Crawling peg
Exchange rates adjusted periodically, typically for high inflation
Management of exchange rates within crawling bands
Width of the band is increased overtime
Managed floating exchange rates
Attempts to influence the exchange rates in response to specific indicators.
Balance of payments inflation rates
Independently floating rate
Exchange rate is market determined
If supply is more elastic than demand, what is the effect of surplus if tax in implied on supply
Regardless of whether a tax is imposed on suppliers or consumers, the relative burden of the tax to each depends on the relative elasticity of supply and demand.
In this case:
- The burden of the tax will be greater on consumers than on producers.
- Total consumer and producer surpluses will be reduced by the amount of the resulting deadweight loss in addition to the total amount of tax collected.
What is a firm’s short-run supply curve under perfect competition?
marginal cost curve above average variable cost.
- MC = P in perfect competition
- Firm is always producing at MC = MR
- Firm will shutdown if P (MC) < AVC
Matching principle (accrual accounting)
The matching principle holds that expenses should be accounted for in the same performance measurement period as the revenue they generate, no matter if cash is received or not
How is dividend paid, dividends received, interest paid, interest received,taxes paid categorized under GAAP and IFRS? (Cash flow)
GAAP:
CFF: Dividends paid
CFO: Interest paid, interest received, dividends received, taxes paid
IFRS:
Dividends paid and interest paid can be either CFO or CFF
Dividends received and interest received can be either CFO or CFI
Taxes paid are operating cash flows unless arose from an investing or financing transaction
If an inventory was 28000, then wrote down to 25000, and eventually wrote up to 30000, how should it be revaluated under IFRS and GAAP? Where is gain recognized?
GAAP, no write up is allowed
IFRS, write up only to the extent of recover previous write down (28000), gain is recognized in income statement
Components of net pension asset under IFRS
- Service costs -> Income statement (expensed)
- Interest income or expense -> Income statement(expensed)
- Re measurements (actuarial g/l, actual return minus expected return) -> other comprehensive income on balance sheet, not amortized
Components of net pension asset under GAAP
- Service costs -> Income statement (expensed)
- Interest expense -> Income statement (expensed)
- Expected return on plan assets -> Income statement (expensed)
- Past service costs -> other comprehensive income, amortized
- Actuarial gains/losses -> other comprehensive income, amortized
Four general categories for credit rating agency
- scale and diversification
2, operational efficiency - margin stability
- leverage.
Cost of preferred stock = ?
Preferred dividend divided by the market price.
Note: NOT par value
After-tax cost of debt is ?
Expected yield to maturity on newly issued debt
If a project is risker than the company’s average project, further, IRR = Marginal cost of capital. The company will finance the project with debt that have after-tax cost less than project’s IRR, should company pursue the project?
No, because company should not consider capital raising and budgeting decisions independently
If stock estimated return < return calculated from beta, is the stock overvalued or undervalued?
Overvalued
Estimated return = expected return
calculated return = required rate of return
Systematic Risk
Also known as “undiversifiable risk”, or market risk. It’s the risk that affect the whole market
Unsystematic risk
Also known as “diversifiable risk”, “company risk” , can be reduced through diversification.
Explain commodity index
Commodity index are based on futures price of commodities, and cannot be replicated by investing in the commodities themselves
Explain Real Estate Investment Trust indexes (REIT) and REIT index
REIT trades like common shares and are liquid, it invest directly in mortgages or real property.
REIT indexes track the prices of shares of those company that invest in real estate business
How will stock price react to news in an efficient market
Increase on report of an increased earnings that exceeds expectation
Explain bond interest rate risk
The sensitivity of a bond’s full price to a change in its yield. Shorter duration will yield lower interest rate risk
How will the following change the bond’s duration and interest rate risk?
- Increase in coupon rate
- Increase in bond’s YTM
- Adding a put or a call provision
- Increase in bond duration
- Decrease interest rate, since more bon’s value will be received sooner, so it is less sensitive
- Decrease interest rate risk. Look at the price-ytm curve, at higher ytm, slope is flatter, thus less sensitive
- Decrease interest rate risk, since these option hedge the risk
- Generally increase interest rate risk, since uncertainty is increased
What is low-quality collateral?
Assets that are likely to be written down in value if firm encounters financial distress.
Such as goodwill or deferred tax assets.
How will yields of lower-quality corporate bonds change during recession?
Yields will increase since the probability of default increases.
How will yield spread between lower-quality and higher quality bonds change during recession?
Increase, since investors tends to sell lower quality bonds and buy high quality issues
What is Moody’s credit rating symbol and base line for investment grades?
Aaa, Aa1, Aa2, Aa3, A1, A2, A3,Baa1, Baa2, etc.
Baseline is Baa3
What is S&P credit rating symbol and base line for investment grade?
AAA, AA+, AA, AA- ,A+, A, A-, BBB+, …
Baseline is BBB-
Relationship between no-arbitrage value of a bond calculated using SPOT price and market price of the bond?
Equal
Which duration reflects a bond’s cash flow change associated with changes in yield?
Effective duration
How to determine the type of option of the bond based on spread?
If option-adjusted spread > zero-volatility spread, bond has positive value to holder, thus it is putable bond.
If option-adjusted spread < zero-volatility spread, bond has negative value to holder, thus it is callable bond
Describe the long and short position in Forward Rate Agreement (FRA)
Long: will borrow the money, thus is at fixed rate, if floating rate at expiration is above the specified rate, the long can borrow money at lower rate, thus will receive payment
Short: Equivalent to lend at rates higher than market rates if market rate fall
Describer settlement of FRA. Ex: 30 day settlement, based on 90-day LIBOR
At expiration, the long would borrow money at specific rate.If long would receive 1000 at expiration, the actual cash settlement should be decreased to present value since actual interest saving comes after 90 days.
Pay = 1000/ (1 + (LIBOR) *90/360)
Leverage buy-out
Use significant amount of borrowed money to acquire a public company. Usually pursued by private equity
What investments would require liquidity premium?
Investments that are illiquid, such as private equity funds
Describe Chebyshev’s inequality
Percentage of data within n std deviation = 1 - 1/(n^2)
Parametric test and non parametric tests
Parametric tests rely on assumpts regarding the thetribution of the population and are specific to population parameters.
Nonparametric tests do not consider particular population parameter or have few assumptions about the population being sampled
Quantity theory of money
MV = PV
Money supply * Velocity = Price * Real output
Recognition methods:
- Completed contract method
- Percentage of completion method
- Installment method
- Cost recovery method
- recognizes longterm contract revenue only as each phase of production is complete.
- recognizes profit corresponding to the costs incurred as a proportion of estimated total costs.
- recognizes profit in proportion to cash collected
- profit is recognized only when cash collected exceeds cost incurred
Operating lease, lessee’s perspective
Inception: balance sheet is unaffected
During term: rental expense is recognized in income statement, lease payment is reported as an COO in cash flow
Financing lease, lessee’s perspective
Inception: lower of PV of future lease payments of fair value of lease assets is recognized as both an asset and liability. (As if used debts to purchase an asset)
During term: Asset is depreciated, interest expense is recognized. Interest expense = lease liability * lease interest rate. Liability is amortized.
Interest payment is CFO
Principle payment is CFF
When will an lease be treated as finance lease? under GAAP and IFRS
GAAP either:
- Title is transferred at the end of lease
- A bargain purchase option exists
- Lease period is at least 75% of asset’s economic life
- PV of the lease payment >= 90% of the leased asset’s fair
IFRS similar but not so quantitative
Compare net income in finance lease and operating lease
Net income is lower initially in finance lease and higher later. This is due to the initial interest is high, as liability decreases, net income increase
Operating lease, lessor’s perspective
Asset is kept on balance sheet
Recognize lease payment as rental income
Recognize depreciation expense on asset
Finance lease, lessor’s perspective
Lease receivable is reported on balance sheet
Lease payment as part interest revenue and part capital
Sales-type lease
Usually lessor is manufacturer PV of lease payments > Carrying value of asset Recognize at inception: 1. Sale, PV of lease payment 2. COGS, carrying value of the asset
Interest revenue recognized over lease term
Direct finance lease
Lessor is not manufacturer, usually A ask company B to buy asset and lease for A
PV of lease payments = carrying value of leased assets
Inception: lessor removes the asset from balance sheet and create lease receivable
Interest revenue recognized over lease term in income statement
Cash flow: Interest portion is CFO, principal reduction is CFI
Simple capital structure
One that has only common stock or only common stock and nonconvertible stock
Do preferred shares have voting rights?
No
