Concepts 3 Flashcards
CFA Professional Conduct Program (PCP), if a sanction is warranted against a member, what is his possible action
Member may accept or reject the sanction. If the member rejects the sanction, the matter is referred to a hearing by a panel of CFA Institute members.
Can a member accept gifts from client?
According to Standard I(B) Independence and Objectivity, members and candidates may accept gifts from clients but must disclose them to their employers
What is Standard I(A) knowledge of the law
Standard I(A) Knowledge of the Law states that members and candidates are not to commit any act that they know or should know violates the Code and Standards.
If a member intentionally violates one of the other standard, he also violates this one.
If a member brings a cheat note into the exam but did not use the note, did he violate Code of Ethics and Standard of Professional Conduct?
Yes , both.
For code of Ethics, he is not acting “with integrity, competence, diligence, respect, and in an ethical manner.”
Up-move factor, down-move factor
Used in binomial tree option pricing.
The up-move factor equals one plus the percentage increase when the variable goes up, and the down-move factor is equal to one divided by the up-move factor.
Ex, over the next period, price will increase by 1% or decrease by 1%. upmove factor = 1.01, down move factor = 1/1.01
Limitation on Central bank’s ability to target interest rate
interest rates are bounded by zero
Limitation on Central Bank’s ability to target inflation
liquidity trap conditions may exist
Limitation on Central Bank’s ability to target exchange rate
Central bank’s ability to increase the value of the domestic currency is limited by the amount of foreign reserves the country has available to buy its own currency in the foreign exchange market
Liquidity trap
A situation in which prevailing interest rates are low and savings rates are high. Consumers choose to avoid bonds and keep savings, believing that interest rates will soon rise. Because bonds have an inverse relationship to interest rates, consumers do not want to hold an asset with a price that is expected to decline.
If short term interest rate is above equilbrium rate, will there be excess or insufficient real money balance?
Excess supply.
In the money supply/demand graph, if interest rate is above equilibrium, Supply is still vertical, demand decreases to the left of supply, thus excess supply.
If real money supply increases, will household buy or sell interest bearing securities?
Buy, an increase in real money balances will leave households and businesses with more money than they wish to hold, so they will purchase interest-bearing securities, driving their prices up and yields down until a new equilibrium short-term rate is established.
Interim SEC filing (quarterly or semiannual reports)
Typically update the major financial statements and foot notes, not necessarily audited/
Is annual reports to shareholders the most factual and object source of information about a firm?
No, Annual reports to shareholders and press releases are written by management and are often viewed as public relations or sales materials.
Proxy statement
Issued to shareholders when there are matters that require shareholder vote.
FIled with SEC.
Are a good source of information regarding the election of board members, management, compensation and stock option issuance.
What type of company does low P/E ratio identify?
It will exclude growth companies
What type of company does low price-to-book or high dividend screen like to identify?
Include too many financial services company
Revenue recognition for long-term projects whose outcome is uncertain
IFRS: Revenue is recognized to the extent of contract cost. Cost are expensed.
Profit is recognized only at completion.
Ex. spent 3000, collected 2000 cash, the firm should still record 3000 revenue, 3000 expense and no profit
GAAP: completed contract method, postpone the reporting of income and expenses until a contract is completed
Revenue recognition for long-term projects whose outcome is measurable
Percentage-of-completion method is used. Percentage of completion is measured by the total cost incurred to date divided by total expected cost of the project.
Should future warranty expense incur a deferred tax asset? or deferred tax liability?
Deferred tax asset.
Warranty cost is expensed, then since these expense is not yet tax deductable, we create a deferred tax asset.
In the future, as warranties are paid, the deferred tax asset will decrease.
If a firm changes from FIFO to LIFO, what is the effect on its net cash position? Assuming rising price
Short-term (4-6 weeks) forecast is not affected.
Long-term (3 - 5 year), since firm is paying less tax due to the higher cost, it would reflect a decrease in outflows for taxes.
Line of credits
Short-term funding from bank primarily used by large, financially sound companies.
Uncommitted line of credit
A bank extends an offer of credit of a certain amount, but may refuse to lend if circumstances change
Committed (regular) line of credit
A bank extends an offer of credit that it “commits to” for a period of time.
Revolving line of credit
An even more reliable source of short-term financing than a committed line. Usually for longer term, sometimes as long as years
Banker’s acceptance
Used by firms that exports goods. It is a guarantee from the bank of the firm that ordered the goods stating that a payment will be made upon receipt of
Factoring
Sales of receivables at a discount from their face values. This method would be dependent on company’s customer’s creditworthy
Degree of Total Leverage
Percent change in earnings per share for a given percent change in sales.
It is the product of DOL and DFL
Degree of Financial Leverage
Percent change in earnings per share (or net income) for a given percent change in operating income
Degree of Operating leverage
Percent change in operating income for a given percent change in sales
NPV Profile plot, x axis and y axis
X: cost of capital (%)
Y: NPV ($)
Will increase in tax decrease or increase financial leverage?
Increase in tax will reduce after tax cost of debt.
With a lower cost of debt the firm will likely change its capital structure to include more debt and less equity (i.e., to increase its financial leverage)
Payment of stock dividend.
What is its effect on firm’st net income, equity, and eps?
The payment of a stock (as opposed to a cash) dividend does not affect the firm’s equity or net income, but will decrease its earnings per share because it increases the number of shares outstanding.
Market model
Return generating model
Ri = αi + βiRm + εi
Beta measures the sensitivity of the return on an asser (Ri) to the market rate of return (Rm)
What is the portofolio variance if correlation between returns = 1
It is the weight average of the two assets.
Open end mutual funds vs Closed end mutual funds
Open-end funds redeem existing shares or issue new shares in accordance with investor demand. Closed-end fund shares are fixed in number and trade on exchanges as though they were common stock.
Will a risk-averse investor choose the global minimum variance portfolio?
Risk-averse investors will optimally choose to hold a portfolio along the capital market line.
E.g.a 100% allocation to the risk-free asset
a leveraged position in the market portfolio
The global minimum variance portfolio lies below the CML and is not an efficient portfolio under the assumptions of the CAPM.
Gordon growth model, V0 or V1? D0 or D1?
V0 and D1
Calculate price weighted index.
Company A has 50 shares outstanding valued at $2 each.
Company B has 10 shares outstanding valued at $10 each.
Price-weighted index = (2+10)/2= 6
Stock split does not affect the index
forward-earnings multiplier
P/E ratio
Given earnings next year, dividend pay out ratio, required return, calculate current price
P = E * (P/E)
Use gordon growth model to calculate
P/E = (D/E) / (k-g)
Non cyclical industries
Health care, utilities, telecommunications, consumer staples
Cyclical industries
Base metal and processing, consumer discretionary, energy, financial services, industrial and producer durables, and technology
Affect of volatility on a callable bond
Increase in volatility -> increase in call option value
Since callable bond is callable by the issuer, for the bond itself it’s like writing a call option. Thus the bond value decrease
Medium-term notes
A corporate note continuously offered by a company to investors through a dealer. Investors can choose from differing maturities, ranging from nine months to 30 years.
Commercial paper
Short-term debt securities issued by large creditworthy corporations. Interest cost of commercial paper is less than the interest on a bank loan
Inverse floating rate bond
the coupon rate on an inverse floater increases when market interest rates decrease
there is an implicit cap on the coupon rate because market interest rates cannot decline further than zero.
Covered bonds
Corporation issues them but their interest and principal payments are provided by a separate group of loans or assets that are legally recognized as bankruptcy-remote.
Key word: bankruptcy remote
Collateralized bonds
An investment-grade bond backed by a pool of junk bonds. Junk bonds are typically not investment grade, but because they pool several types of credit quality bonds together, they offer enough diversification to be “investment grade.”
Is excessive drinking and driving (getting arrested for this) violation of Standard on knowledge of the law and the Standard on misconduct?
No, Watson’s excessive drinking is unfortunate but we have no evidence that it has affected his work, professional integrity, judgment, or reputation. His arrest for public intoxication occurred while he was away from work.
How many years does it require for a firm to be complied with GIPS in order to claim compliance?
0, GIPS require a firm to show a GIPS-compliant history for a minimum of five years, or since inception of the firm or the composite if in existence for less than five years.
Is it a violation of Standard if candidate regularly calls larger clients first after changes in investment recommendations have been faxed to all clients?
No, Following up changes in recommendations with phone calls to larger clients is not a violation of the Standard if the changes have been disseminated fairly.
Proxy vote
Proxies have economic value to customers
Members should explicitly disclose firm’s proxy votes to clients
It is not necessary to vote all proxies.
Shape of t-distribution compared to normal distribution
Fatter tails. Since it has more probabilities in tails
Variance in terms of expectation
V = p1 * (x1 - E(x) )^2 + p2 * (x2 - E(x))^2 + …
Shortfall risk
Portfolio value will fall below some minimum level at a future date
Will incorrect production decision made when inflation rate is higher or lower than expected?
Both.
Either higher or lower-than-expected inflation can cause producers to misinterpret unexpected changes in the price level as signals of changes in demand, and produce other than the equilibrium quantity of output.
When is LIFO better than FIFO, in what aspect?
The most useful estimates of inventory and cost of sales are those that best approximate current cost.
Whether prices are increasing or decreasing, FIFO provides a better estimate of inventory values, and LIFO provides a better estimate of cost of sales.
Stable price: no difference between LIFO and FIFO
Which account best estimates non-financial firm’s investing activities?
Noncurrent assets.
Flotation costs
Fees charged by I-bankers when a company raises external equity capital.
Should be included in initial outlay
If an investor follow a price index exactly, will he outperform or underperform it?
Outperform, since dividend is not included in price index calculation
Portfolio duration
an approximation of the price sensitivity of a portfolio to parallel shifts of the yield curve
Top-heavy capital structure
a capital structure that includes a high percentage of secured bank debt.
Firm with top-heavy capital structure may be limited in its access to additional bank borrowing, which increases the likelihood of default if the firm encounters financial distress.
Interpolated spreads
I-spreads, spreads to swap rates
Simple yield
Simple yield is a bond’s annual coupon payment plus amortization of a discount or minus amortization of a premium.
Spot rate
appropriate discount rate for a security that makes A SINGLE payment in the future
Treasury inflation protected securities (TIPS)
have coupon cash flows, not spot rate
Secondary sale (leveraged buyout)
In a secondary sale, a private equity firm sells one of its portfolio companies to a group of investors or another private equity firm. It is an exit strategy.
