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Cram Flashcards

1
Q

Heteroskedasticity

A

Non-constant error variance
Detect with Breusch-Pagan test
Correct with White-corrected standrad errors

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2
Q

Autocorrelation

A

Correlation among error terms
Detect with Durbin-Watson test
Correct by adjusting standard errors using Hansen method

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3
Q

Multicollinearity

A

High correlation among X’s
Detect if F-test significant, t-test insignificant
Correct by dropping X variables

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4
Q

Model Misspecification

A
  1. Omitting a variable
  2. Variable should be transformed
  3. Incorrectly pooling data
  4. Using lagged dependent variable as independent variable
  5. Forecasting the past
  6. Measuring independent variables with error
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5
Q

Covariance stationary

A

Mean and variance don’t change over time

To determine if covariance stationary:

  1. Plot data
  2. Run an AR model and test correlations
  3. Perform Dickey-Fuller test
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6
Q

Covered interest rate parity

A

“Covered” by arbitrage-free framework

F = S0 * (1+Ra)/(1+Rb)

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7
Q

Uncovered interest rate parity

A

Expected change in price (A vs B) = Ra - Rb

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8
Q

Fisher Relation

A

Rnominal = Rreal + E(inflation)

RnomA - RnomB = E(inflation A) - E(inflation B)

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9
Q

Relative Purchasing Power Parity

A

High inflation rates leads to currency depreciation

Change in spot price (A vs B) = inflation A - inflation B

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10
Q

Mundell-Fleming model

A

Impact of monetary and fiscal policies on IR’s and exchange rates.

Under high capital mobility, expansionary monetary policy/restrictive fiscal policy -> low IR’s -> currency depreciation

Under low capital mobility, expansionary monetary policy/expansionary fiscal policy -> current account deficits -> currency depreciation

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11
Q

Dornbusch overshooting model

A

Restrictive monetary policy -> short-term appreciation of currency, then slow depreciation to PPP value

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12
Q

Growth Rate in GDP (2 eq’s)

A

= long-term growth rate of technology
+ a (long-term growth rate of capital)
+ (1 - a) (long-term growth rate of labor)

= long-term growth rate of labor force + long-term growth rate in labor productivity

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13
Q

Labor productivity

A

Output per Worker Y/L = T (K/L)^a

Y = output
K = capital
T = tech
L = labor
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14
Q

Classical Growth Theory

A

Real GDP/person reverts to subsistence level

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15
Q

Neoclassical Growth Theory

A

Sustainable growth rate is a function of population growth, labor’s share of income and the rate of technological advancement.

Growth rate in labor driven only by improvement in technology.

Assumes diminishing returns to capital

g* = theta/(1-a), G* = g* + deltaL

theta = tech growth rate
(1-a) = labor share of GDP
G* = substainable growth rate of output
deltaL = growth of labor
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16
Q

Endogenous Growth Theory

A

Investment in capital can have constant returns

increase in savings rate is permanent increase in growth rate
R&D expenditures increase technological progress

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17
Q

Classifications of Regulators

A

Can be government agencies or independent. Independent can be SRO or non-SRO

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18
Q

Self-Regulation in Financial Markets

A

Independent SROs are more prevalent in common-law countries than in civil-law countries

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19
Q

Net regulatory burden

A

Costs to the regulated entities minus the private benefits of regulation

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20
Q

PBO components

A

PBO components:

  1. Current service cost
  2. Interest Cost
  3. Actuarial g/l
  4. benefits paid
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21
Q

Pension cost (B/S)

A 
For IFRS and GAAP:
Funded status (B/S) = plan assets - PBO
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22
Q

Pension Cost (I/S)

A

Total periodic pension cost (both) = contributions - change in funded status = ending PBO - beginning PBO + benefits paid - actual return on plan assets. Differ where TPPC is reflected (I/S vs. OCI)

GAAP: TPPC in P/L = service cost + interest cost +- amort of actuarial G/L + amort of past service cost - expected return on plan assets

IFRS, reported pension expense = service cost + past service cost + net interest expense

Under IFRS, DR = expected rate of return on plan assets. Net interest expense = DR * beginning funded status. If funded status was positive, a net interest income would be recognized

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23
Q

Cash Flow Adjustment of Pension Cost

A

If TPPC < firm contribution, difference is change in PBO (reclassify difference from CFF to CFO after tax)

If TPPC > firm contribution, diff = borrowing (reclassify difference from CFO to CFF after-tax)

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24
Q

Current rate method

A

Self-contained, functional =/= presentation

  1. A/L at current rate
  2. CS @ historical rate
  3. I/S @ average rate
  4. Exposure = S.E.
  5. Difidends at rate when paid
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25
Temporal Method
Integrated sub, functional = presentation 1. Monetary A/L @ current rate 2. Nonmonetary A/L @ historical rate 3. Sales, SGA @ average rate 4. COGS, depreciation @ historical rate 5. Exposure = monetary assets - monetary liabs Net asset position & depr. foreign currency = loss Net liab position & depr foreign currency = gain
26
Hyperinflation
3-yr inflation > 100% GAAP: use temporal method IFRS: 1st, restate for inflation, 2nd, translate with current rates
27
Extended dupont
Tax burden * Interest burden * EBIT margin * Total asset turnover * financial leverage = NI/EBT * EBT/EBIT * EBIT/revenue * revenue/avg assets * avg assets/avg equity
28
Accruals Ratio (B/S)
accruals ratio (B/S) = (NOAend - NOAbeg) / (NOAend + NOAbeg)/2
29
Accruals Ratio (CF statement approach)
accruals ratio (CF) = (NI - CFO - CFI) / (NOAend + NOAbeg)/2
30
Liquidity coverage ratio
highly liquid assets/expected cash outflows
31
Net stable funding ratio
available stable funding/required stable funding
32
Underwriting loss ratio
claims paid + delta loss reserves / net premium earned
33
Expense ratio
underwriting expenses inc. commissions / net premium written
34
Loss and Loss adjustment expense ratio
loss expense + loss adjustment expense / net premiums earned
35
Dividends to policyholders
dividends to PH / net premiums earned
36
CRAD
combined ratio - dividends to PH
37
Combined ratio
???
38
Total investment return ratio
total investment income / investment assets
39
Life and health insurers' ratios
total benefits paid / (net premiums written and deposits), commissions + expenses / (net premiums written and deposits)
40
Cash flow, terminal value: Corp Fi
CF = (S - C - D)(1 - T) + D = (S - C)(1 - T) + DT TNOCF = sale + NWCInv - T(Sale - BV)
41
Effects of inflation
Reduces tax savings from depreciation decreases value of fixed payments to bondholders affects costs and revenues differently
42
Types of real options
``` TAFFE Timing Abandonment Flexibility Fundamental Options Expansion ```
43
Economic income
AT CF + change in project's MV. Economic depreciation based on change in investment's MV
44
Economic Profit/Residual Income
EP = NOPAT - $WACC MVA = sum of EP's discounted @ WACC Residual income = NI - equity charge
45
Investor preference theories
Dividend preference theory: investors prefer certainty of current cash vs. future capital gains Tax aversion theory: investors are tax averse to dividends, prefer companies buy back share
46
Double taxation
effective taxation = Tc + (1-Tc)(Personal tax rate)
47
Ethical Decision Making
Friedman Doctrine - only responsibility is to increase profits within the rules of the game Utilitarianism - produce the highest good for the largest number of people Kantian ethics: people are more than just an economic input and deserve dignity and respect Rights theories - even if an action is legal, it may violate fundamental rights and be unethical Justice theories - focus on just distribution of economic output
48
Pre-offer defense mechanisms
Poison pills and puts, reincorporate in a state w/ restrictive takeover laws, staggered board elections, restricted voting rights, supermajority voting, fair price amendments, golden parachutes
49
Post-offer defense mechanisms
Litigation, greenmail, share repurchase, leveraged recapture, the "crown jewel", "Pac-Man", "just say no" defenses, and white knight/squire
50
Herfindahl Hirschmann Index
Market power is sum of squared market shares for all industry firms. Moderately concentrated industry (HHI 1000-1800), merger likely to be challenged if HHI increases 100 points (or 50 pts if HHI > 1800)
51
Merger Valuations
``` Combined firm = Va + Vt + S - C Takeover premium (to target): Gain = TP = P - V Synergies (to acquirer): Gain = S - TP = S - (P-V) ```
52
Use DDM when:
1. Firm has dividend history 2. Dividend policy is related to earnings 3. Minority shareholder perspective
53
Use FCF when:
1. Firm lacks stable dividend policy 2. Dividend policy not related to earnings 3. FCF is related to profitability 4. Controlling shareholder perspective
54
Use RI when:
1. Firm lacks dividend history | 2. Expected FCF is negative
55
FCFF Formulas
``` FCFF = NI + Dep + Int (1-Tc) - FCInv - WCInv FCFF = EBIT(1-Tc) + Dep - FCInv - WCInv FCFF = EBITDA (1-Tc) + Dep*Tc - FCInv - WCInv FCFF = CFO + Int(1-Tc) - FCInv ```
56
FCFE Formulas
``` FCFE = FCFF - Int(1-Tc) + Net Borrowing FCFE = NI + Dep - FCInv - WCInv + Net Borrowing FCFE = NI + (1-%debt)(Dep - FCInv - WCInv) FCFE = CFO - FCInv + Net Borrowing ```
57
P/E Problems and Formulas
1. If earnings < 0, P/E meaningless 2. Volatile, transitory portion of earnings makes interpretation difficult 3. Management discretion over accounting choices affects reported earnings leading P/E = (1-b)/(r-g) trailing P/E = (1-b)(1+g)/(r-g)
58
P/B Adv/Disadvantages and formula
Justified P/B = ROE - g / r -g Adv: 1. BV almost always > 0 2. BV more stable than EPS 3. Measures NAV of financial institutions Disadv: 1. Size differences cause misleading comparisons 2. Influenced by accounting choices 3. BV =/= MV due to inflation/technology
59
P/S Adv/Disadv and formula
Justified P/S = PM * (1-b)(1+g)/(r-g) Adv: 1. Meaningful even for distressed firms 2. Sales revenue not easily manipulated 3. Not as volatile as P/E ratios 4. Useful for mature, cyclical and start-up firms Disadv: 1. High sales =/= imply high profits and CFs 2. Does not capture cost structure differences 3. Revenue recognition practices still distort sales
60
Price to CF ratios
Adv: 1. CF harder to manipulate than EPS 2. More stable than P/E 3. Mitigates earnings quality concerns Disadv: 1. Difficult to estimate true CFO 2. FCFE better but more volatile
61
Residual income formula
RI = E - r * BV(t-1)
62
PE valuation: total discount
= 1 - (1-DLOC)(1-DLOM), DLOC = 1 - (1/(1+control prem)) ``` Decr DLOM: 1. Impending IPO or sale of firm 2. Repayment of divs 3. Earlier, higher payments 4. A greater pool of buyers Incr: 1. Restrictions on selling stock 2. Greater risk and value uncertainty ```
63
Spreads (3x)
swap spread = swap rate - treasury yield TED spread = 3-mo LIBOR - 3-mo T-Bill LIBOR-OIS = LIBOR - "overnight indexed swap" rate
64
Term structure IR models
CIR: dr = a(b-r)dt + sigma*sqrt(r)*dz Vasicek: dr = a(b-r)dt + sigma*dz Ho-Lee: dr = theta*dz + signa*dz
65
One-sided duration
Callable bonds have lower down-duration, putables have lower up-duration
66
Value of capped/floored floater
``` capped = straight floater value - embedded cap value floored = straight floater value + embedded floor value ```
67
Structural Models of debt/equity
risk debt = value of rf debt - value of put option on company's assets equity ~ european call on company assets
68
Approximations for CDS: payment and change in value
Up front CDS payment for CDS buyer =PV(protection leg) - PV(premium leg) =(CDS spread - CDS coupon) * duration * NP Change in value for a CDS after inception = change in spread * duration * NP
69
Quoted bond futures price
= forward price/conversion factor | = ((full price)(1+rf)^T - AI(T) - FVC))/CF
70
Option value using arb-free pricing
``` C = h*S0 + [-hS+ + C+]/(1+Rf) = h*S0 + (-hS- + C-)/(1+Rf) P = h*S0 + (-hS- + P-)/(1+Rf) = hS0 + (-hS+ + P+)/(1+Rf) ```
71
Value of property using direct capitalization
``` = rental income if fully occupied + other income = potential gross income - vacency and collection loss = effective gross income - operating expense = NOI ```
72
debt service coverage ratio, LTV ratio
``` DSCR = Y1 NOI / debt service LTV = loan amount / appraisal value ```
73
NAV approach to REIT share valuation
``` estimated cash NOI / assumed cap rate = estimated value of operating real estate + cash and AR - debt and other liabilities = NAV / # shares outstanding = NAV/share ```
74
Price-to-FFO approach to REIT share valuation
FFO / shares outstanding = FFO/share * sector average P/FFO multiple = NAV/share
75
Price-to-AFFO approach to REIT share valuation
``` = FFO - non-cash rents - recurring maintenance-type CapEx = AFFO /shares outstanding = AFFO/share * property subsector average P/AFFO multiple = NAV/share ```
76
Sources of value creation: PE
1. Reengineer firm 2. Favorable debt financing 3. superior alignment of interests between management and PE ownership
77
Exit routes: high-to-low value
1. IPO 2. Secondary market sales 3. Mgmt buyout 4. Liquidations
78
Term structure of commodity futures
1. Insurance: contract buyers compensated for providing protection to commodity producers. implies backwardation is normal 2. Hedging pressure hypothesis: like insurance theory, but includes both long hedgers ( -> contango) and short hedgers (-> backwardation) 3. Theory of storage: spot and futures prices related through storage costs and conveniance yield roll return is positive in backwardation b/c long-dated contracts are cheaper than expiring contracts
79
Optimal level of active risk
SR = sqrt ( SR(b)^2 + IR(P)^2) Total portfolio risk = SD(b)^2 + SD(A)^2
80
Full "Fundamental" law of active management
``` E(Ra) = TC * IC * Sqrt(BR) * sigmaA IC = 2*(% correct)-1 ```
81
Types of Algorithms
Execution: break an order down into smaller pieces to minimize market impact High-frequency: programs that trade on real-time market data to pursue profits

CFA 2 (1 decks)

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