Exam Prep - Need To Knows

Question 1

Price elasticity of demand

Answer 1

% Change in Demand / % Change in Price

Question 2

What are the maturities of short, medium and long dated gilts?

Answer 2

Short dated: less than 7 years to redemption
Medium dated: 7 to 15 years
Long dated: over 15 years

Question 3

What are the main features of a REIT?

Answer 3

• 90% of income must be paid out for tax benefits.
• 75% of assets must be property related.
• Each investor cannot own more than 10%.
• Must own at leat 3 properties, no holdings over 40% of the NAV.
• No CGT within REITs.

Question 4

What is the CAPM formula and inputs?

Answer 4

CAPM = Risk free rate + beta x (Market return - risk free rate)

Market return - risk free rate = the market risk premium.

Question 5

What is the formula to rebase an index?

Answer 5

New base / old base x Period X = New index number for period X.

The start value is the index number at the base year.

Question 6

What is the Sharpe ratio?

Answer 6

Sharpe ratio = Portfolio return - risk free rate / Standard deviation.

It provides the portfolio return per unit of risk.

Question 7

What is the Treynor ratio?

Answer 7

Treynor ratio = Portfolio return - risk free rate / beta.

Question 8

What is the Jensen measure?

Answer 8

Jensen measure = Portfolio return - CAPM.

Question 9

What is the information ratio?

Answer 9

Information ratio = Portfolio return - Bmk return / standard deviation of surplus returns.

The standard deviation of surplus return is also known as the tracking error or active risk.

I.e. Excess return / st deviation of excess return.

Question 10

What is the formula for Macaulay Duration?

Answer 10

Macaulay Duration = ∑ Time weighted cash flows / ∑ PV of cash flows

Question 11

What is the Modified Duration formula?

Answer 11

Modified duration = Macaulay duration / 1+yield

MD overestimates price falls and underestimates rises (pessimistic), due to convexity of the yield curve.

Question 12

How do you calculate the yield on T-bills?

Answer 12

T-Bill yield = Price - par / price+1 x 365 / no. of days til redemption -1 x 100

Compound T-Bill yield = Price - par / price+1 ^365/no. days til redemption -1 x 100

I.e you find the rate of return and multiply by 365/n or take it to the power of 365/n for compounding. This is also the formula for annual return.

Question 13

How is the geometric mean calculated?

Answer 13

Geometric mean = (1+r) x (1+r)^1/n

If they are not percentage figures you do not need to add one to each value, simply multiply them and take them to the power of 1 / n.

Question 14

What is the annuity formula?

Answer 14

CF x 1/r x (1 - 1/(1+r)^n

When using the annuity formula for fixed income, the coupon is simply the CF and you add this to the capital yield over 1 + r^n.

Question 15

How is the APR calculated?

Answer 15

APR = (1 + monthly rate)^12 - 1

Question 16

What is the lowest rating for an investment grade bond?

Answer 16

S&P: BBB-
Moody’s: Baa3
Fitch: BBB

Question 17

What is the perpetuity formula?

Answer 17

Price = Coupon / yield.

Undated bonds are valued using the perpetuity formula.

Question 18

How can you calculate future spot rates in the FX market?

Answer 18

Future spot rate = Spot rate x (1+quoted rate / 1+base rate)

Question 19

What is the formula for the Gordons Growth Model?

Answer 19

(Ex-div) Price = Dividend x (1+growth rate) / (required return - growth rate)

Question 20

How is the GRY calculated?

Answer 20

GRY = ∑ Coupon / (1+r)^ +… including principal in the final payment.

GRY aka YTM.

If you are given the price and coupon rate, to find IRR you must find the rate (r) figure by trial and error until it discounts the cash flows & principal back to the price that’s given.

Question 21

What do these derivatives terms represent:
Delta -
Theta -
Vega -
Rho -

Answer 21

Delta - Option price relative to underlying asset price.
Theta - Option price relative to time.
Vega - Option price relative to volatility of underlying asset.
Rho - Option price relative to interest rates.

Question 22

How is the multiplier found?

Answer 22

The multiplier is found by taking 1 divided by the Marginal Propensity to Save.

1 / MPS

Question 23

How do you calculate a bond’s price for a certain required return?

Answer 23

Calculate the sum of the coupons for each year including the principal in the final year, divided by 1 + required return (e.g 1.08 / 8%) at each year.

Question 24

How is the flat yield calculated for a bond?

Answer 24

The flat yield is found by simply dividing the gross annual coupon by the price of the bond, x 100 for the percentage figure.

AKA ‘running yield’ or ‘coupon yield’.

3 month indexation lag on index linked bonds.

Question 25

How is the inter quartile range calculated?

Answer 25

The median of the last quartile - the median of the first quartile.

Question 26

How is straight line depreciation calculated?

Answer 26

Annual depreciation = Original cost - residual value / lifetime

Question 27

How is the reducing balance method of depreciation calculated?

Answer 27

1 - n to the root of the residual value over the original cost.

Question 28

How do you calculate the number of contracts to hedge a portfolio?

Answer 28

No. of contracts = Cash exposure face value / Futures contract face value x beta

The FTSE 100 futures are quoted at 10 pounds, therefore index points x 10 = price per point. You must then multiply the contracts by the beta to find the beta hedge.
Short sterling contracts cost 12.50 pounds per basis point.

Question 29

How do you find the compound growth rate between two periods of return?

Answer 29

Compound growth rate = (End value / Start value)^1 / n

Don’t forget to include the nominal value when discounting or finding the price of a bond!

Question 30

How can you find the IRR figure for the present value of a zero coupon bond?

Answer 30

IRR = (Par value / Price)^ 1 / n

Subtract 1 and multiply by 100 and this is you IRR %.

Question 31

How to calculate the forward exchange rate using the interest rate parity formula?

Answer 31

Forward rate = Spot rate x (1+quoted inflation rate / 1+base inflation rate)

Question 32

How is the change in price of a bond calculated using Modified Duration?

Answer 32

∆Price = -MD x ∆interest rate x price.

The MD is entered as a negative figure to take account of the negative price/yield relationship, showing that bonds price falls as interest rates rise.