Formulas

Question 1

FCFF Firm Value

Answer 1

infinity(Sum)t=1 [FCFF,t / (1+WACC)^t]
-Must add the market value of non-operating assets to value obtained from FCF model when computing company value

Question 2

Indirect Equity Valuation

Answer 2

Equity Value = Firm value - Market Value debt

Question 3

Direct Equity Valuation

Answer 3

Equity Value = infinity(Sum)t=1 [FCFE,t / (1 + r)^t]

Question 4

FCFF, NI

Answer 4

FCFF = NI + NCC + int (1-t) - FCInv - WCInv

Question 5

FCInv

Answer 5

FCInv = Capex - Proceeds from sale of long term assets

Question 6

WCInv

Answer 6

WCInv = Change (working cap over the year)

Question 7

Working Capital

Answer 7

Working Capital = CA (excl. Cash) - CL (excl. ST debt)

Question 8

FCFF, CFO

Answer 8

FCFF = CFO + int(1-t) - FCInv

Question 9

FCFF, EBITDA

Answer 9

FCFF = EBITDA(1-t) + Dep(t) - FCInv - WCInv

Question 10

FCFF, EBIT

Answer 10

FCFF = EBIT(1-t) + Dep - FCInv - WCInv

Question 11

FCFF to FCFE

Answer 11

FCFE = FCFF - int(1-t) + Net Borrowing

-FCFE approach is preferred when company’s capital structure is relatively stable

Question 12

FCFE, NI

Answer 12

FCFE = NI + NCC - FCInv - WCInv + Net borrowing

Question 13

FCFE, CFO

Answer 13

FCFE = CFO - FCInv + Net borrowing

Question 14

FCFE, EBIT

Answer 14

FCFE = (EBIT - Int)(1-t) + Dep - FCInv - WCInv + Net Borrow

Question 15

FCFE, EBITDA

Answer 15

FCFE = (EBITDA - Int)(1-t) + Dep(t) - FCInv - WCInv + Net borrow

Question 16

Uses of FCFF

Answer 16

FCFF = Increase in cash + Net payment to debt providers + net payment to equity providers

Question 17

Uses of FCFE

Answer 17

FCFE = Increase in cash + Net payments to capital providers

Question 18

Net payments to debt providers

Answer 18

= Int exp(1-t) + Principal repayment - Net borrowing

Question 19

Net Payments to Equity (Capital) Providers

Answer 19

Cash dividends + Share repurchase - New equity issues

Question 20

Single-Stage (Constant Growth) FCFF Valuation

Answer 20

Firm Value = (FCFF,0 * (1+g)) / (WACC - g) = FCFF,1 / (WACC - g)

Question 21

Single-Stage (constant growth) FCFE Valuation

Answer 21

Firm Equity Value = (FCFE,0 * (1+g)) / (r - g) = FCFE,1 / (r - g)

Question 22

2-Stage FCFF Valuation

Answer 22

n(Sum)t=1 [FCFF,t / (1 + WACC)^t] + (FCFF,n+1 / (WACC -g)) * (1 / (1 + WACC)^n))

Question 23

Justified Trailing PE, Terminal Value

Answer 23

TV = Justified Trailing PE * Forecasted Earnings,n

Question 24

Justified Leading PE, Terminal Value

Answer 24

TV = Justified leading PE * Forecasted earnings, n+1

Question 25

P/B Ratio

Answer 25

=market value Common SE / Book value common SE =Market price/shr / book value/shr

Question 26

Book Value of Common SE

Answer 26

= Total assets - Total liabilities - P.stock

Question 27

P/S Ratio

Answer 27

=market price/shr / Sales/shr =P/E \* Net Profit Margin = P/E \* E/S

Question 28

P/CF Ratio

Answer 28

(Market price/shr) / (FCF/shr)

Question 29

EPS

Answer 29

EPS = BVPS \* ROE

Question 30

Justified P/B Ratio

Answer 30

P,0 / B,0 = (ROE - g) / (r - g)

Question 31

Justified P/S Ratio

Answer 31

P,0 / S,0 = [(E,0 / S,0)\* (1-b)\* (1+g)] / (r - g)

Question 32

Justified Dividend Yield

Answer 32

D,0 / P,0 = (r-g) / (1+g)

Question 33

Justified P/E Ratio, Inflation

Answer 33

P,0 / E,1 = 1 / [P + (1-lamda)I] P = Real rate of return Lamda = % of inflation that can pass through to revenue I = Rate of inflation

Question 34

Enterprise Value

Answer 34

EV = MV(Equity) + MV(P.stock) + MV(interest-bearing-debt) + Minority Interest (Non Controlling Interest) - Value of cash and short term investments

Question 35

Unexpected Earnings

Answer 35

UE = EPS,t - E(EPS,t)

Question 36

Residual Income, Direct

Answer 36

RI = NI - Equity Charge

Question 37

Equity Charge

Answer 37

= Cost of equity capital \* Equity Capital

Question 38

Residual Income, Alternative

Answer 38

RI = After-tax operating profit - Capital charge

Question 39

Capital Charge

Answer 39

= Equity charge + debt charge

Question 40

Debt charge

Answer 40

= Cost of debt\*(1-t) \* Debt capital

Question 41

Economic Value Added

Answer 41

EVA = NOPAT - (C% \* TC) NOPAT = Net operating profit after tax = EBIT \*(1-t) C% = Cost of Capital (WACC)

Question 42

Market Value Added

Answer 42

MVA = MV(Company) - Accounting Book Value(Total Capital) MV(Company) = MV Equity + MV Debt

Question 43

Residual Income Model, RI,t

Answer 43

RI,t = E,t - (r \* B,t-1)

Question 44

Residual Income Model, Firm Value

Answer 44

V,0 = B,0 + infinity(Sum)t=1 [RI,t / (1 + r)^t] -Separately identifiable assets and goodwill should be included in book value of company when performing RI valuation

Question 45

Alternative Residual Income Model, EPS,t

Answer 45

EPS,t = ROE \* (B,t-1)

Question 46

Alternative Residual Income Model, RI,t

Answer 46

RI,t = (ROE - r)\* B,t-1

Question 47

Constant Growth Residual Income Model

Answer 47

V,0 = B,0 + [(ROE - r) / (r - g)]B,0 = Current Book value + PV(Expected stream of RI)

Question 48

Tobins q

Answer 48

=MV(Debt + equity) / Replacement Cost (Total Assets) -Value between 0 and 1 indicates company undervalued. Value above 1 indicates company overvalued

Question 49

Residual Income Model, Persistence Factor

Answer 49

V,0 = B,0 + T-1(Sum)t=1[E,t - r(B,t-1) / (1+r)^t] + [(E,T - r(B,T-1)) / ((1+r-w)(1+r)^(T-1)]

Question 50

Implied Growth Rate in Residual Income Model

Answer 50

g = r - [((ROE - r) \* B,0) / (V,0 - B,0)]

Question 51

Capitalized Cash Flow Model (CCM), Firm Value

Answer 51

Firm Value = FCFF,1 / (WACC - g,f)

Question 52

Capitalized Cash Flow Model (CCM), Equity Value

Answer 52

Equity value = FCFE,1 / (r-g)

Question 53

CAPM

Answer 53

Required ROE = r,f + (Beta \* MRP)

Question 54

Expanded CAPM

Answer 54

Required ROE = r,f + (Beta \* MRP) + Small Stock Premium + Company Specific Premium

Question 55

Build-up approach

Answer 55

r,f + MRP + Small Stock Premium + Company Specific Premium + Industry Risk Premium

Question 56

Discount for Lack of Control (DLOC)

Answer 56

=1 - (1 / (1 + control premium))

Question 57

FCFE, Debt Ratio

Answer 57

FCFE = NI - (1 - Debt ratio)[(FCInv-dep) + WCInv]

Question 58

Scaled Earnings Surprise

Answer 58

= Earnings surprise / (Std.Dev. of forecasts)

Question 59

Standardized Unexpected Earnings

Answer 59

= earnings surprise / (Std.Dev. of past unexpected earnings) -The smallest absolute value for SUE indicates the least difference of forecast to actual results

Question 60

Future COGS

Answer 60

= (Historical COGS / Rev)\* Projected Sales =(1 - Historical Gross Profit Margin) \* Projected Sales

Question 61

Effective Tax Rate

Answer 61

= Income Tax expense (on income statement) / Pre-tax income

Question 62

Cash Tax Rate

Answer 62

= Tax actually paid / Pre-Tax income

Question 63

Return on Invested Capital (ROIC)

Answer 63

= NOPAT / Invested Capital NOPAT = EBIT\*(1-t) -This measures how much of the comp's EBITDA is actually making it to net operating profit after tax. Capital providers will be willing to pay more for higher quality EBITDA (as evidenced by a higher ROIC)

Question 64

Invested Capital

Answer 64

= Operating assets - Operating Liabilities

Question 65

Return on Common Equity (ROCE)

Answer 65

= Operating Profit / Capital Employed

Question 66

Capital Employed

Answer 66

=Debt Capital + Equity Capital

Question 67

Gordon Growth Model

Answer 67

V,0 = D,1 / (r-g) - This model implies a constant payout ratio, meaning g reflects growth in both divs and earnings, and expected growth in comp's stock price - As divs and stock price are growing at same rate, div yield will remain unchanged overtime

Question 68

Present Value of Growth Opportunities (PVGO), V,0

Answer 68

V,0 = (E,1 / r) + PVGO

Question 69

PVGO

Answer 69

PVGO = Mrkt Price - No Growth Value per share

Question 70

No Growth Value Per Share

Answer 70

= E,1 / r

Question 71

Justified Trailing P/E Ratio

Answer 71

= (D,1 /E,0) / (r - g) = [(1-b)(1+g)] / (r-g)

Question 72

Justified Leading P/E Ratio

Answer 72

= (D,1 / E,1) / (r-g) = (1-b) / (r-g)

Question 73

Noncallable Fixed Rate Perpetual Preferred Stock, V,0

Answer 73

= D / r

Question 74

General 2-Stage DDM

Answer 74

V,0 = n(Sum)t=1[(D,0(1+g,s)^t) / (1+r)^t] + [(D,n\*(1+g,L) / ((1 + r)^n \* (r - g,L)) V,0 = (D1 + P1) / (1+r)

Question 75

H-Model

Answer 75

``` V,0 = [(D,0 \* (1 + g,L)) / (r - g,L)] + [(D,0 \* H \* (g,s - g,L)) / (r - g,L)] H = half-life = 0.5 x the length of the high growth period (period where growth is declining lineraly) D0 = First dividend of the linearly declining growth period ``` USE THIS FOR TERMINAL VALUE WHEN THERE ARE OTHER PERIODS OF GROWTH

Question 76

H-Model Required Return

Answer 76

r = (D,0 / P,0) \* [(1 + g,L) + H(g,s - g,L)] + g,L

Question 77

Sustainable Growth Rate

Answer 77

g = b \* ROE = Retention Rate \* ROE b = 1 - Dividend Payout Ratio

Question 78

Leading P/E Ratio, PVGO

Answer 78

Leading P/E Ratio = (1/r) + (PVGO / E,1) 1/r = Value of PE for no growth company PVGO / E,1 = Component of P/E ratio relating to growth opportunities

Question 79

Perceived Mispricing

Answer 79

= True Mispricing + Error in estimate of intrinsic value =V,E - P = (V - P) + (V,E - V) V,E: Estimate of intrinsic value P: Market price V= True (unobservable) intrinsic value

Question 80

Dividend Yield

Answer 80

=D,H / P,0

Question 81

Price Appreciation Return

Answer 81

=(P,H - P,0) / P,0

Question 82

Holding Period Return (HPR)

Answer 82

=Dividend Yield + Price Appreciation Return = (PH - P,0 + D,H) / P,0

Question 83

Expected (Realized) Alpha

Answer 83

=Expected Return (Actual HPR) - Required Return

Question 84

Expected Return

Answer 84

=Required Return + Convergence Return

Question 85

Intrinsic Value, Stable Dividend

Answer 85

V,0 = D1 / (k,e - g) k,e: Required return

Question 86

k,e (IRR), Stable Dividend Growth

Answer 86

k,e = (D1 / P0) + g

Question 87

Gordon Growth Model, ERP Estimate

Answer 87

ERP = (D1 / P0) + g - r,LTGD

Question 88

Farma French Model (FFM)

Answer 88

r,i = R,f + [B,i,mrkt \* RMRF] + [B,i,size \* SMB] + [B,i,value \* HML] RMRF: Return Market less Return risk free, = ERP SMB: Small Cap return premium, = R,small - R,big HML: Value Return premium, = R,HBM - R,LBM

Question 89

Pastor-Stambaugh Model (PSM)

Answer 89

r,i = R,f + [B,i,mrkt \* RMRF] + [B,i,size \* SMB] + [B,i,value \* HML] + [B,i,liq \* LIQ] RMRF: Return Market less Return risk free, = ERP SMB: Small Cap return premium, = R,small - R,big HML: Value Return premium, = R,HBM - R,LBM Baseline value for liquidity beta is 0, which represents average liquidity

Question 90

Adjusted Beta

Answer 90

= 2/3 \* (Unadjusted Beta) + [1/3 \* (1)] -Beta is difficult to estimate consistently

Question 91

Asset Beta

Answer 91

B,asset = B,equity \* [1/ (1+ (1-t)(D/E)]

Question 92

Equity Beta

Answer 92

B,equity = B,asset \* [1+ (1-t)(D/E)]

Question 93

Ibbotson and Chen's Model (ICM)

Answer 93

ERP = {[(1 + EINFL)(1 + EGREPS)(1 + EGPE) - 1] +EINC} -Exp. R,f EINFL: Expected INflation EGREPS: Expected growth rate in real earnings per share EGPE: Expected growth rate in P/E ratio

Question 94

Expected Inflation (EINFL), ICM Model

Answer 94

can be estimated as the difference between LT T bonds and TIPS of similar security EINFL = [(1 + YTM of 20-yr T bonds) / (1 + YTM of 20yr TIPS)] - 1

Question 95

Expected Growth Rate in Real Earnings Per Share (EGREPS)

Answer 95

Can be estimated as the sum of labor productivity growth and labor supply growth

Question 96

Unlevered Net Income

Answer 96

=Net income + net interest after tax

Question 97

Net Interest After Tax

Answer 97

=(Int expense - Int income)\*(1-t)

Question 98

Net Operating Profit Less Amortized Taxes (NOPLAT)

Answer 98

NOPLAT = unlevered net income + Change(deferred taxes)

Question 99

FCFF, NOPLAT

Answer 99

FCFF = NOPLAT + NCC - Change(net working capital) - Capex

Question 100

FCFF Terminal Value,T, Constant Growth

Answer 100

=FCFF,T \* [(1+g) / (WACC - g)]

Question 101

Takeover Premium (TP)

Answer 101

TP = (DP - SP) / SP DP: Deal price per share SP: Share price

Question 102

Target Shareholders Gain

Answer 102

=Takeover Premium = P,T - V,T P,T: Price paid for target V,T: Pre-merger value of target

Question 103

Acquirer's Gain

Answer 103

=Synergies - Premium = S - (P,T - V,T)

Question 104

Initial Outlay for New Investment (IO)

Answer 104

IO = FCInv + NWCInv

Question 105

Net Working Capital Investment (NWCInv)

Answer 105

=Change(Noncash CA) - Change (Nondebt CL)

Question 106

Annual After-Tax Operating Cash Flow (ATOCF)

Answer 106

(S-C)(1-t) + tD S: Sales C: Cash operating expenses D:Depreciation t: tax rate

Question 107

Profitability Index (PI)

Answer 107

PI = 1 + (NPV/IO)

Question 108

Terminal Year After-Tax Non-Operating Cash Flow (TNOCF)

Answer 108

TNOCF = Sal,T + NWCInv - t(Sal,T - BV,T)

Question 109

Initial Outlay for Replacement Project (IO)

Answer 109

IO = FCInv + NWCInv - Sal,0 + t(Sal,0 - BV,0)

Question 110

Annual After-Tax Operating Cash Flow (ATOCF), Replacement Project

Answer 110

=Change(Cash flows) =[Change(S) - Change(C)](1-t) + t\*Change(D) S: Sales C: Cash operating expenses D:Depreciation

Question 111

Terminal Year After-Tax Non-Operating Cash Flow (TNOCF), Replacement Project

Answer 111

TNOCF = Change(Sal,T) + NWCInv - t\* Change(Sal,T - B,T)

Question 112

Post-Merger Value of Combined Company

Answer 112

VA\* = V,A + V,T + S - C V,A: Pre-merger value, acquirer V,T: Pre-merger value, target S: Synergies created C: Cash paid to target shareholders

Question 113

Expected Decrease in Share Price Ex-Div

Answer 113

P,W - P,X = [(1-T,D)/(1-T,CG)] \* D P,W = Share price with right to receive Div P,X = Share price without right

Question 114

Effective Tax Rate on Dividends, Double Tax System

Answer 114

-Under this system, earnings are first taxed at corporate level and then again at shareholder level if they are distributed to taxable investors as dividends ETR = CTR + [(1-CTR) \* MTR,D]

Question 115

Effective Tax Rate on Divs, Split Rate System

Answer 115

- Under this system, earnings that are distribute as divs by company are taxed at lower rate than earnings that are retained by company. Divs are then taxed again at shareholder level as ordinary income. - Note that earnings that are distributed as divs are still taxed twice, but lower tax rate on earnings that are distributed mitigates the penalty ETR = CTR,D + [(1-CTR,D) \* MTR,D]

Question 116

Expected Increase in Dividend, Stable Divided Policy

Answer 116

- For PER SHARE CALCULATIONS: [(Expected earnings \* Target Payout ratio) - Prev. Div.] \* Adjustment factor - FOR TOTAL CALCULATIONS =Expected increase in earnings \* TPR \* Adjustment Factor -Unbder s table dividend policy, divs would remain the same amount regardless of earnings volatility

Question 117

Dividend, Residual Dividend Policy

Answer 117

D= Residual earnings = Earnings - (Cap budgeting \* % Equity in cap structure), OR 0 (whichever is greater)

Question 118

Earnings Yield

Answer 118

=EPS / P,0

Question 119

Dividend Payout Ratio

Answer 119

=Divs/Net Income

Question 120

Dividend Coverage Ratio

Answer 120

= Net Income / Dividends

Question 121

FCFE Coverage Ratio

Answer 121

= FCFE / (Divs + Share Repurchases)

Question 122

Leveraged Company Value

Answer 122

V,L = V,U + tD =(Int / r,D) + [(EBIT - Int)(1-t) /r,E] = EBIT (1-t) / (WACC)

Question 123

Required Return on Equity, Leveraged Company (w/ Taxes)

Answer 123

r,E = r,0 + (r,0 - r,D)(1-t)(D/E)

Question 124

Periodic Pension Cost

Answer 124

=End Net Pension Liabilities - Beg. Net Pension Liabilities + Employer Contribution Net Pension Liabilities = Plan Assets - Benefit Obligation

Question 125

Employer Contributions

Answer 125

=End FV(Plan Assets) - Beg. FV(Plan Assets) - Act. Return on plan assets + Benefits Paid

Question 126

Full Goodwill, Goodwill

Answer 126

=Fair value 100% entity - Fair value 100% net identifiable assets -This is the only goodwill method allowed by US GAAP

Question 127

Pension Expense (IFRS) included in P&L

Answer 127

=Service Cost + Net Interest Income/expense

Question 128

Pension Expense (US GAAP)

Answer 128

=Current service costs + Int expense - Expected return on plan assets

Question 129

Remeasurement (IFRS)

Answer 129

=Actuarial gain + [Actual return - (r \* FV(Plan assets)) -This is recognized in OCI. Actuarial gains and losses are not amortized into P&L under IFRS

Question 130

Net Interest Expense/Income, Pension Accounting

Answer 130

=(Opening Pension Obligation \* r) - (FV Plan Assets \* r)

Question 131

Full Goodwill, NonControlling Interest (NCI)

Answer 131

NCI = % of NCI \* Subsidiary's fair value

Question 132

Goodwill, Partial Goodwill

Answer 132

=Purchase price - Fair Value of Proportionate share of acquired net assets

Question 133

Partial Goodwill, NonControlling Interest (NCI)

Answer 133

=% of NCI \* Fair value of subsidiary's identifiable net assets

Question 134

Additional Paid In Capital, Acquisition Method

Answer 134

=Parent APIC + Current Market Value of Shares Issued - Par Value shares issued

Question 135

Goodwill impairment IFRS

Answer 135

Impairment Loss = Carrying Value of unit - Recoverable Amount of unit

Question 136

Goodwill Impairment, US GAAP

Answer 136

Implied Goodwill = FV(Unit) - FV (Net identifiable assets) Impairment Loss = Recognized goodwill - implied goodwill

Question 137

Adjusted Operating Profit (US GAAP)

Answer 137

=Reported Operating Profit + Pension Expense - Current Service Costs

Question 138

Adjusted Income Before Taxes

Answer 138

=Reported Income Pre-Tax + (Act return on plan assets - Expected Return on plan assets)

Question 139

Combined Ratio

Answer 139

=Loss & loss adjustment ratio + Underwriting expense ratio -This is a measure of the efficiency of an underwriting operation. Combined ratio of less than 100% is considered efficient, greater than 100% considered inefficient (underwriting loss)

Question 140

Loss & Loss Adjustment Expense Ratio

Answer 140

=(Loss expense + Loss Adjustment expense) / net premium earned

Question 141

Underwriting Expense Ratio

Answer 141

= underwriting expense / Net premiums written -Indicator of efficiency of money spent on new premium

Question 142

Dividends to Policyholders Ratio

Answer 142

dividends to policyholders / net premiums earned

Question 143

Combined Ratio After Dividends

Answer 143

combined ratio + dividends to policyholders ratio

Question 144

Covered Interest Rate Parity

Answer 144

(1 + i, BC) = [(1 + i,PC)(S,PC/BC) / F,PC/BC] - If this holds, the return to a foreign investor with a fully hedged domestic currency exposure would be the same as the one-year PC LIBOR rate - As this is based on arbitrage, it is the only interest rate parity relationship expected to hold over the short run

Question 145

Forward Rate Calculation, Covered\*

Answer 145

F,PC/BC = S,PC/BC \* [(1 + (i,PC \* act/360)) / (1 + (i,BC \* act/360))] \*Replace F,PC/BC with Se,PC/BC for uncovered

Question 146

Forward Premium/Discount, Covered\*

Answer 146

=F,PC/BC - S,PC/BC =S,PC/BC \* [((i,PC - i,BC) \* (act/360)) / (1 + (i,BC \* act/360))] \*Replace F,PC/BC with Se,PC/BC for uncovered

Question 147

Estimated Forward Premium/Discount

Answer 147

~=F,PC/BC - S,PC/BC ~= i,PC - i,BC

Question 148

Law of 1 Price

Answer 148

P,x,PC = P,x,BC \* S,PC/BC

Question 149

Absolute PPP

Answer 149

GPL,PC = GPL,BC \* S,PC/BC -This tends not to hold in the long run bc product mixes and consumption baskets differ across countries and there are transaction costs and trade impediments

Question 150

Relative PPP

Answer 150

E(S,T,PC/BC) = S,0,PC/BC \* [(1 + pi(PC)) / (1 + pi(BC))] ^ T -This works better in the long run than in the short run

Question 151

Estimated Change in Spot Rate, Relative PPP

Answer 151

%Change(S,PC/BC) ~= Pi(PC) - Pi(BC)

Question 152

Estimated Change in Future Spot Rate, Ex-Ante PPP

Answer 152

%Change(S,e,PC/BC) ~=Pi,e(PC) - Pi,e(BC)

Question 153

Fischer Effect

Answer 153

i = r + pi,e i = nominal rate

Question 154

International Fischer Effect

Answer 154

(i,PC - i,BC) = (pi,e,PC - pi,e,BC)

Question 155

Real Interest Rate Parity

Answer 155

(r,PC - r,BC) = (i,PC - i,BC) - (pi,e,PC - pi,e,BC) -This is the assertion that real rates will converge to the same level across countries. It requires that both uncovered interest rate parity and ex-ante PPP hold

Question 156

GDP and PE

Answer 156

P = GDP \* (E/GDP) \* (P/E) P = Aggregate Price/value of earnings

Question 157

Neoclassical (Solow's) Model, Growth Rate in Output

Answer 157

Y = theta / (1 - a) + n theta = TFP growth rate a = elasticity of output with respect to capital (1-a) = Labor cost in Total Factor Cost n = labor supply growth rate

Question 158

Mundell-Flemming Model, High Capital Mobility

Answer 158

Expansive FP, Expansive MP: Ambiguous Expansive FP, Restrictive MP: DC Appreciates Restrictive FP, Expansive MP: DC Depreciates Restrictive FP, Restrictive MP: Ambiguous

Question 159

Mundell-Flemming Model, Low Capital Mobility

Answer 159

Expansive FP, Expansive MP: DC depreciates Expansive FP, Restrictive MP: Ambiguous Restrictive FP, Expansive MP: Ambiguous Restrictive FP, Restrictive MP: DC appreciates

Question 160

Effect of Capital Deepening on Growth

Answer 160

=Growth rate of productivity - Growth rate of TFP

Question 161

Difference between Acquisition Method and and Equity Method

Answer 161

Under equity method, revenues recognized will be only those of the parent. Under acquisition method

Question 162

fail-to-reject-the-null region

Answer 162

In a hypothesis test, this region is centered on the hypothesized value of the population parameter In a confidence interval, this region is centered on the estimated parameter value from sample data

Question 163

Which Corrections for violations of regression assumptions have an impact on regression coefficients

Answer 163

Serial correlation, conditional heteroskedasticity, and multicollinearity do not directly have an impact on regression coefficient esitmates, they have an impact on their standard errors. HOWEVER Mutlicollienarity is corrected for by performing step-wise regression, which eliminated one indep variable at a time. elimination of indep var (esp when it is highly correlated with other indep vars) has an impact on regression coefficient esitmates.

Question 164

Positive Serial Correlation

Answer 164

- This is a serial correlation in which positive regression errors for one observation increases the possibility of observing a positive (negative) regression error for another observation. - It causes the standard errors for regression coefficients to be underestimated, leading to inflated t-stats and incorrect rejection of null hypothesis (Type I errors) - While the DW Stat and regression coefficients remain unchanged after correcting for this, the standard errors change. DW stat can range from 0 (where serial correlation equals +1) to 4 (where serial correlation =-1). DW stat above 2 = negative serial correlation. DW stat =0 indicates no serial correlation

Question 165

Chi-Squared Test

Answer 165

- Used to test whether a hypothesized value of variance is equal to the true population variance - Calculated as the product of the number of observations in the sample and the coefficient of determination in a 2nd regression (where squared residuals from original regression are regressed against the indep vars in the regression)

Question 166

Growth Accounting Equation

Answer 166

Growth rate of output = Rate of tech change + Growth rate of capital + Growth rate of labor -Both capital and labor are assumed to have negigable growth rate in long run, leaving tech as drive of LR growth Change(Y)/Y = Change(A)/A + [a\*(Change(K)/K)] + {(1-a)\*(Change(L)/L)] a = Capital contribution to output 1 - a = Labor contribution to output

Question 167

Convergence Hypothesis

Answer 167

-Predicts that growth rates will be higher in developing countries relative to developed. Postulates that the gap between developed and developing will narrow over time. Empirically the data are mixed

Question 168

Taylor Rule

Answer 168

-Used to estimate the target interest rates for domestic and foreign countries I = r,n + pi + a(pi - pi\*) + B(y + y\*) r,n = neutral policy rate pi = current inflation rate a = inflation mandate weight pi\* = target inflation rate B = output mandate weight y + y\* = current output gap For forex questions, calc difference between Target rate calcd above and current policy rate in both countries and see which interest rate is expected to fall more. The one whos rate is expected to fall more will experience depreciation

Question 169

Data Preparation (Cleansing)

Answer 169

The process of examining, identifying, and minimizing errors in raw data

Question 170

Data Wrangling (Pre Processing)

Answer 170

Involves making data ready for ML model training

Question 171

Trimming/Truncation

Answer 171

Part of Data Wrangling Extreme values/outliers are removed from dataset

Question 172

Winsorization

Answer 172

Part of data wrangling Extreme values/outliers are replaced with the max and min values from data that are not considered outliers

Question 173

Multicollinearity

Answer 173

- Occurs when 2/more indep vars (or combos of indep vars) in a regression model are highly (but not perfectly) correlated with each other. - While it does not effect the consistency of OLS estiamtes and regression coeffs, it makes them inaccurate and unreliable. Standard errors for regression coefficients are inflated, leading to t-stats becoming too small and less powerful - Can be detected by a high R^2 and significant F-stat, coupled with insignificant T-stats -Also can be detected if there is high pairwise correlations

Question 174

Heteroskedasticity

Answer 174

The result of error terms differing across observations. Use Bruesch-Pagan test to determine if regreesion error terms are this Should only be concerned with conditional heteroskedasticity, which occurs when error variances are condition on the values of the indep vars. Conditional heteroskedasticity results in overtatement of regression's overall significance and sig of indv regression coefficients Can correct for with robust standard errors or generalized least squares regression

Question 175

T-Stat Calculation

Answer 175

t = (sample data - hypothesized value) / Standard error of sample

Question 176

Interest Parity Relations

Answer 176

Question 177

CDS Physical Settlement

Answer 177

Protection buyer delivers underlying debt instrument to protection seller, with par value of bonds delivered equaling the notional amount of CDS. In return, portection seller pays buyer the par value of the debt (which is equal to CDS notional amount)

Question 178

CDS Cash Settlement

Answer 178

Protections seller pays protection buyer an amount of cash equal to the difference between notional amount and current value of the cheapest to deliver bonds. Protection buyer can then sell unerlying bonds --\> total payoff = Payment from protection seller + sale proceeds from bonds Payment from protection seller = NA \* (1 - post-default MV % of par on CTD)

Question 179

Confidence Interval Creation

Answer 179

Confidence Interval = Relevant Coefficient from regression +/- [Critical t-stat (from t-table) \* Standard error of regression coefficient]

Question 180

Critical Values for 2 Tailed z-Stat tests

Answer 180

1% Sig Level = 2.58 5% Sig Level = 1.96 10% Sig Level = 1.65

Question 181

Critical Values for 1 Tailed Z-stat Test

Answer 181

1% Sig Level = 2.33 5% Sig Level = 1.65 10% Sig Level = 1.28

Question 182

2-Way Dupont Decomposition

Answer 182

ROE = ROA \* Financial Leverage

Question 183

Return on Assets (ROA)

Answer 183

= Net income / Avg. Total Assets

Question 184

Financial Leverage Ratio (AKA Equity Multiplier)

Answer 184

= Avg. Total Assets / Avg. Total Common SE

Question 185

3-Way Dupont Decomposition

Answer 185

ROE = Net Profit Margin \* Asset Turnover \* Financial Leverage

Question 186

Net Profit Margin

Answer 186

= Net income / Revenue

Question 187

5-Way Dupont Decomposition

Answer 187

ROE = tax burden \* interest burden \* EBIT Margin \* Asset Turnover \* financial Leverage

Question 188

Tax Burden

Answer 188

= Net income / EBT = 1 - avg. tax rate

Question 189

Interest Burden

Answer 189

= EBT / EBIT

Question 190

Return on Equity (ROE)

Answer 190

= Net income / Avg. Total Equity

Question 191

Residual Income Calculation Table

Answer 191

_EPS/BV Calculation Table_ **Year 15 16 17** Beginning Book Value (B,t-1) + EPS (= ROE,t \* B,t-1) -Divs =Ending Book Value (B,t) _RI Calculation Table_ EPS -Equity Charge (=cost of equity \* B,t-1) =Residual Income ALL CAPITAL CHARGES ARE BASED ON THE BOOK VALUE

Question 192

Autoregressive Conditional Heteroskedasticity (ARCH)

Answer 192

- The situation where the variance of the error terms in a model are dependent on the variance of the error term in previous periods - Can be identified by regressing squared residuals with lagged values of themselves as squared residual represents the variance of the error term - Should ARCH exist in a model, by definition, it can be used to predict the variance of the error term in the model

Question 193

Regulatory Capture

Answer 193

Occurs when regulation arises to protect the interests of the regulated. Most likely to occur when the regulated entities have the most influence over the policy of the regulator

Question 194

Dornbusch Model

Answer 194

Predicts that a decrease in domestic money supply will most likely lead to appreciation in the SR followed by depreciation over time to a level that is still higher than the initial exchange rate In SR, since prices are not flexible, a decrease in domestic money supply results in decrease in real money supply. Real rates rise, resulting in capital inflows and substantial domestic currency appreciation. It appreciates to a level higher than predicted by PPP. In LR, prices are flexible so the currency settles at the value implied by PPP. As the currency overshoots in SR, it depreciates over LR to a level predicted by PPP, which is still higher than initial exchange rate

Question 195

Carry Trade Distribution and Return Calculation

Answer 195

The carry trade is profitable during times of stability, though it can suffer severe losses should volatility/crises erupt. As such the distribution of returns tends to be negatively skewed with fat tails (i.e. drawn toward negative outliers and experiences more frequent extreme outcomes than normal distribution would imply) Carry trade predicated on uncovered interest rate parity not holding. Carry trade works bc higher domestic rates attract foreign capital flows, increasing demand for domestic currency and causing it to appreciate Total Return on Carry Trade = (1 + yield on investment currency)\*(S,t,PC/BC / S,0,PC/BC) - (1+ yield on funding currency) In above equation, investing currency is PC and funding currency is BC

Question 196

Uncovered Interest Rate Parity

Answer 196

-Says that the change in the domestic exchange rate will approximately equal the real interest rate differential between foreign and domestic economies. If this held true, domestic currency would appreciate when foreign rate is above domestic. Cary trade predicated on uncovered interest rate parity not holding -This works better in the long run than in the short run

Question 197

Logistic Regression Coefficients

Answer 197

Are used to find the probability of positive sentiment. A mathematical function is then used to convert the regression coefficient to a probability

Question 198

Consumption-Hedging

Answer 198

During bad economic times, equities have poor consumption hedging properties and performance relative to IG corp bonds -For an asset to serve as a hedge against bad consumption outcomes, covariance between investor's expected ITRS (inter temporal rate of substitution) and the future price of the asset must be ***positive***. This results in a higher price for the asset and a lower risk premium

Question 199

Dividend Imputation Tax System

Answer 199

- Under this system, earnings that are distributed as dividends are effectively taxed only once, at shareholders marginal tax rate. Therefore, effective tax rate on divs = Investors marginal tax rate - Under such system, company's earnings are fixed taxed at corporate level. If investors marginal tax rate \< corporate tax rate, will receive tax credit (AKA Franking credit) for taxes paid by comp on distributed earnings. If investors marginal tax rate \> corporate tax rate, must pay additional taxes so total taxes paid are in line with marginal tax rate.

Question 200

Factors that tend to lead to companies using more debt in capital structure:

Answer 200

-Weaker legal systems, high levels of info asymmetry, and higher personal tax rates on divs

Question 201

Coefficient of Determination (R^2) Concepts

Answer 201

**-When introducing a new explanatory variable:** - If new variable has explanatory power, RSS will increase relative to SST and new R^2 will be greater than original R^2 - If new variable has 0 explanatory power, RSS will remain the same and new R^2 would equal original R^2 - Not possible for new R^2 to be less than original R^2 as R^2 of second regression would at least account for variation in dep var thats explained by the 2 indep vars **-If k is greater than 1, R^2 will always be greater than adjusted R^2** **-Adjusted R^2 of original regression can be greater than, less than, or equal to adjusted R^2 of new regression** **-**R^2 represents the proportion of the variation in the dependent variable explained by the model . I.e. An R^2 of 0.36 means the model explains 36% of the variation in the dependent variable

Question 202

Equilibrium vs Arbitrage Free Term Structure Models

Answer 202

- EQ structure models typically require estiamtion of fewer parameters than AF structure models, but this comes at cost of less precision in modeling the observed yield curve - EQ structure models typically make assumption regarding term premium, while AF models do not

Question 203

MM Capital Structure Irrelevance Assumptions

Answer 203

1. Investors have homogenous expectations regarding the cash flows from an investment in bonds/stocks 2. Capital markets are perfect. No taxes, no transaction costs, no bankruptcy costs, no asymmetric info 3. Investors can borrow and lend at risk free rate 4. There are no agency costs - mgmt always acts in best interests of shareholders 5. The financing and investment decisions are independent of eachother

Question 204

Regression Analysis Tests

Answer 204

- Dickey Fuller test is used to investigate the presence of a unit root in a time series - Durbin Watson test is used to test for serial correlation in a model, except for autoregressive models where serial correlation must be investigated through direct autocorrelation analysis - BP test is used to test for heteroskedasticity. The BP test is a 1-tailed test as C. Het is only a problem if it is large

Question 205

Extendible Bond

Answer 205

This is equivalent to a putable bond with the option to put the bond at the end of the bonds original maturity for bond par value

Question 206

Mutually Exclusive Projects with Unequal Lives

Answer 206

Method 1: Least Common Multiple of Lives Approach -Both projects are repeated until their “chains” extend over the same time horizon, being the least common multiple Method 2: Equivalent Annual Annuity Approach (EAA) -First calculate projects NPV. Use this NPV as the PV in financial calculations, with FV=0 and i = cost of capital and N = project life→ calculate payment. Project with highest pmt (EAA) should be selected

Question 207

Dickey Fuller (Engle-Granger) Test

Answer 207

- Used to test for a unit root in an AR(1) model, thereby testing for covariance stationarity - Null hypothesis for the test is that the time series has a unit root, while alternative hypothesis is that the error term in regression is covariance stationary. - If Null hypothesis is rejected, the error term in regression is covariance stationary. Therefore, the 2 time series are cointegrated. This means the parameters and SEs from linear regression will be consistent and will allow testing of the hypothesis about the long-term relationship between the 2 series - The dependent variable is the first difference, while the indep var is the first lag

Question 208

Economic Profit

Answer 208

=NOPAT -

Question 209

Coefficient of Determination (R^2) Calculation

Answer 209

R^2 = Explained variation / Total Variation = Regression sum of squares (RSS) / [RSS + Sum of squared Errors (SSE)] Sum of Squared Errors (SSE) = Residual Sum of Squares =(Sum of squared differences - Sum of squared residuals) / (Sum of squared differences) -Correlation coefficient = RAD(R^2)

Question 210

Factors Affecting Pension Obligation

Answer 210

* **Discount Rate** - Inverse relationship. The higher the discount rate, the lower the PO (PV of promised future pmts) * **Current Service Costs** - Direct relationship. This is the increase in PO as a result of an employees service in current period * **Interest Expense** - Direct relationship. This is the increase in value of obligation due to the passage of time * **Past Service Costs** - Direct Relationship. This is the increase in PO from retroactive benefits given to employees for yrs of service provided before date of adoption * Changes in actuarial assumptions (e.g. discount rate, rate of future compensation increases, life expectancy) * **Actuarial Loss** - Changes in actuarial assumptions that increases the pension obligation * **Actuarial Gain** - Changes in actuarial assumptions that decreases the pension obligation * Year to attain Health Care Trend Rate (-) - If the year at which the ultimate health care trend rate is reached is moved earlier, pension expense and pension obligation will decrease

Question 211

Ex-Ante Alpha

Answer 211

- Ex-Ante means before the fact - Ex-ante alpha = Expected return - required return

Question 212

Adjusted R^2 Calculation

Answer 212

= 1 - [(n-1) / (n - k - 1)] \* (1 - R^2) -if adjusted R^2 after adding additional variable is less than adjusted R^2 of regression before addition of new variable, new variable should not be added to analysis

Question 213

PV of Expected Loss

Answer 213

=PV of Cash Flow - PV of Risk-free cash flow - PV of Cash flow = PV of cash flow, using a rate including credit spreads - PV of risk free cash flow = PV of cash flow using the risk free rate

Question 214

Interest Rate Swaptions

Answer 214

- A receiver swaption is one that receives-fixed, pays-floating. Payoff = Max(0, x-c)\*SUM(PV factors) - A payer swaption is one that receives-floating, pays-fixed. Payoff = Max(0,c-x)\*SUM(PV factors) x = periodic exercise rate c = periodic SFR calculated using current term structure

Question 215

Steps to Calculate VaR

Answer 215

1. Perform necessary adjustments (unannualize or annualize). If you are given annual expected return and volatility, but are asked to calculate daily VaR→ Daily return = (ann. return / 250 trading days). Daily Std. Dev = (ann. volatility / RAD(250)) 2. Multiply daily std. dev by T,crit given by confidence level one a 1-tailed test. i.e. if tased with determining 5% one-day VaR, multiply daily std. dev by 1.65 3. Now subtract the answer in step 2 from period-specific expected return. As VaR is expressed as an absolute number, take the positive value of this 4. Multiple answer in 3 to portfolio value

Question 216

Mean-Reverting Level

Answer 216

-At the mean-reverting level, X,t+1 = X,t Rearranging the AR(1) Model gives the mean reverting level as Mean reverting level = b,0 / (1 - b,1) b,0 = intercept

Question 217

Poison Put

Answer 217

-A pre-offer defense mechanism that allow the target firm's bondholders to sell (put) their bonds back to the company. Result is that an acquiring firm must be prepard to refinance the target which increases the need for cash and raises cost of acqusition

Question 218

Flip-in Poison Pill

Answer 218

-Pre-Offer Defense Mechanism that makes the target company less attractive by creating rights which allow for the issuance of shares of the target company's stock at a substantial discount to market value

Question 219

Flip-Over Poison Pill

Answer 219

-Pre-Offer defense mechanism where the target company's shareholders receive the right to purchase shares of acquiring company at a significant discunt from market value

Question 220

Differences between Equity Method and Proportionate Consolidation (IFRS)

Answer 220

- Under equity method, profit-and-loss will have a single line-item showing acquirer's proportionate share of targets net profit - Under proportionate consolidation, Acquirer's revenues and net profit would reflect the proprtionate share of target's revenue and net profit - While both methods show the same net profit, proportionate consolidation shows higher revenues

Question 221

Data Input and Their Effect on Private Company Valuation

Answer 221

- Restricted Stock Grants (Unregistered Shares) - a DLOM based on values of these would underestimate the true discount bc these shares will enjoy ready marketability (no such guarantee for private company shares). Therefore, value estimate of company will be inflated - IPOs: Post-IPO prices tend to be higher than pre-IPO prices due to other factors besides greater marketability. So, DLOM based on differences between pre- and post-IPO prices would overestimate the true discount and understate value est. of company. - Put Options: Put prices primarily reflect the cost of downside protection (not the price of attaining marketability). Using put prices to estimate DLOM would overestimate the true discount and understate the value of the company

Question 222

FX Gains and Losses

Answer 222

`-Can be recognized as either operating or non-operating items

Question 223

Equity Method of Accounting

Answer 223

- Investment is intially recognized on investor's balance sheet at cost under noncurrent assets - Investors proportionate share of investee earnings increase carrying amt of investment, while its prop share of losses and divs decreases carrying value - Investors prop share of investee earnings is reported withing a single line item on its income statement - While Dividends reduce the carrying value of the investment in the addiliate on parents balance sheet, they do not impact amount reported on income statement. I.e. investment income from equity method investment = %prop. share of investment \* investee income

Question 224

Pooling of Interests Method

Answer 224

- 2 firms are combined using their historical book values, and their operating results are restated as if they had always operated as a single entity - Fair values ***not used i***n accounting for a business combo in this method - As value of depreciable assets is lower under this method (since they are measured at historical cost) , depreciation expense is lower and reported income and asset turnover is higher

Question 225

Purchase (Acquisition) Method

Answer 225

- Combination is accounted for as a purchase of net assets, where net assets are recorded at ***fair values*** - All assets, liabilities, revs, and expenses of acquiree are combined with those of parent - Only acquirer's retained earnings are carried over to combined entity

Question 226

Diminishing Marginal Returns to Capital

Answer 226

- If share of capital in GDP (a) is close to 1, diminishing marginal returns to capital are ***not*** significant - Marginal Product of capital can be expressed as a(Y/K). The higher the output-capital ratio, the higher the marginal product of capital

Question 227

Convertible Straight Bond Value

Answer 227

- Use par value (FV) and issued coupon rate to determine PMT - use YTM of comparable option-free bond as i - Calc PV

Question 228

Consumption Substition and Hedging

Answer 228

- The real risk-free rate and the inter-temporal rate of substitution (ITRS) are inversely related. Therefore, the higher the real risk free rate, the lower the willingness to substitute current consumption with future consumption. This means that current consumption becomes more important relative to future consumption - For an asset to serve as a hedge against bad consumption outcomes, the covariance between the investor's expected ITRS and the future price of the asset must be ***positive***. This results in a higher price for the asset and a lower risk premium

Question 229

Reclassification of Securities

Answer 229

-You are able to reclassify securities designated at fair value and available for sale securities to held-for-trading status, as well as equity method investments if you ***do not*** have control/significant influence over the investment

Question 230

Proportionate Consolidation

Answer 230

- This is an alternative to the equity method - It includes the proportional amount of each asset, liability, revenue, and expense account of the subsidiary in the corresponding acct of the parent

Question 231

Appropriate Interpretation of Cash Flow From Economic Perspective, Employer Contribution and total periodic pension cost

Answer 231

-If total periodic pension cost is over the Employer contribution to the pension plan, the difference can be considered a source of financing (borrowing), which is a financing inflow

Question 232

Results of an omitted variable being correlated with variables already in the model

Answer 232

-Result in biased and inconsistent parameter estimates and inconsistent SEs

Question 233

Sample Variance of dependent variable Calculation From Regression

Answer 233

=Sum of squares total / (N - 1)

Question 234

F-stat Concepts

Answer 234

- F-stat tests whether all the slope coefficients in a linear regression are equal to 0 - To determine if the F-stat is significant at a certain confidence level, look to the F-stats corresponding p-value: If p-value \< Confidence level → reject null hypothesis of a slope equal to 0. If P-value\> Confidence level→ accept null hypothesis of a slope equal to 0

Question 235

Futures Contracts Sources of Returns

Answer 235

**Roll Return**: The yield on rolling over one maturing contract to a far-term contract. This depends on the difference between spot and futures prices **Price Return:** The % change in futures contract prices over time **Collateral Return:** The yield on the margin acct required to open and maintain a position in any futures contract. The return is a function of interest rates

Question 236

Held-For-Trading Classification

Answer 236

Equity Income = Change in MV + Divs received =(MV1 - MV0 + Div) Carrying Value (FI) = MV at end of year

Question 237

Designated at Fair Value Classification

Answer 237

Equity income = change in MV + Divs received

Question 238

Available-for-Sale Classification

Answer 238

\_Equity income is just the divs received = Divs - Carry value (FI) is the MV at the end of the year - Gains and losses on these bypass the income statement under IFRS and GAAP. Gains/Losses reported directly to equity. Consistent recordings of losses on these should be adjusted for in net income used for finding residual income

Question 239

Held-to-Maturity Classification

Answer 239

Carrying Value (FI) = original cost

Question 240

Underlying on an Interest Rate Call Option on 3-month LIBOR that Expires in 6 Months

Answer 240

- Underlying is an FRA on 3-month Libor that expires in 6 months. - The underlying of the FRA is a 3-month Libor deposit that is made after 6 months and matures 9 months from option initiation

Question 241

Option Valuation Relations

Answer 241

- Dividend yield (-): Increase in div yield leads to lower est. fair value of options - Assumed volatility (+): increase in assumed volatility results in higher est. fair value of stock options - Risk free rate (+): increase in risk free rate results in higher est. fair value of stock options - Increase in option value is a conservative choice as it results in higher compensation expense and lower net income

Question 242

Text Cleansing

Answer 242

- Numerical values removed as they have no use for sentiment prediction - % and $ symbols substituted with word annotation - semi-colons, commas and special characters such as “+” and “©” are removed

Question 243

Probability Firm defaults on at least one coupon payment or its face value at maturity

Answer 243

-First, calc prob that the firm survives each payment =(1 - Cond. POD)^(# of payment periods) 1 - prob firm survives each payment = prob firm defaults on at least one payment

Question 244

Inside Bid-Ask Spread (AKA Market bid-ask Spread)

Answer 244

The difference between the highest bid price and the lowest ask price

Question 245

OAS and Volatility

Answer 245

Callable Bonds: OAS = z-spread - Call option cost -This makes the OAS and volatility Inversley related (i.e. an increase in volatility assumption leads to an increase in call option cost and therefore reduces the OAS) Putable Bonds: OAS = z-spread + Put option cost - Makes OAS and volatility directly related (i.e. an increase in volatility assumption leads to an increase in put option cost and therefore increases the OAS) - For bonds that have otherwise similar characteristics, the bond with the higher OAS is underpriced while that with the lower OAS is overpriced

Question 246

Health Care Plan Facts

Answer 246

- Cost of future benefits under defined benefit health care plan results from current employee service. While these costs will be paid out in future period, they are expenses of the current period and therefore may expected to be funded. But, employers arent normally required by regulation to pre-fund plans involving other post-employment benefits, so they usually do not - Since health care plans are an optional employee benefit provided by employer, plan could be eliminated in future if costs became burdensome and/or comp preferrs to use those assets in current operations/other alternative ways

Question 247

Disclosures about Pensions and post-employment benefits, including actuarial assumptions

Answer 247

- These are normally disclosed in the notes to the financial statements - While Pension Plan documents would define the terms and benefits, it would not define the assumptions used to value the assets and liabilities

Question 248

Total Cash Outflow related to Post-employment costs

Answer 248

-This is the sum of the employer contributions for the year to all post-employment plants =Sum(Employer Contributions)

Question 249

Influence of the Current Account on Exchange Rates

Answer 249

All of the below are long run impacts - The flow supply/demand Channel: A country than exports more than it imports will see an increased demand for its currency, resulting in currency appreciation - The Portfolio Balance Channel: A country operating at a trade surplus will have more of a deficit country's currency than it wants, resulting in downwards pressure on deficit country's currency - Debt Sustainability Channel: If country runs persistent deficits, it will be indebted to foreigners and its currency will be depreciated so current account deficit narrows

Question 250

Vertical Mergers

Answer 250

- Mergers in which both companies are in the same production chain - Vertical Merger with Backward Integration: A merger in which a company expands its role to fulfill tasks formerly completed by businesses up the supply chain. When a company buys another company that supplies the products/services needed for production. I.e. a retailer purchases a manufacturer. **A company tries to increase ownership over companies that were once its suppliers** - Vertical Merger with Forward Integration: **A company tries to increase ownership over companies that were once its customers.** i.e. a clothing label purchases its own retailers

Question 251

Bootstrapping Effect of Earnings

Answer 251

-An acquiring firm's EPS will increase when pre-acquisition P/E of acquirer is higher than pre-acquisition P/E of target firm

Question 252

Post-Offer Defense Mechanisms

Answer 252

- White Knight Defense: A friendly acquirer enters the bidding war - Pac-Man Defense: The target company attempts to acquire the acquirer - Greenmail is when acquirer purchases enough shares in a company so that target company will need to repurchase its shares at a premium

Question 253

Weighted Harmonic Mean, PE

Answer 253

= 1 / (SUM(Weight, i / PE,i) -Harmonic mean tends to mitigate the impact of large outliers. It may aggravate the impact of small outliers, but such outliers are bounded by 0 on the downside

Question 254

Effective Duration, Bond Types, and Interest Rate Regimes

Answer 254

-Callable Bonds: When rates rise and are high compared to bonds coupon rate, call option is out of the money and price would be the same as a straight bond. So, the effect of rate change on price of callable and straight would be similar, meaning the effective duration of callable and straight would be similar. Effective duration would rise to about the same level as straight bond Meaning effective duration of callable bonds and interest rates have a positive relationship. When rates rise, effective duration of callable bonds rise -Putable Bonds: When rates rise and are high compared to bonds coupon rate, put option is in the money and price of putable will not fall as much as straight bond bc investor can put the bond. Thus, effective duration of putable bond is lower than effective duration of straight bond in this scenario. meaning effective duration of putable bonds and interest rates have a negative relationship. When rates rise, effective duration of putable bonds fall

Question 255

Key-Rate Duration vs One-Sided Duration

Answer 255

- Key rate duration captures a bonds sensitivity to changes in the shape of the yield curve due to changes in steepness and curvature (i.e. steepening or flattening) - One-sided duration is better than effective or 2-sided duration at capturing rate sensitvity of callable/putable bond, but only for a parallel shift in yield curve, not for changes in yield curve - The higher the coupon rate, the ***lower*** the chance of the bond having some negative key rate durations

Question 256

Effective Spreads

Answer 256

Compare trade execution prices with the midquote price at the time the order is entered Effective Spread for Buy Order: (Trade Price - ((Bid + Ask)/2)) x 2 Effective Spread Transaction Cost estimate for Buys = Trade Size \* (Trade Price - ((Bid + Ask)/2)) Effective Spread for Sell Order: (((Bid + Ask)/2) - Trade Price) \* 2 Effective Spread Transaction Cost estimate for Sells = Trade size \* (((Bid + Ask)/2) - Trade Price) -Sensible esimate of transaction costs when orders are filled in single trades, poor est of transaction costs when traders split large orders into many parts

Question 257

VWAP Transaction Cost Esimtates

Answer 257

Compare trade prices to the prices obtained by other traders trading at the same time VWAP Transaction cost esitmate for buys = Trade size \* (Trade VWAP - VWAP benchmark) VWAP Transaction cost estimate for sells = Trade size \* (VWAP Benchmark - Trade VWAP)

Question 258

Implementation Shortfall Method

Answer 258

Includes consideration of all explicit and implicit costs, as well as impact costs, delay costs, and opportunity costs

Question 259

Inflation-Linked Bond Factoids

Answer 259

- The break-even inflation rate incorporates the yield difference between inflation linked and non-inflation linked govt bonds of the same maturity - The difference in yields between nominal and inflation-linked bonds reflects the uncertainty about the quantity of goods and services investors will be able to consume in the future - Increases in uncertainty about future inflation would be associated with high break-even inflation rates

Question 260

Explicit Trading Costs

Answer 260

-Direct costs of trading, such as broker commissions, transaction taxes, stamp duties, and exchange fees. They are costs for which a trader could receive a receipt

Question 261

Implicit Trading Costs

Answer 261

-Indirect costs caused by the market impact of trading. Small orders have limited market impact while alrger orders have greater impact. Implicit costs result from the following issues _Bid-Ask Spread_ _Market (Price) Impact-_The effect of the trade on transaction prices _Delay Costs (Slippage)_-Arise from the inability to complete the desired trade immediately _Opportunity Costs (Unrealized profit/loss)_-Arise from failure to execute a trade promptly

Question 262

Inside Spread

Answer 262

The spread between the best (highest) bid price and the best (lowest) ask price

Question 263

Private Equity Fund Return Calculation

Answer 263

-Prior Operating Results (-) Called-down capital =Gross Cash flow (return to fund) (-) Mgmt fees and carried interest =Net cash flow (return to LPs)

Question 264

Growth Relative to GDP Growth Approach

Answer 264

\_Analyst considers how a company's growth rate will compare with growth in ***nominal*** GDP

Question 265

Insurance Life Cycles

Answer 265

-Hard Market: Hard markets (specifically for P&C insurers) feature higher premium prices, increased profitability, and an increased ability for insurers to maintain adequate capital. Good times attract new competitors, which lowers premium prices, profitability, and capital typically depletes as markets soften, making capital adequacy difficult to achieve

Question 266

Types of Share Repurchases

Answer 266

- Fixed Price Tender Offer: These normally require a premium over current market price - Negotiated Purchase Agreement: Equally as likely to take place at prices lower than market as they are to take place at prices above market, particularly when shareholders are trying to meet liquidity needs - Open Market Purchases - market based, can be timed to avoid price impact

Question 267

Liquidity Preference Theory

Answer 267

- Investors require a liquidity premium to lend over longer maturities. - Forward rates are an upwardly biased estimate of expected future spot rates, and yield curve will typically be upwards sloping - A downward sloping yield curve is possible only if expected future spot rates decline by enough to offset the liquidity premium

Question 268

Segmented Markets Theory

Answer 268

- Shape of yield curve is determined by supply/demand for funds at each maturity - Depending on the nature of supply and demand mismatch, a downward/upward sloping yield curve is possible - theory does NOT state that institutions will deviate from their preferred maturities if they are adequately compensated. This is ONLY true under ***the preferred habitat theory***

Question 269

Unbiased Expectations Theory

Answer 269

- Frward rates are an unbiased predictor of expected future spot rates - THeory can explain upward/downward sloping yield curve - Assumes risk neutrality and only applies to risk-free assets, ***not*** risky assets

Question 270

Modern Theories of Term Structure

Answer 270

- CIR, Vasicek, and Ho-Lee have the same structure in that they have a drift term and a stochastic term. Composition of drift term for CIR and Vasicek models is the same, while its different for Ho-Lee model. Stochastic term are different for all 3 - Interest rate volatility is constant for Vasicek and Ho-Lee models, but for CIR volatility increases with the level of rates - Both CIR and Vasicek models are mean reverting in that they assume ST rates converge to LT rates over time. Ho-Lee model does NOT make this assumption - HoLee model is most likely to be arbitrage free in ST

Question 271

Credit Valuation Adjustment (CVA)

Answer 271

CVA,t = LGD,t x *POD,t x* DF,t - Fair Value of bond and CVA are inversely related, meaning when CVA increases, bond fair value decreases - An increase in CVA and resulting decrease in bond fair value results in an increase in YTM and credit spread - A higher interest rate volatility assumption results in a lower CVA, meaning a higher fair vlaue of bond