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2020 CFA LEVEL II > FRA > Flashcards

FRA Flashcards

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1
Q

CAMELS

A

best known of systematically scrutinizing a bank’s level of systematic risk

Capital adequacy
Asset quality
Management capability
Earnings sufficiency
Liquidity position
Sensitivity to market risk
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2
Q

Capital adequacy

A

whether a bank’s level of capital is sufficient for its financial position to weather potential losses

Risk-weighted asset (RWA)
Under Basel III, tier 1 capital = common equity (less intangibles and deferred tax asset) + subordinated instruments with no specified maturity and no contractual interest/dividend

Tier ii capital = subordinated instruments with maturity exceeding five years

Minimum CS tier1 of 4.5% of RWA
Total tier 1 of 6% RAW
Total capital (tier 1 and 2) of 8% RWA

stable funding - 1 year

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3
Q

Asset quality

A

considers liquidity and credit quality of the securities and loans, and how diversified these assets are.

off-balance sheet items including guarantees, unused lines of credit, and letter of credit should also be evaluated

loans (amortized cost = amortized cost- allowances for loan losses)

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4
Q

Management capabilities

A 
effective mgmt involves successfully identifying and exploiting appropriate profit opportunities while simultaneously managing risk
credit risk
market risk
operating risk
legal risk
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5
Q

Earnings

A

sufficient earnings are required to provide adequate ROC
high quality earnings are :
unbiased accounting estimate
sustainable earnings

fair value are used to measure financial assets

  1. level i inputs are quoted prices for identical financial a/l in active market
  2. level 2 inputs are observable but are not the quoted prices for identical financial instruments

level 3 in puts are unobservable

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6
Q

Liquidity

A

Liquidity coverage ratio (LCR)
= HIGH LIQUID assets/
banks expected cash outflow (anticipated 1-month liquidity needs in a stress scenario)

highly liquid asset = easily convertible into cash

Minimum liquity - 30 days
# of days of stress volume of cash outflows:
30* LCR

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7
Q

Sensitivity to market risk

A

considers the extent to which a bank’s financial position and earnings could be negatively impacted by shifts in the markets.

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8
Q

other factors in analyzing a bank

A 
off-balance sheet liability
support by gov't
risks disclosed
competitive environment
corporate culture
segmental data
fx exposure
mission of the bank
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9
Q

factors to consider in analyzing an insurance company

A

capitalization ,liquidity, business profile, characteristics of earnings, and returns on investments

life and health (roa, roe, growth and vol of capital, bvps)
-long term contract
-claims are straightforward to predict
higher returns offered by riskier investments

Property and casualty
-short term, only 1 year or so
-claims are more difficult to foresee
require high degree of liquidity
lower & stable return/risk

revenues com from

1) premiums collected from the purchasers of insurance
2) investment returns earned on funds collected as premiums and held to pay out as benefits

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10
Q

capital adequacy formula

A

capital/risk-weighted assets

RAW= $asset * risk adjusted weight

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11
Q

Common equity tier 1 capital

A 
common stock
Issuance surplus related to cs
retained earnings
accumulated other comprehensive income
adjustments: - intangible assets &  - DTA
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12
Q

Liquidity coverage ratio (LCR)

A

= HIGH LIQUID assets/

bank’s expected cash OUTFLOW

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13
Q

Net stable funding ratio (NSFR)

A

Available stable funding
/ banks’ required stable funding

set a target minimum of greater than 100%

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14
Q

P&C distribution

A
  1. direct writing
    have their own sales and marketing staff
  2. agency writing
    use independent agents, exclusive agents, and insurance brokers to sell policies
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15
Q

loss and loss adjustment expense ratio

A

(loss expense + loss adjustment expense)
/ net premiums earned

the lower the better
=claims paid +change loss reserves/net premium earned

indicator of the quality of a company’s underwriting activities - the degree of success an underwriter has achieved in estimating the risks insured

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16
Q

underwriting expense ratio

A

underwriting expense including commissions
/net premiums written

indicator of the efficiency of money spent on obtaining new premiums

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17
Q

combined ratio

A

loss and loss adj expense ratio
+ underwriting expense ratio

= total insurance expense / net premium earned > 100%
implies underwriting loss
if low implies, hard mkt
if high implies, soft market

a measure of the overall underwriting profitability and efficiency of an underwriting operation.

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18
Q

dividends to policy holders ratio

A

dividends to policyholders/net premium earned

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19
Q

combined ratio after dividends

A

combined ratio - dividends to policyholders ratio

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20
Q

target minimum capital adequacy ratio

A

amount of qualifying capital/

amount of RWA required

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21
Q

high quality reporting

A

GAAP compliant and decision-useful
high quality earnings

persistence and sustainability
relevant and faithfully represent the economic reality of the company’s activities

adequate: high quality earnings covers the company’s cost of capital
sustainable: high quality tend to persist in the future

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22
Q

potential problems that affect the quality of financial reports can result from

A

1 measurement and timing issue
2. classification issues

GAAP compliance is necessary, but not sufficient, condition for high-quality financial reporting

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23
Q

earnings are

A

accrual + cash

aggregated accruals= accrual-based earnings - cash earnings

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24
Q

B/S approach to decompose earning

A

net operating assets = operating assets - operating liabilities

NOA = (total asset- cash)- (total liabilities - total debt)

accrual ratio = (NOAt- NOAt-1)/average(NOAt+NOAt-1)

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25
Q

CF approach to decompose earning

A

preferred because it generates a cleaner measure which is free from the effects of non-cash acquisitions and foreign currency translation adjustment effects

earnings= NIt- (CFOt+CFIt)
Accrual ratio = (NIt- (CFOt+CFIt))/ avg (NOAt+NOAt-1)

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26
Q

the higher the accrual ratio

A

the lower the earning quality

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27
Q

net interest margin ratio

A

[int. received(long term( - interest paid (short term)]

/ avg asset

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28
Q

loss reserve

A

est. value of unpaid claims
if downgrade implies conservative in est. their loss
upgrade implies aggressive profit booking, warning sign for analyst

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29
Q

Bemeish model

A

mean=0, std=1
limitation: rely on accounting data, may not reflect economic reality
prob of manipulation (M-Score) probit model

if m-score increase, prob of earnings manipulation increase
cut off=3.8%
M> -1.78

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30
Q

DSR days sales receivable index

A

> 1 implies revenue inflation
=receivable / sales t
/ (rec/sales t-1)

31
Q

GMI gross margin index

A

> 1 deteriorate likely to manipulate earnings
=gross margin t-1/
gross margin t

32
Q

AQI Asset quality index

A

increase mean excess capitalizing expense
=(1-pp&e+ca)/TA
/(1-pp&e+ca/ta)t-1

33
Q

SGI sales growth index

A

manipulate sales and earnings

= salest/sales t-1

34
Q

DEPI depre. index

A

depr rate t-1 /
depr rate t
>1 implies asset are depre. slower to manipulate earnings

depr rate= dep(dep+pp&e)
if decrease implies understated depr rate

35
Q

SGAI (sg&a expense index)

A

SGA/sales over prioer period

Sales growth index of more than 1 simply implies that the growth in sales is positive.

36
Q

accruals

A

(income before extraordinary items
-cash from operations)
/ total assets

are less persistent than cash component
revert to mean more quickly

37
Q

LEVI (leverage index)

A

leverage t/leverage t-1

leverage =debt/assets

38
Q

Account receivable turover

A

365/DSO

39
Q

Earnings t+1

A

a +b1*earnings t +error

= a+ b1(cash flow)t + b2(accruals)4 + error
b1>b2

40
Q

Altman Z score model

A

probability for bankruptcy
the higher the better, the less the more likely to go bankrupt

limitation: single period static model, does not capture change in days over time

net working capital/total asset
RE/total asset
operational profit/total asset
maket value of equity/bv of liability
sales/total assets
all positively related to Z-score
41
Q

flag of accruals

A

positive net income, but negative operating cash flow

higher growth rate of rec. relative to growth rate of revenue
higher sales outstanding (DSO) overtime, poor revenue quality

rec. turnover = sales/avg rec

42
Q

rev. recognition issues, aggressive revenue recognition

A

channel-stuffing

bill & hold

43
Q

missclassification

A 
revenue a/r
reclassify inventory as LT asets
reclassifying non-core revenue as rev. from core continuing operations
reclassifying exp as operating 
treat CFI (sale of LT asset) as CFO
44
Q

Dupont analysis

A

adj. b/s, i/s for investment in associate

45
Q

ROE (5)

A 
NI/EBT* 
EBT/EBIT*
EBIT/SALES *
SALES/AVG ASSETS *
Assets/Equity)

Tax burden * int. burden * EBIT margin * TATO * financial leverage

46
Q

ROE (3)

A

net profit margin * asset turnover * leverage

47
Q

adj asset base

A

total asset - investment in associates

48
Q

adj NI

A

NI- NI of associates

49
Q

adj tax burden

A

(NI-Equity income)/EBIT

50
Q

adj TATO

A

Rev /

(beg total asset-beg equity invesmtnt) + (end ta-end equity invesment)/2

51
Q

determining future capital allocation

A

capital expense/total asset
=1 allocation of capital expense
>1 growing the segment & low EBIT implies over-allocate resources
<1 lesser proportion

52
Q

EST CF

A

EBIT+DEPR/AMORTIZATION

53
Q

CGO cash generated from operations

A

EBIT + non-cash changes - increase in working capital

= OCF+ cash paid for interest + cash taxes paid

54
Q

adj total asset b/s

A

asset + lease - depr on lease

55
Q

value of opeartion

A

ending lease * liability
= bb lease + int. - rent

total equity = equity + +rent pmt - depr-int pmt

56
Q

adj I/S

A 
EBIT
\+ rent exp
=EBIT excluding cost of op. leases
-depr of operating leases
=adj EBIT
57
Q

Mean reversion in earnings

A

tendency of earnins at extreme levels to revert back to normal levels overtime, implies that earnings at very high levels are not sustainable

58
Q

high financial reporting quality

A

completeness (existence of off-balance sheet liabilities)
unbiased measurement
clarity of presentation

59
Q

income from continuing operations

A

includes all revenues and expenses except discontinued operations and extraordinary items

60
Q

capitalizing a lease enhances earnings quality. An operating lease lowers earnings quality.

A

capitalizing a lease enhances earnings quality. An operating lease lowers earnings quality.

61
Q

Revenue quality issues may be indicated by

A

large increases in accounts receivable or large decreases in unearned revenue
an increase in the volatility of the ratio of revenue to cash collections
and by lessor use of capital leases.

62
Q

Operating leases

A

are a form of off-balance sheet financing that result in an UNDERstatement of an entity’s liabilities.

63
Q

Double-declining balance (DDB) depreciation

A

is a more conservative method of depreciation than straight-line because more depreciation expense is reported in the early years under DDB.

64
Q

Number of days of stress

A

=30* Liquidity coverage ratio (LCR)
Liquidity coverage ratio (LCR)
= high liquid asset/net out flow

65
Q

Systemic risk refers to

A

the risk that impairment in one part of the financial system could spread throughout other parts of the financial system, and then negatively affect the entire economy.

66
Q

tax burden ratio

A

1 - the effective tax rate

67
Q

the higher the cash flow based accruals ratios

A

the lower the earnings quality

68
Q

the highest the M-score

A

the higher the prob of manipulation

69
Q

banks is systemic important, role of bank

A
  1. serve as intermediaries
  2. accepting deposits from capital providers
  3. providing capital via loans to borrowers
70
Q

minimum capital requirement

A

minimum % of its rwa that a bank must fund with equity capital
it prevents a bank from assuming so much financial leverage that it’s unable to withstand loan losses

71
Q

minimum liquidity

A

bank must hold enough high-quality liquid assets to cover its liquidity needs in a 30-day liquidity stress scenario

72
Q

stable funding

A

minimum amount of stable funding relative to bank’s liquidity needs over a one-year horizon

73
Q

Is off-balance asset require capital funding and be risk weighted?

A

yes

74
Q

conversion price

A

par / conversion ratio

2020 CFA LEVEL II (15 decks)

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