After doing each of the 2009 CFAI mock exams and sample exams following my CFA level two strategy with 14 days left, here are the points that I made a note for myself to remember. I hope they are of use to someone out there…
Altinv (bonds) The purpose of credit tranching is for the subordinate tranche to absorb credit losses.
Alt inv (bonds) Non-amortizing assets, prior to the lockout or revolving period, principal repayments can be either paid out to security holders or reinvested in additional loans.
Alt inv (bonds) The main parties to a securitization are the seller or originator, the servicer, and the issuer or SPV.
Alt inv (bonds) The insurance protection provides for the timely payment of principal and interest payments as due.
Bonds CPR (conditional prepayment rate) = 6% X t/30 X PSA (public sec association prepayment benchmark) / 100
Bonds months elapsed = number of months – WAM
Bonds agency securities still have credit risk
Bonds excess spread accounts don’t pay out all interest to security holders – can cover future defaults
Fixed income succession plan –> character
Fixed income USE quick and current ratios for liquidity
Fixed income high bank loans mean junk likely, high bonds issuance means higher rated likely
Fixed income don’t easily place things on negative outlook
Fixed income larger PAC collar equals more certainty payment schedule will be satisfied, therefore largest prepayment protection – The narrower the PAC window (labelled Expected Principal Repayment Dates in Exhibit 1), the more likely an MBS will behave like a bullet corporate bond.
Fixed income If mortgage rates rise above the contract rate, the expected cash-flow improves, but the cash flow is discounted at a higher rate. The net effect may be either a rise or a fall in IO value.
Fixed income REVISE OAS / volatility / option costs etc for bonds – You would want to own a security with the lowest option cost, a relatively high OAS if volatility decreases and higher OAS as volatility increases, and relatively better price performance if volatility either decreases or increases.
Fixed income Evaluating MBS and other structured securities subject to prepayment risk requires a model that reflects that cash flows are ”interest rate path-dependent”
Fixed income Cash flow duration is an inferior form of effective duration. Even if advanced analytics are used to determine the best prepayment assumption, it will not be as accurate as building a Monte Carlo simulation which determines prepayment rates stochastically given various interest rate changes to determine the average price of the MBS.
Corporate finance excessive compensation is asset risk
Corporate finance target payout ratio stuff – = last div + increase in earnings X target X 1/number of years)
Corporate finance value of firm is maximised when WACC is minimised
Corporate finance (S-C) x (1-t) + Dxt
Corporate finance Be very careful for economic vs accounting income
Corporate finance Econ income = cash flow – (ending MV-beginning MV)
Corporate finance greater risk reduces NPV
Derivatives learn the probability up move / down move formula
Derivatives revise meaning of gamma delta bs
Derivatives remember the put call parity thing
Derivatives revise swaps
Derivatives revise swaptions
Derivatives SWAPS _ REVISE = Calculate and interpret the fixed rate on a plain vanilla interest rate swap and the market value of the swap during its life
Derivatives While there is no credit risk at contract initiation, the potential credit risk of an interest rate swap is greatest at the middle of its life; it does not increase throughout the life of the swap.
Derivatives A receiver swaption is equivalent to a call option
Derivatives REVISE SWAPTION PAYOFFS – Calculate and interpret the value of an interest rate swaption on the expiration day -Using the information in Exhibit 1 and Howell’s sixth statement: [4.32% – 3.90%) * (90/360)]= $105,000 () = 1 / ( 1 + 0.0400*90/360) = 0.9901 () = 1 / ( 1 + 0.0435*180/360) = 0.9787 ($105,000 * 0.9901) + ($105,000 * 0.9787) = $206,725
Derivatives F = S x 1+r f / 1+r base
Derivatives learn to price forward contracts
Derivatives learn the derivative % up / down formula
Derivatives Only the position owing money has credit risk near expiry.
Derivatives F0,t = So – PVD x (1+r)^t OR F0,t = So x (1+r)^t – FVD
Derivatives Value (fwd) = So-F / (1+r)^t
Derivatives F = So e ^-cd c^rcT – go over continuous fwd pricing
Derivatives F(o,t)= S0 (1+r for) / 1+r base – DONT FORGET THIS FORMULA
Derivatives to convert given rates to continuous rates do ln(1+rate)
Derivatives convenience yield will decrease the futures price – Fo(t) = So(1+r)^t + FV (CB) – CB = costs of storage minus convenience yield
Economics external factors in porters framework are government , social changes, technology, demographics and foreign influences
Economics graham and dodd want to buy cycling businesses at bargain prices and growth stocks at or under intrinsic value
Economics prem / discount = fwd rate – spot / spot X (12/number of months) X 100%
Economics revise international Fischer relation
Economics Triangular arbitrage
Economics go over uncovered IRP
Economics F=So x (1+Rforeign)/(1+rbase) (IRP)
Economics S1=S0 x (1+Iforeign / (1+Ibase)
Economics foreign/base, base:foreign is how they do quotes. Spastics.
Equity EVA = NI – $WACC (or ke x equity capital)
Equity Value = book + [(ROE – r )/ (r-g)] X book
Equity higher values of tax and interest burden (EAT/EBT and EBT/EBIT) mean lower burden apparently
Equity operating margin is EBIT / rev and pre-tax margin is EBT /rev
Equity Franchise Factor = 1/r – 1/ROE
Equity Sustainable Growth Rate = Retention Ratio X ROE
Equity Growth Factor = g/(r-g)
Equity Franchise P/E = Franchise Factor X Growth Factor
Equity Intrinsic P/E = Franchise P/E + Tangible P/E = (26.66 + 6.67) = 33.33 Tangible P/E = 1/required rate of return = 1/.15 = 6.67 Franchise Factor = 1/r – 1/ROE = 1/0.15 – 1/0.18 = 1.111 Sustainable Growth Rate = Retention Ratio X ROE = (1 – .20) X .18 = .1440 Growth Factor = g/(r-g) = .1440/(.150 – .1440) = 24 Franchise P/E = Franchise Factor X Growth Factor = 1.111 X 24.0 = 26.66
Equity REVISE FRANCHISE FACTOR P/E RUBBISH
Equity Intrinsic P/E = (1 – retention ratio) / (required rate of return – sustainable growth)
Equity Sustainable growth = (retention ratio * ROE) / ((required return – (retention ratio * ROE))
Equity Intrinsic P/E using prospective earnings: / = 1/ [ρ + (1 – λ)I]; ρ = r – I ρ = 15% – 5% = 10%; / = 1 / [0.10 + (0.40 x 0.05)] = 8.33.
Equity Absolute valuation models specify an asset’s intrinsic value and relative valuation models specify an asset’s value relative to that of another asset.
Equity READ the QUESTION = asset turnover is not the asset multiplier
Equity higher intrinsic P/E’s are LESS attractive
Equity use cost of equity for residual income (not about financing decisions)
Equity use FCF when capacity to pay dividends differs from dividends
Equity FCFF is better than FCFE whenever the capital structure is changing
Equity FCFE = FCFF – int(1-t) + net borrowing
Equity Net borrowing is the change in long term debt
Equity make sure to use end years dividend
Equity GO OVER EQUITY HARD
Ethics need consent before working for someone else,
Ethics client accounts have priority of account where employees have beneficial ownership
Ethics must provide research reports to audience members at reasonable price
Ethics do not provide other client details to clients
Ethics don’t have to disclose soft dollar arrangements just need to ensure quality blah blah
Ethics can’t have compensation tied to investment banking clients
Ethics Funded status = plan assets – PBO (which SFAS is this? )
ethics can’t communicate a rating different to current rating
ethics issue final report if there is doubt
Financial Statement Analysis
FSA revise consolidation / pc and equity method (incremental effect on NI = total – minority interest for consolidation)
FSA balance sheet carrying values year on year are cost + share of NI – dividends received
FSA equity income is only from those you control (consolidation) or JVs (not equity or small investments)
FSA only include dividend income from AVS, HTM, trading and equity method (check last bit)
FSA all current method (all assets convert at current rate (year end), all income statement converts at the average rate)
FSA PBO – learn the stupid SFAS numbers – Under SFAS No. 158 the pension liability recognized is the ending pension obligation minus the ending pension assets without any adjustments for unrecognized amounts. 972-604 = 368
FSA ECONOMIC vs expected pension expense – be careful – it’s easy – The economic pension expense would include service cost plus interest cost less actual return on assets: 60 + 54 – 56 = 58. Alternatively, it is the change in the pension obligation less the change in plan assets adjusted for cash contributions and benefit payments. [Change in benefit obligation + benefits paid (non-expense item)] – [Change in plan assets – (contributions – benefits paid)]
FSA don’t forget to get Fcinv from investment in fixed assets regardless of fixed asset sales, WCInv from CFS
FSA [NI – (CFO+CFI) / (NOA end – NOA beg / 2)]
FSA Advances from customers are a legitimate liability and should not be part of an adjustment of the firm’s debt. Guarantees represent a contingent liability and need to be included in a firm’s adjusted debt level. Sale of receivables (with recourse) can be thought of as collateralized borrowing and needs to be part of the adjustment to the debt level.
FSA Sweet Home’s reduction of the accounts receivables’ allowance should be reversed; this would increase the allowance for doubtful accounts by 150 and hence reduce the net receivables balance. So total assets decrease by 150. The adjustment would also require an increase the bad debt expense of 150 which reduces net income by 150(1-.35) = 97.50.
FSA Quality of earnings refers to the degree of conservatism in reported earnings. Accelerated depreciation methods are an indication of high earnings quality; both sale of receivables with partial recourse and guarantees of unconsolidated subsidiary debt represent off-balance sheet financing techniques, which lower the quality of earnings.
FSA Go Over equity method and consolidation method.
FSA pension expense reported vs underlying pensions expense — service cost + interest cost -EXP return + amortization of unrecognized loss or prior cost
FSA functional / local / presentation currency. All current (funct + local same), temporal (functional presentation same)
FSA remember which things to translate at which rates
FSA influence but not control is minority active investment
FSA Go over question 20,21,22 for the workings of the equity method