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All CFA Institute members and candidates are required to comply with the Code and Standards Basic structure for enforcing the Code and Standards The CFA Institute Bylaws Rules of Procedure Based on two primary principles Fair process to member and candidate Confidentiality of proceedings

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Maintains oversight and responsibility Structure of the CFA Institute Professional Conduct Program Professional Conduct program (PCP) The CFA Institute Board of Governors Through the Disciplinary Review Committee (DRC) Is responsible for the enforcement of the Code and Standards

The CFA Designated Officer

Directs Professional Conduct Staff Self-disclosure

Conducts professional conduct inquiries

An inquiry can be prompted by several circumstances

Written complaints Evidence of misconduct Report by a CFA exam proctor


Requesting a written explanation from the member or candidate

1. Code Of Ethics And Standards Of Professional Conduct

Process for the enforcement of the Code and Standards

The Professional Conduct staff conducts an investigation that may include When an inquiry is initiated Upon reviewing the material obtained during the investigation, the Designated Officer may

The member or candidate Interviewing Complaining parties Third parties Collecting documents and records in support of its investigation Conclude the inquiry with no disciplinary sanction Issue a cautionary letter Continue proceedings to discipline the member or candidate If finding that a violation of the Code and Standards occurred, the Designated Officer proposes a disciplinary sanction Accepted by member Rejected by member The matter is referred to a hearing by a panel of CFA Institute members

Act with integrity, competence, diligence, respect and in an ethical manner Six components of the Code of Ethics Integrity of investment profession & interest of clients above personal interest Care & judgment Practice ethics & encourage others to practice Integrity & rules of capital markets Professional competence

Seven Standards of Professional Conduct

Professionalism Integrity of Capital markets Duties of Clients Duties to Employers Investment analysis, Recommendations & Actions Conflict of interest Responsibilities as a CFA Institute member or CFA Candidate

Understand and comply with applicable laws and regulations Code and Standards vs. Local law Follow stricter law and regulation knowingly participate or assist ->Leave employers (in extreme cases)

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Responsible for violations in which they Dissociate from illegal, unethical activities Guidance Participation or association with violations by others

Attempt to stop the behavior by bringing it to the attention of employer through a supervisor or compliance department Intermediate steps May consider directly confronting the involved individuals If not successful,-> step away and dissociate from the activity by Removing their name from written reports Asking for a different assignment

A. Knowledge of the law

Inaction with continued association may be construed as knowing participation Not require reporting violations to government, CFAI, but... Stay informed Review procedures Recommended procedures for compliance (RPC) Members and candidates Maintain current files When in doubt,->seek advice of compliance personnel or legal counsel When dissociating from violations,-> Document any violations and urge firms to stop them Develop and/or adopt a code of ethics Firms Application Make available to employees info that highlights applicable laws and regulations Establish written procedures for reporting suspected violation of laws,...

Maintain independence and objectivity in professional activities By benefits External pressures Gifts, Invitations to lavish functions, Tickets, Favors, Job referrals, Allocation of shares in oversubscribed IPOs... To issue favorable reports May try to pressure sell-side analysts

From public companies From Buy-side clients

e.g. to issue favorable research reports/recommendations for certain companies How to cope with external and internal pressures Guidance Internal pressures From their own firms Investment-banking relationships to issue favorable research on current or prospective investment-banking clients Conflicts of interest -->must disclose to employers

-->Modest gifts and entertainment are acceptable but special care must be taken convey true opinions -->Recommendations must

-->Best practice: reject any offer of gift,..threatening independence and objectivity --> free of bias from pressures be stated in clear and unambiguous language -->Portfolio managers must respect and foster honesty of sell-side research Is fraught with conflicts Must engage in thorough, independent, and unbiased analysis Issuer-paid research Must fully disclose potential conflicts, including the nature of compensation -->Analysts Must strictly limit the type of compensation they accept for conducting research Best practice Protect integrity of opinions Create a restricted list Restrict special cost arrangements RPC Limit gifts Restrict employee investments Review procedures Written policies on independence and objectivity of research Equity IPOs Private placements Accept only flat fee for their work prior to writing the report Without regard to conclusions or recommendations

B. Independence and objectivity


Definition of "Misrepresentation" Must not knowingly make misrepresentation or give false impression in Guidance Must not misrepresent any aspect of practice, including

any untrue statement or omission of a fact or any fasle or misleading statement oral representations, advertising electronic communications written materials qualifications or credentials, services performance record characteristics of an investment any misrepresentation relating to member's professional activities

C. Misrepresentation

Must not guarantee clients specific return on investments that are inherently volatile Standard I(C) prohibits plagiarism in preparation of material for distribution to employers, associates, clients, prospects, general publich Written list of available services, description of firm's qualification Designate employees to speak on behalf of firm RPC Prepare summary of qualifications and experience, list of services capable of performing Maintain copies To avoid plagiarism Attribute quotations Attribute summaries

Address conduct related to professional life Guidance Violations Any act involving lying, cheating, stealing, other dishonest conduct that reflects adversely on member's professional activities would be violation Conduct damaging trustworthiness or competence Abuse of the CFA Institute Professional Conduct Program Develop and/or adopt a code of ethics RPC Disseminate to all employee a list of potential violations Check references of potential employees

D. Misconduct

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Definition of "Material nonpublic information" Must be particularly aware of info selectively disclosed by corporations Guidance Analysis of Public info + nonmaterial nonpublic info --> Investment conclusion Mosaic Theory Analysts are free to act on this collection of info without risking violation Analysts should save and document all their research

A. Material nonpublic information (MNI)

Make reasonable efforts to achieve public dissemination of material info If public dissemination is not possible, Must communicate the info only to the designated supervisory and compliance personnel within the firm Must not take investment action on the basis of the info


Must not knowingly engage in conduct inducing insiders to privately disclose MNI adopt compliance procedures preventing misuse of MNI Encourage firms to



develop & follow disclosure policies to ensure proper dissemination use "firewall"

Prohibition of all proprietary trading while firm is in possession of MNI may be inappropriate

transactions that deceive market participants

Transactions that artificially distort prices or volume Securing a controlling, dominant position in a financial instrument to exploit and manipulate price of a related derivative/or underlying asset

can be related to

B. Market manipulation

dissemination of false or misleading info

including spreading false rumors to induce trading by others

Standard II(B) not meant to

prohibit legitimate trading strategies prohibit transactions done for tax purposes

The intent of action is critical to determining whether it is a violation of this Standard

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duty to exercise reasonable care Prudence require cautions and discretion act with care, skill, and diligence follow the investment parameters set forth by clients & balancing risk & return a

Guidance A. Loyalty, prudence, and care

Responsibility to a client includes

duty of loyalty

Determine identity of "client" Must be aware of whether they have "custody" or effective control of client assets Manage pool of assets in accordance with terms of governing documents Put their obligation to client first in all dealings Avoid all real or potential conflicts of interest Forgo using opportunities for their own benefit at the expense of client Follow any guidelines set out by client for the management of assets Judge investment decisions in context of total portfolio Vote proxies in an informed & responsible manner Understand & adhere to fiduciary duties

"Soft dollars" Submit to clients at least quarterly itemized statements Separate assets Review investments periodically Establish policies & procedures with respect to proxy voting and the use of client brokerage Encourage firms to address some topics (p. ) Do not discriminate against any clients "Fairly" vs "equally Standard III(B) addresses the manner of disseminating investment recommendations or changes in prior recommendations to clients Ensure fair opportunity to act on Encourage firms to design equitable system to prevent selective, discriminatory disclosure Investment recommendations particularly clients may have acted on Material changes should be communicated to all current clients or been affected by earlier advise Clients who don't know changes and therefore place orders contrary to a current recommendation should be advised of the changed recommendation before the order is accepted


Guidance B. Fair dealing

2.3 Standard III DUTIES TO CLIENTS RPC (p. )

Investment actions

Treat all clients fairly in light of their investment objectives & circumstances duty of fairness and loyalty to clients can Disclose to clients & never be overridden by client consent to prospects written patently unfair allocation procedures allocation procedures Should not take advantage of their position in the industry to the detriment of clients

Guidance C. Suitability

In investment advisory relationships

Be sure to gather client info in the form of an IPS and make suitability analysis prior to making recommendation/taking investment action Inquiry should be repeated at least annually/prior to material changes -->suitability analysis must be If clients withhold info done based on info provided Risk analysis Fund managers Be sure investments are consistent with the stated mandate

In case of unsolicited trade requests unsuitable for client RPC

-->refrain from making trade or seek affirmative statement from client that suitability is not a consideration

Written IPS Investors' objectives and constraints should be maintained and reviewed periodically to reflect any changes in clients' circumstances Standard III(D) prohibits misrepresentations of past performance or reasonably expected performance --> Provide credible performance info -->Should not state or imply that clients will obtain or benefit from rate of return generated in the past --> ensure that their claims are Research analysts promoting the success fair, accurate, and complete of accuracy of their recommendations If the presentation is brief, must make available to clients and prospects the detailed info upon request RPC GIPS on the basis of their special ability to conduct a portion of clients' business or personal affairs arising from or is relevant to that portion of clients' business that is the subject of special or confidential relationship Comply with applicable laws When in doubt -->consult with compliance department/ outside counsel before disclosing Standard III(E) is applicable when members receive info Standard III(E) does not prevent cooperating with an investigation by CFAI PCP

Guidance D. Performance presentation

Guidance E. Preservation of confidentiality


Page 6 In matters related to their employment, members and candidates must not engage in conduct that harms the interests of the employer
-->Comply with policies and procedures established by employers that govern employer-employee relationship Standard IV(A) does not require to place employer interests ahead of personal interests in all matters The relationship imposes duties and responsibilities on both parties

Employer-employee relationship

Independent practice Guidance

Abstain from independent competitive activity that could conflict with employer's interests Provide notification to employer, obtain consent from employer in advance

A. Loyalty
Planning to leave, must continue to act in employer's best interest Must Firm records or work performed on behalf of firm stored on a home computer should be erased or returned to employer engage in activities conflicting with duty until resignation effective Must not contact existing clients/potential clients prior to leaving for soliciting take records of files to a new employer without written permission Free to make arrangements/preparations provided that not breaching duty of loyalty Applicable non-compete agreement Whistle blowing Nature of employment

Leaving an employer



Obtain written consent from employer before accepting compensation or other benefits from third parties...

B. Additional compensation arrangements


Should make an immediate written report to their employers

Must have in-depth knowledge of the Code & Standards Apply knowledge in discharging supervisory responsibilities Delegation of supervisory duties does not relieve members of supervisory responsibility -->Instruct subordinates methods to prevent and detect violations

Make reasonable efforts to detect violation of laws, rules, regulations, and Code & Standards Must understand what constitutes an adequate compliance system Guidance -->Establish and implementing Compliance procedures Make reasonable efforts to see that appropriate compliance procedures are established, documented, communicated to covered personnel and followed Bring an inadequate compliance system to senior managers's attention & recommend corrective action If clearly cannot discharge responsibilities 'cos of absence of compliance system, In case of employee's violation, -->decline in writing to accept responsibilities

C. Responsibilities of supervisors

promptly initiate investigation take steps to ensure no repetition

Recommend employer to adopt a code of ethics Respond promptly RPC If there is a violation Conduct a thorough investigation Increase supervision or place appropriate limitations on the wrongdoer pending the outcome of the investigation

investment philosophy followed The application of Standard V(A) depends on role of member in the investment decision-making process support and resources provided by employer

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Must make reasonable efforts to cover all pertinent issues when arriving at recommendation Provide or offer to provide supporting info to clients when making recommendations/changing recommendations Guidance

A. Diligence and reasonable basis

Using secondary or third-party research

-->must make reasonable &diligent efforts to determine whether 2nd/3rd party research is sound

Group research and decision making

If member does not agree with the independent and objective view of the group

-->Not necessarily have to decline to be identified if believing consensus opinion has reasonable & adequate basis -->Should document member's difference of opinion with group

RPC (p. )

Standard V(B) addresses conduct with respect to communicating with clients Communication is not confined to written form but via any means of communication Developing and maintaining clear, frequent, and thorough communication practices is critical distinguish clearly between facts & opinions present basic characteristics of the analyzed security in preparing research report Must adequately illustrate to clients & prospective clients the manner of conducting investment decision-making process keep them informed with respect to changes to the chosen investment process Guidance


B. Communication with clients and prospective clients

Brief communications

-->must be supported by background report or data on request

Capsule form recommendations

-->should notify clients that additional info and analyses are available from the producer of the report

Investment advice based on quantitative research and analysis

-->must be supported by readily available reference material -->in a manner consistent with previously applied methodology or with changes highlighted

Should outline known limitations, consider principal risks in investment analysis, report RPC

In hard copy or electric form Fulfilling regulatory requirements may satisfy the requirements of this Standard Must explicitly determine whether it does


C. Record retention

Absence of regulatory guidance RPC

CFAI recommends maintaining records for at least 7 yrs

is a critical part of working in investment industry Managing conflicts can take many forms prominent Disclosures must be made in plain language in a manner to effectively communicate the info to clients between member or their firm and issuer Relationships investment banking underwriting and financial relationships Broker/dealer market-making activities Material beneficial ownership of stock All matters may impair objectivity Guidance Disclosure to clients Investment personnel also serves as a director between duties to clients and to shareholders of the company poses conflicts of interest may receive option to purchase securities of the company as compensation MNI -->members providing investment services also serving as directors should be isolated from those making investment decisions -->Sell-side members -->Buy-side members should disclose material beneficial ownership interest in securities/investment recommended should disclose procedures for reporting requirements for personal transactions by firewalls Best practice is to avoid conflicts of interest when possible If not, disclosure is necessary

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A. Disclosure of conflicts

What? Disclosure of conflicts to employers

Same circumstances with clients Any potential conflict situation Enough info Must comply with employer's restrictions regarding conflict of interest



Other requirements

Must take reasonable steps to avoid conflicts If conflicts occur inadvertently, must report them promptly

Should disclose special compensation arrangements with employer that might conflict with client interest RPC Document request & may consider dissociating from the activity if firm does not permit disclosure of special compensation arrangements Disclose to clients info that fee based on a share of capital gains Disclose as a footnote to research report published if members have outstanding agent options to buy stocks as a part of compensation package

Clients & employers' transactions have priority Co-investment -->personal investment positions or transactions should never adversely affect client investments may occur client is not disadvantaged by the trade Conflicts of interests Guidance investment professional does not benefit personally from trades undertaken for clients investment professional complies with applicable regulatory requirements Having knowledge of pending transactions, assess to info during normal preparation of research recommendations -->Must not convey such info

-->make sure

B. Priority of transactions

May undertake personal transactions after clients & employers have had adequate opportunity to act on recommendation Family accounts (that are client accounts) RPC (p. ) should be treated like other accounts if member has beneficial ownership -->may still be subject to pre clearance or reporting requirements

employer whom client prospective client compensation Inform

C. Referral fees


consideration benefit received from, or paid to, others


before entry into any formal agreement nature of the consideration or benefit

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Cheating on CFA exam or any exam Prohibiting any conduct that undermines the integrity of the CFA charter (p. ) Not following rules and policies of the CFA program Giving confidential info on the CFA Program to candidates or the public ..... Not precluded from expressing opinion regarding the CFA Program or CFAI

A. Conduct as members and candidates in the CFA program

Preventing promotional efforts that make promises or guarantees tied to the CFA designation

Over-promise the competence of an individual Over-promise future investment results


Applies to any form of communication

B. Reference to CFA Institute, the CFA Designation and the CFA program

To maintain CFAI membership

Remit annually to CFAI a completed Professional Conduct Statement Pay applicable CFAI membership dues on an annual basis

Using the CFA designation (p. Curriculum)

Referencing candidacy in the CFA program (p. Curriculum)

Proper using of the CFA marks (p. Curriculum)

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a1. Why were the GIPS Standards created?

3. Introduction to Global Investment Performance Standards (GIPS)

a2. Who can claim compliance? a3. Who benefit from Compliance? b. Construction & purpose of Composites c. Verification The Structure of the GIPS Standards

GIPS Objectives

4a. Key characteristics of the GIPS standards & fundamentals of compliance

Key characteristics Fundamentals of compliance Requirements Recommendations

3+4 GIPS
Investment firm definition

b. The scope of the GIPS

Historical performance record

c1. How are GIPS standards implemented in countries with existing standards for performance reporting

c2. Appropriate response when the GIPS standards & local regulations conflict

d. Major sections of GIPS standards

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Required rate of return

a. Interest rate, considered as

Discount rate Opportunity cost

b. Interest rate

c,d. EAR




Ordinary Annuity Annuity Due

e. CF calculations


PV of a Perpetuity

Uneven CF

f1. Time index

Find PMT

f2. Loan payment and Amortization

Find N Find I/Y Amortization table

Rate of compound growth

f3. Other applications

Number of periods for specific growth Funding a future obligation

f4. Connection between PV, FV & series of CF

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a,b. Calculate, Interpret, Decision rule

Problems IRR Conflict with NPV due to # Initial costs # timing

c. HPR

Money Weighted

IRR More appropriate if manager has complete control over cash in/out

d. Portfolio rate of return


Time weighted

Compound growth Geometric mean Not affected by cash in/out Preferred method

Bank discount yield

Holding period yield

e. Yields of T-bills

Effective annual yield

Money market yield

f1. Convert among these yields

f2. Bond equivalent yield

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Statistical methods Population vs. Sample Descriptive statistics Inferential statistics


Types of measurement scales

Nominal scales Ordinal scales Interval scales Ratio scales

Parameter vs. Sample statistic


Frequency distribution

Definition Construction of a frequency distribution 7 steps

Absolute frequency Relative frequency


Cumulative absolute frequency Cumulative relative frequency Histogram


Frequency polygon Population mean vs. Sample mean Arithmetic mean Weighted mean (portfolio return) Mean Geometric mean (compound growth)

e. Measures of central tendency


m. Use of arithmetic or geometric mean when determining investment returns

Harmonic mean (cost of shares) Harmonic < geometric < arithmetic Odd number of observations Even number of observations No mode Mode Unimodal, bimodal, trimodal Model interval

Quartiles (4) Quintile (5)

f. Quantile

Decile (10) Percentile (100) Range Ly =(n+1)*y/100

g. Dispersion (measure of risk) h. Chebyshev's inequality i. Relative dispersion

MAD Variance & Standard deviation 1-1/(k^2) Population Sample (use n-1)

CV (Coefficient of Variation) = StdDev / Average Sharpe Ratio / Reward-to-Variability ratio mean=median=mode Calculate: Sample skewness = =Excess return/ StdDev


j,k. Shape of distribution

Nonsymmetrical (Skewness) (b/c of outliers)

Positively skewed (Sk>0) Types

mode<median<mean mean<median<mode

Negatively skewed (Sk<0) --> more risk


Sample kurtosis = Excess kurtosis = sample kurtosis - 3 Leptokurtic: more peaked, fatter tails (excess kurtosis > 0) --> more risk Platykurtic: less peaked (excess kurtosis < 0) Mesokurtic: identical (excess kurtosis = 0)

l. Kurtosis

Compared with normal distribution

Random variable Outcome Event Mutually exclusive events Exhaustive events

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Floating c


2 defining properties of probability

0<=P(E)<=1 sum of all P(E) =1, if set of events is mutually exclusive & exhaustive Empirical past data formal reasoning and inspection process personal judgment


Determine probabilities



c. Odds for vs. odds against the event

Unconditional probabilities


Conditional probabilities

Multiplication rule

e. Probability rules

Addition rule Total probability rule

Joint Probability

Of 2 events Of any number of independent events


f. Calculate

Probability of at least one event will occur

g. Dependent events vs. Independent events

h. Total probability rule

i. Use of conditional expectation in investment applications

j. Tree diagram

k. Covariance and Correlation (-1 to 1)

Expected return

l. Portfolio

Variance and standard deviation

m. Calculate covariance given a joint probability function

n. Bayes' formula
Factorial Labeling Combination Permutation

o. Counting methods

Probability distribution Random variables Discrete Continuous Discrete distribution vs. continuous distribution

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Probability function p(x)

for discrete variable

c,d. Functions

PDF- Probability density function f(x) CDF- Cumulative distribution function F(x)=P(X<=x)

Discrete uniform

e,f,g. Discrete random variables

Bernoulli Binomial

h. Tracking error

i. Continuous uniform distribution

Normal distribution


j,k. Normal distribution

Univariate distribution vs. Multivariate distribution (the role of correlation)

1 --> 68%

l. Confidence intervals (for normal distribution)

1.65 --> 90% 1.96 or 2 --> 95% 2.575 --> 99%

m. Standard normal distribution and standardize


Shortfall risk = Probability that (return < threshold)

n. Roy's safety-first criterion

SFRatio = Compare to Sharpe

o. Lognormal distribution
Discretely compounded EAR=

p. Compounded rate of return

Continuously compounded

From S: HPR=

Monte Carlo simulation

q,r. Simulation

Historical simulation

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Simple random sampling

a,b. Sampling concepts

Sampling error Sampling distribution

Simple random sampling

c. Sampling methods

Stratified random sampling

Time- series

d. Set of data

Cross- sectional


e. Central limit theorem

f. Standard error of the sample mean

Point estimation

h. Estimate a population parameter

Confidence interval estimation



g. Desirable properties of an estimator

Efficient Consistent

Used when

Small samples (n<30), unknown variance Normal (or approximately normal) distribution

i. Student's t-distribution

Symmetrical Properties Degrees of freedom df=n-1 Less peaked, fatter tails than normal Higher n --> approach z

Non-Normal AND n<30

Not available --> z test if n >=30 --> t approach z --> both are ok

j. Calculate confidence interval

Other situations

Known variance

Unknown variance --> t test

Sample size n (larger is better), but

Possible mistake: Observations from a different population may be included Higher Cost

Data mining bias

k. Selection of sample size

Sample selection bias Bias Survivorship bias Look-ahead bias Time-period bias

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Statement about population parameter Hypothesis One-tailed and two-tailed tests of hypotheses 1. State the hypothesis

Null hypothesis Alternative hypothesis

2. Identify the test statistic & probability distribution

b. Test statistic

May follow t, z,Chi-square, F distribution

3. Specifying significance level

Hypothesis testing steps 4. State decision rule

b. Significance level and critical value

Reject ...

c. Decision rule

5. Collect data and calculate test statistic 6. Make statistical decision Statistical result

d. Distinguish

Economically meaningful result

7. Make economic/investment decision Type I (alpha) reject null when it's true

b. Errors
Type II

(beta) do not reject null when it's false



c. The power of a test

c. The relation between confidence intervals and hypothesis tests e. How to use p-value
f. Mean of a normally distributed population with known variance unknown variance

Test means

g. The equality of means of 2 normally distributed populations, based on independent random samples with h. The mean difference of 2 normally distributed populations (paired comparisons test)

equal assumed variances unequal assumed variances

Single population

Chi-square test

i. Test variance

Two independent populations


Parametric test


Nonparametric test


Page 19 Floating Topic

Overview: 3 views

Technicians EMH advocates TA is the study of collective market sentiment


Prices are determined by the interaction of Supply & Demand

a. Technical analysis

Applications Market price reflects both rational & irrational investor behavior (EMH does not hold) Assumptions Trends & Patterns exist & tend to repeat, can be used to forecast

Closing prices as a continuous line

Line chart

OHLC chart

Bar chart


b. Charts

Candlestick chart

Plot only price reversals Point & figure chart

X: increases O: decreases

Scale Volume chart Time intervals Relative strength analysis

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Definition: a trend approaches a range of prices but fails to continue beyond that range

Floating Topic

Head & Shoulders Reversal patterns Head & shoulders

Inverse head & shoulders

Double tops & bottoms Definition: a pause in a trend rather than a reversal

d. Chart patterns



Continuation patterns


Flags & Pennants

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Floating Topic

c. Trends
breakout vs. breakdown Trend

Support & Resistance lines

Support & Resistance lines Change in polarity (Polarity= phn cc, i lp) --> to smooth fluctuations --> trends are easier to see

=mean of the last n closing prices (n=20; 250...) Moving average lines

______ (smoother/less smooth) line larger n --> if overly long n --> may obscure price trend (obscure = hide) viewed as support or resistance level

ST average line crosses LT average line

above below

--> golden cross --> _________ (buy/sell) signal --> dead cross --> _________ (buy/sell) signal


SMA (Simple Moving Average) vs. EMA (Exponential) (place more weigts on recent data) e.g.: bollinger band (20,2) means 2 standard deviations above and below the 20-day moving average line viewed as contrarian indicator: if price at or above upper band --> over___ (bought/sold) market --> we should ____ (buy/sell)

Bollinger bands


e. Common TA indicators
Momentum () oscillator (or Rate of Change oscillator)

closing price today & n days earlier (today - past day) x 100 2 formulas today / past day Relative strength index --> oscillate around 0

--> oscillate around 100

RSI = (1 - 1/ (1 + RS)) x 100

between 0 & 100 compare to 30 and 70

RS = Total price increases / Total price decreases

Oscillators (dao ng)

Moving average convergence/ divergence oscillator

MACD line (e.g.: MACD (26,12): ExpMA(26)-ExpMA(12) Signal line: ExpMA(9) of MACD MACD line crossing above Signal line (or divergence histogram crosses up) --> buy signal Lines %K line: (latest price - recent low) / (recent high - recent low) %D line: 3-period average of %K line Fast %K = %K basic calculation Fast %D = 3-period SMA of Fast %K Slow %K = Fast %K smoothed with 3-period SMA Slow %D = 3-period SMA of Slow %K

If %K line crosses up %D line --> buy signal Stochastic oscillator Fast stochastic oscillator

Slow stochastic oscillator

Opinion polls (survey) =put vol / call vol Put/Call ratio Calculated statistical indices Sentiment indicators Margin debt Short interest ratio Non-price-based indicators viewed as contrarian indicator: if very high --> __________ (bearish/bullish) investor sentiment --> over_______ (bought/sold) market =volatility of options on S&P 500 CBOE Volatility Index (VIX) if high --> investors ____ (bearish/bullish) --> we should be______ (bearish/bullish)

if increase --> investors are ________ (bearish/bullish) --> prices are __________ (increasing/decreasing) short interest = number of shares that investors have borrowed and sold short

=short interest / average daily trading volume

contrarian indicator of follow the smart money indicator? =(number of advancing issues/number of declining issues) / (volume of advancing issues / volume of declining issues) Arms index or TRIN (short-term TRading INdex) Compare to 1: Spikes upward = daily ____ (gain/loss) Spikes downward = daily ______ (gain/loss)

Flow of funds indicators

Margin debt

if increase --> investors _________ (buy/sell) more = mutual fund cash / total assets viewed as contrarian indicator =market _________ (peak/trough) because Issuers sell new shares when stock prices are thought to be _____ (high/low)

Mutual fund cash position New equity issuance (IPO) and Secondary offerings

Page 22

Kondratieff Wave (40 to 60 years)

f. Cycles

18-year cycle


Decennial (10-year) pattern 4-year Presidential cycle Upward moves: 5 waves (1,3,5=impulses; 2,4=corrective; 2=pullback Downward moves: 3 waves (A,B,C) (A=bulltrap)


g. Elliott Wave Theory

Downtrend: downward moves (5 waves); upward moves (3 waves) Fibonacci numbers Size of waves correspond with Fibonacci ratios 0,1,1,2,3,5,8,13,21... Golden ratio: 1.618 or 0.618

Price target can be 1.618 of the previous high

Different waves

Grand Supercycle (centuries)








Sub-Minuette (few minutes)

Major asset classes: stocks, bonds, commodities, currencies

h. Intermarket analysis

interrelationships (relative strength ratios) among

Equity sectors/ industries International markets

Floating Topic

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Page 24

Markets for factors of production

a. Types of markets

Markets for services and finished goods Capital markets

b. Principles of demand and supply


c,d. Demand & Supply Curves

Movement along

d. Process of aggregating Demand and Supply


e. Equilibria

Individual and aggregate inverse demand and supply functions

13. Demand And Supply Analysis: Introduction

f.g. Calculate and interpret

Individual and aggregate demand and supply curves Amount of excess demand Amount of excess supply

Types of auctions


Winning price

Consumer surplus

l. Calculate and interpret

Producer surplus Total surplus

i. Causes of demand or supply imbalance

Impact of govt regulation and intervention


Effect of introduction and removal of a mkt interference

Price elasticity of demand

m. Elasticity

Income elasticity Cross- price elasticity

Page 25

Consumer choice theory

Consumer utility theory

Indifference curves Use of

Opportunity sets


Budget constraints

Calculate and interpret a budget constraint

14. Demand And Supply Analysis: Consumer Demand

d. Consumer's equilibrium bundle of goods

Substitution effects

e. Compare
Income effects

normal goods Distinguish inferior goods

Giffen goods Explain Veblen goods

Accounting profit

Page 26

a. Concepts

Normal profit

Economic profit

Total revenue

b. Revenue

Average revenue Marginal revenue

a c. Factors of production
Total costs

Average costs

d. Costs

Marginal costs

Fixed costs

Variable costs

Breakeven points

Shutdown points

15. Demand And Supply Analysis: The Firm

Economies of scale

Diseconomies of scale

g. Determine profit-maximizing level of output

SR profit maximization

h. Distinguish
LR profit maximization

Decreasing-cost industries

i. Distinguish

Constant-cost Industries

Increasing-cost industries


j. Product of labor



Diminishing marginal returns


Profit-maximizing utilization level of an input

Optimal combination of resources-->Minimize cost

Page 27





16. The Firm And Market Structures



f. Concentration measures

g. Identify type of market structure

a. Calculate GDP using

Expenditure approach Income approach

Page 28

Sum-of-value-added method

b. Compare
Value-of-final-output method

a GDP c.
GDP deflator Compare Nominal GDP Real GDP

GDP National income

d. Compare
Personal income Personal disposable income

Saving Investment

e. Fundamental relationship among

Fiscal balance Trade balance

17. Aggregate Output, Price, And Economic Growth


IS curve LM curve Aggregate demand curve

Aggregate Demand and Supply


g. Aggregate supply curve in


h. Shifts and movements along D & S curves

i. Fluctuations in aggregate D & S --> SR changes in econ & biz cycle



Measurement Sustainability

Economic growth

k. Production function approach

Input growth

l. Components of economic growth

Growth of total factor productivity

Page 29

Biz Cycle

a. Describe
Phases of Biz Cycle

Business cycle

b. Economy moving through biz Cycle -->

Inventory levels Labor Physical capital utilization levels

c. Theories of Biz Cycle


d. Unemployment



e. Explain

Disinflation Deflation

18. Understanding Business Cycles


f. Indices used to measure inflation

g. Inflation measures

Uses Limitations

h. Factors --> affect price levels

Cost push inflation Demand-pull inflation

i. Describe economic indicators

Uses Limitations

Economic indicators
Past biz cycle

j. Identify

Current biz cycle Expected future biz cycle

Monetary policy

Page 30

a. Compare
Fiscal policy

Definition, qualities and functions of money Money creation process

Demand for money

c. Theories of
Supply of money

d. Fisher effect e. Central banks

Roles Objectives

f. Implementation of monetary policy Monetary policy g. Qualities of effective central banks

economic growth

h. Relationships between monetary policy and

inflation interest exchange rate

19. Monetary And Fiscal Policy

Expansionary monetary policy

Contractionary monetary policy

j. Limitations of monetary policy


k. Describe

l. Tools of fiscal policy

Spending tools Revenue tools

Fiscal policy

m. Being concerned with Size of a fiscal debt

Arguments for Arguments against

implementation of fiscal policy

n. Explain
difficulties of implementation

Expansionary fiscal policy

Contractionary fiscal policy

p. Interaction of monetary and fiscal policy

Page 31

Warm-Up: International Trade a


a. International trade


Comparative advantage

b. Distinguish
Absolute advantage


c. Models of trade


Trade restrictions

d. Restrictions
Capital restrictions

Trading blocs

20. International Trade And Capital Flows

e. Motivations for and Advantages of

Common markets

Economic unions



Current account Capital account Financial account

Balance of payments

g. Influenced by



World Bank

h. Functions and objectives of international organizations



Define an exchange rate Nominal exchange rates

Page 32



Real exchange rates Spot exchange rates Forward exchange rates


b. FOREX market


d. % change in a currency relative to another currency

21. Currency Exchange Rates

e. Currency cross-rates

Forward quotations Forward discount or premium

f.g. h. Calculate and interpret Forward rate consistent with

spot rate and interest rate

Countries that do not have their own currency

i. Exchange rate regimes

Countries that have their own currency

International trade

j. Impact of exchange rates on countries'

Capital flows

Page 33



Role of FiR

Fin position Provide info about Fin performance

Page 34
of an entity that is useful to a wide range of users in making economic decisions

Changes in fin position Use info in a company's Fin Statements Use other relevant info To evaluate past, current, and prospective performance and fin position Invest in securities To make economic decisions. E.g.: Recommend to investors Whether to extend trade, bank credit Analysts: form opinions about company's ability to earn profits and generate CF

a. Roles of FR and FSA

Roles of FSA

Income Statement (financial performance)

Revenues Expenses Gains and Losses Assets

Balance Sheet (financial position) (A=L+OE)

Liabilities Owners' equity

b. Role of key FS
CF statement

Operating CF Investing CF Financing CF Statement of changes in Owners' equity

accounting methods, assumptions, estimates acquisitions or disposals legal actions employee benefit plans contingencies and commitments significant customers sales to related parties segments of firm

FS notes (footnotes)

Additional items:

are audited Supplementary schedules not audited operating income or sales by region or business segments reserves for an oil and gas company info about hedging activities and financial instruments

c. Importance of

22. FSA Introduction


assessment of financial performance and condition of a company from the perspective of its management Results from operations, with trends in sales and expenses Publicly held companies in US Capital resources and liquidity, with trends in CF General business overview discuss accounting policies that require significant judgements by management discuss significant effects of trends, events, uncertainties liquidity and capital resource issues, transactions or events with liquidity implications Discontinued operations, extraordinary items, unusual or infrequent events Extensive disclosures in interim financial statements disclosure of a segment's need for CF or its contribution to revenues or profit

= independent review of an entity's FS objective: auditor's opinion on fairness and reliability of FS, "no material errors" Independent review though FS prepared by mgmt and are its responsibility 3 parts Reasonable assurance of no material errors (follow generally accepted auditing standards) FS prepared in accordance with accepted accounting principles, reasonable accounting principles and estimates, consistency Explanatory paragraph: when a material loss is probable but amount cannot be reasonably estimated. Uncertainties may relate to the going concern assumption --> signal serious problems and need close examination by analyst (under US GAAP): Opinion on internal controls Unqualified opinion: auditor believes statements are free from material omissions and errors 3 types of Opinions Qualified opinion: if statements make any exceptions to accounting principles --> explain these exceptions Adverse opinion: if statements are not presented fairly or are materially nonconforming with accounting standards

d. Audits of FS

Standard auditor's opinion

Interim reports SEC filings

Quarterly or Semiannual reports (update FS and footnotes, but not audited) from EDGAR to shareholders when there are matters that require a shareholder vote

e. Other info sources than annual FS and supplementary info

Proxy statements

Filed with SEC

About election of board members, compensation, management and qualifications and issuance of stock options Corporate reports and press releases Viewed as PR or sales materials

State the objective and context Gather data Process data Analyze and interpret data Report the conclusions or recommendations Update the analysis

f. Steps in FSA framework

Assets Liabilities

Page 35

a. Fin Statement elements and accounts

5 Elements

Owners' equity Revenue Expenses

Basic form

A=L+OW A=L+CC+Ending Retained Earnings A=L+CC+Beginning RE+R-X-D

b. Accounting equation

Extended forms

c. Recording process

Double entry accounting

Unearned revenue

23. Financial Reporting Mechanics

d. Accruals and other adjustments


Accrued revenue Prepaid expenses Accrued expenses

Other adjustments

Historical vs Current costs --> Valuation adjustments --> income statement or in "other comprehensive income

e. Relationship among IS, BS, CF, OE (p.23)

General Journal (Journal entries) General ledger (sort entries by account)

f. Flow of Info in Accounting system

Initial trial balance-->adjusted trial balance FSs

g. Use of results of accounting process in security analysis

Objective of Fin statements

Page 36


Importance of reporting standards in security analysis and valuation Of standard-setting bodies (establishing standards)

IASB (International Accounting Standards Board) US FASB (Financial Accounting Standards Board)

b. Role

Of regulatory authorities (enforcing standards)

IOSCO (International Organization of Securities Commissions) UK FSA- Financial Services Authority US SEC- Securities and Exchange Commission

Status of global convergence of accounting standards

disagree standard setting bodies regulatory authorities


Barriers to developing one universally accepted set of financial reporting standards

political pressures from business groups and others Objective of financial statements Understandability Comparability Qualitative characteristics Relevance consistent among firms and time periods info timely and sufficiently detailed -> influence decision faithful representation substance over form neutrality prudence and conservatism in estimates completeness


d. IFRS framework

Required reporting elements

assets, liabilities, equity, income, expenses Historical cost: amount originally paid for the asset Current cost: would have to pay today for the same asset Realizable value: amount for which firm could sell the asset Present value: discounted future cash flows Fair value: 2 parties in an arm's length transaction would exchange the asset

Measurement bases


reliability and relevance (timely) cost Intangible and non-quantifiable info Accrual basis Going concern Required financial statements BS, IS, CFS, OE, Explanatory notes (incl. accounting policies)


Fair presentation Principles for PREPARING Going concern basis Accrual basis Consistency Materiality Aggregation Principles for PRESENTING No offsetting Classified balance sheet Minimum information is required Comparative information Purpose of framework IASB requires mgmt to consider the framework if no explicit standard exists IASB same objective FASB different objectives for biz and non-biz Assumptions Qualitative characteristics IASB emphasizes going concern FASB: relevance, reliability IASB: comparability, understandability also

24. Financial Reporting Standards

e. General requirements for Financial Statements

Objectives of financial statements

Primary characteristics

f. IFRS (by IASB) # US GAAP (by FASB)

Financial statement elements

IASB: income+expenses Performance FASB: Revenues, Expenses, Gains, Losses, comprehensive income IASB: resource from which future economic benefit is expected FASB: future economic benefit "Probable" IASB: define criteria for recognition FASB: define assets and liabilities IASB: allow FASB: not allow

Asset definition

Values of assets to be adjusted upward Reconciliation statement Characteristics of a coherent financial reporting framework Transparency Comprehensiveness Consistency Valuation Barriers to creating a coherent financial reporting framework

Principles-based Standard setting Rules-based

IFRS relies on broad framework FASB in the past specific guidance how to classify trx FASB moving now blend the other two


Objectives oriented Measurement update

h. Importance of monitoring developments in financial reporting standards

In the footnotes & in MD&A (management judgment)

i. Evaluate company disclosures of significant accounting policies & estimates

new accounting standards --> 3 statements

standard does not apply will not affect the FS materially are still evaluating the effects of the new standards

Revenues Components Expenses Gross profit Presentation formats

Page 37

a. IS

Accrual accounting

unearned revenue IASB

General principles of Revenue recognition

FASB evidence of arrangement btw buyer and seller SEC product delivered or service rendered price is determined or determinable seller reasonably sure of collecting money

Long term contracts

Percentage-of-completion method Completed-contract method Certain collectibility -> normal method

b,c. Revenue recognition

Installment sales Applications Barter transactions

Not reasonably estimated collectibility -> installment method Highly uncertain collectibility -> cost recovery method Round trip transactions primary obligator bear inventory & credit risk ability to choose supplier reasonable latitude to establish prices

Gross revenue reporting (vs. net revenue reporting) Implications for Financial Analysis

Inventories Matching principle Depreciation Long-lived assets Depletion Amortization

d. Expense recognition

Bad debt, warranty expenses estimation Period costs Admin

25. Understanding The Income Statement

Implications for Financial Analysis

Discontinued operations Nonrecurring items Unusual or infrequent items Extraordinary items Changes in accounting standards Change in accounting principle Change in accounting estimate Prior-period adjustment

e. Financial reporting treatment and analysis of

Operating components

f. Distinguish

Nonoperating components

Capital structure

Simple Complex

Basic EPS

Formula: Effect of: Stock dividends and Stock splits

g. EPS
Diluted EPS


Dilutive securities Antidilutive securities

Treasury stock method

i,j. Common size IS & financial ratios

FX translation gains and losses Adjustments for minimum pension liability

l. Items excluded from IS but affect OE- other comprehensive income

Unrealized gains and losses from

CF hedging derivatives Available-for-sale securities

k. Comprehensive income: e.g.. on page __


Page 38

a. Elements

Liabilities Equity

b1. Uses of BS in financial analysis

b2. Limitations of BS in financial analysis

Account format Report format Classified BS

2 common formats

c. Formats of BS

Current assets Current vs.non current Current liabilities Non current assets Non current liabilities Liquidity-based presentation Reporting noncontrolling/ minority interest

d. Classifying

Historical cost Bases Fair value Replacement cost PV of future CF Cash and cash equivalent Account receivable Current assets lower of cost or net realizable value Inventories standard costing retail method Marketable securities Prepaid expenses and others Accounts payable

26. Understanding The Balance Sheet

e. Measurement bases
Current liabilities

Note payables Current portion of long term debt Tax payables Accrued liabilities Unearned revenue/income Tangible assets Used in operations Not used in operation -> investment assets Identifiable (finite period) -> amortized Intangible assets Unidentifiable (infinite) -> not amortized, but tested for impairment at least annually Internally produced -> not recorded, except legal costs Goodwill

Non-current assets

Contributed capital Minority (noncontrolling) interest Retained earnings

f. Components of OE

Treasury stock Accumulated other comprehensive income


g. Analyse

Statement of changes in OE

h. Common-size balance sheet

i. Liquidity & solvency ratios

The CF statement

Page 39

affect Net Income affect Long term assets and certain investments affect capital structure


b. Noncash investing, financing activities

Not reported Disclosed in footnote or supplemental schedule to CF statement

dividends paid


interest paid



interest and dividend received


taxes paid



27. Understanding The CF Statement

d,e, f,g. CF methods


Total currency amounts

Major sources and uses of cash CFO CFI CFF

h. Analyse and interpret

Common-size CF statement, divided by

Revenue Total cash inflow (for inflows) and Total cash outflow (for outflows)

Free cash flow

to Firm: FCFF=NI+NCC+Int*(1-t)-FCInv-WCInv=CFO+Int*(1-t)-FCInv to Equity: FCFE=CFO-FCInv+NetBorrowing CF to revenue =CFO/net revenue =CFO/average total assets =CFO/average total equity

available to

Stockholders Debt holders

Cash return-on-asset Performance ratios Cash return-on-equity Cash-to-income Cash flow per share CF ratios Debt coverage Interest coverage Reinvestment ratio Coverage ratios Debt payment ratio Dividend payment Investing and financing ratio

=CFO/Operating income =(CFO-preferred dividends)/ Weighted average number of common shares)


=CFO/Total debt =(CFO+Interest paid+taxes paid)/interest paid =CFO/cash paid for long term assets =CFO/cash long term debt repayment =CFO/dividends paid =CFO/cash outflows from investing and financing activities

Page 40


Page 41

Ratio analysis Common size Vertical Horizontal Charts: stacked column graph, line graph Balance sheet Income statement

Page 42

a. Analyses

Receivables management

Receivables T.O = annual sales/average receivables Days of sales outstanding or average collection period = 365/ receivables T.O Inventory T.O = COGS/average inventory Days of inventory on hand = 365/inventory T.O Payables T.O = purchases/average trade payables Number of days of payables = 365/payables T.O Total asset T.O = revenue/average total assets Fixed asset T.O = revenue/average net fixed assets Working capital T.O = revenue/average working capital

Inventory management


Trade credit management Total assets management Fixed assets management Working capital management

Current ratio = current assets/current liabilities Quick ratio = (cash + marketable securities + receivables)/current liabilities


Cash ratio= (cash + marketable securities)/ current liabilities Defensive interval= (cash + marketable securities + receivables)/ average daily expenditures Cash conversion cycle = days sales outstanding + days of inventory on hand - number of days of payables

b,c. Classes of ratios

Use of debt financing

Debt-to-equity = D/E Debt-to-capital = D/(D+E) Debt-to-assets = D/A

Ability to repay debt obligations

Financial leverage = A/E Interest coverage = EBIT/Interest payments Fixed charge coverage= (EBIT + lease payments) / (interest payments+lease payments)

Net profit margin= Net income/ Revenue

28. Financial Analysis Techniques

Gross profit margin= (Net sales - COGS)/ Revenue Operating profitability Operating profit margin = EBIT/ Revenue Pretax margin= EBT/ Revenue

Profitability relative to funds


Formula 1: ROA= Net income/ Average total assets Formula 2: ROA= (Net income + int exp (1- tax rate))/ Average total assets

Operating ROA = EBIT / Average total assets ROTC (Return on Total Capital) = EBIT/ Average total capital ROE = Net income/ Average total equity Return on common equity = (Net income - preferred dividends)/ Average common equity

Ratio analysis Valuation

Sales per share, EPS, P/CF ... (in Equity study section)

Original approach

d. DuPont analysis
Extended (5-way) DuPont

Valuation ratios Dividends and Retention Rate Net income per employee and Sales per employee Industry-specific ratios Growth in same-store sales Sales per square foot Equity analysis Business risk Revenue Coefficients of variation of Operating income Net income for service and consulting firms for restaurants and retail industries

for retail industry

e. Ratios used in
Capital adequacy VaR For Banks, Insurance companies, financial firms Reserve requirements Liquid asset requirement Net interest margin Credit analysis Ratios: interest coverage ratios, return on capital, debt-to-assets, CF to total debt ... Altman Z-score Business segment Segment analysis Geographic segment

f. Model and forecast earnings

Using ratio analysis Using techniques: sensitivity analysis, scenario analysis, simulation

Page 43

28. Financial analysis techniques

Sales: 1 laptop per day, P=10m Cost of goods sold: Cost=5m SG&A EBIT Interest expense EBT Income tax Net income Dividends Increase/Decrease in Retained earnings 100% 25% VND 3,650 (1,825) (210) 1,615 (15) 1,600 400 1,200 1,200 -50.0% -5.8%

Cash Account receivable Inventory Total current assets Net PPE Total assets Account payable Short-term debt Long-term debt Equity Total liabilities+equity 10 days 7 days on credit 5 days in store 105 70 25 200 300 500 50 150 300 500 1.4% 8.2% 2.9%

Page 44

Inventory cost flow methods Inventory valuation methods IFRS-> Lower of cost or NRV US GAAP -> LCM=lower of cost or market ending = beginning + purchases - COGS

Inventory accounting

product cost --> capitalized period cost --> expensed

a. IFRS & GAAP rules for determining Inventory cost

Specification Indication

b,c. Computing ending inventory and COGS

FIFO LIFO Weighted average cost


d. Inventory systems


29. Inventories
e. Effects of different inventory accounting methods on

COGS Inventory balances Other FS items: taxes , net income , working capital , cash flows


Lower of cost or NRV Lower of cost or market No write-up

f. Inventory reporting


Commodity-like products

g. FR presentation & disclosures of inventories


h. Effects of different inventory accounting methods on

Liquidity Activity Solvency

Page 45

Capitalize a1. Accounting standards Expense

NI Shareholders' equity CFO CFI

CF a2. Effects of capitalizing vs expensing on

Financial ratios

Profitability Interest coverage ratio

Implications for analysis

30.1. Long-lived Assets- Part1Capitalization a3. Capitalized interest

Interest incurred during construction --> capitalize What interest rate to use?

required by both US GAAP & IFRS

i/r on debt related to construction if no construction debt outstanding-> based on existing unrelated borrowings Interest costs in excess of project construction -> expensed

reported in FSs

Unidentifiable: Goodwill

GW=Purchase price -Fair value Not amortized but impairment test

IFRS: R&D anything Created internally --> EXPENSED except for Identifiable

R: Expense D: Capitalise
Software for sale --> similar to IFRS Software for use Before technical feasibility: expense After technical feasibility: capitalize Capitalize all

b. Intangible assets

US GAAP: R&D software

Purchased externally --> CAPITALIZED (asset at cost) USGAAP --> expense Obtained in business acquisition IFRS --> not expense

Page 46
Carrying Value (or Book value)

c1. Concepts

Historical cost Economic depreciation

SL (Straight Line) depr=2/n* book value Accelerated depreciation DDB (Double Declining Balance) or final year: depr=book value - salvage Units-of-production

d. Depreciation methods

c2. Effect on net income

c3. Useful lives and Salvage Values

Component depreciation

e,f. Amortization of intangible assets

Cost model

30.2. Long-lived Assets- Part2 Depreciation And Impairment


Revaluation model (land, buildings...)

Reversal of previous loss --> gain in IS Above historical cost --> revaluation surplus in equity


Recoverable amount = max (value in use, fair value - selling cost) If carrying value > recoverable amount --> impair

Value in use = PV of future CF stream

Step 1: Recoverability test US GAAP Tangible assets Step 2: Loss measurement Intangible assets

h. Impairment

Reversing an impairment loss

Asset for sale Asset held for use

Sales --> Gains/ Losses

i. Derecognition of PPE & intangible assets

Abandoned --> no proceeds, loss=carrying value Exchange --> equivalent to sell and buy another

j. FS presentation & disclosures of PPE & intangible assets


k. Financial reporting of investment property

Taxable income Taxes payable TAX RETURN Income tax paid current tax expense actual cash flow =past or current loss --> create DTA

Page 47

Tax loss carryforward

Tax base = net amount of asset/liability used for tax reporting purposes Accounting profit Income tax expense FINANCIAL REPORTING DTL Income before tax Earnings before tax =Taxes payable + change in DTL - change in DTA

a. Terminology

= Income tax expense - Taxes payable Cause: depreciation =Taxes payable - income tax expense Causes: Warranty expenses, Tax-loss carry forwards


Valuation allowance: contra account to DTA Carrying value = net balance sheet value of asset/liability Permanent difference vs. Temporary difference DTL Revenues/Gains recognized in IS before in tax return Expenses/Losses tax deductible before recognized in IS (depreciation) Revenues/Gains taxable before recognized in IS

Income tax exp. > Current tax exp.



Income tax exp. < Current tax exp.

Expenses/Losses recognized in IS before tax deductible (warranty expenses, post-employment benefits) Tax loss carryforwards

Treatment for analytical purpose: DTL not expected to reverse --> equity Definition Assets Examples Definition Liabilities Examples Customer advance Warranty liability Note payable Depreciable equipment R&D AR

31. Income Taxes

c. Tax base of

d. Calculation
Adjustment to FS =Taxes payable + change in DTL - change in DTA

e. Income tax rate changes

Impact on FS and ratios Temporary differences between tax base and carrying value will reverse result in DTA or DTL

f. Differences

Permanent differences

between taxable income and pretax income not reverse makes effective tax rate different from statutory tax rate >50% probability effective tax rate = income tax expense / pretax income

g. Valuation allowance for DTA

Depreciation --> DTL (if reverse, if not --> equity) Impairments --> DTA Restructuring --> DTA

h. Deferred tax items

LIFO, FIFO Post-employment benefits and deferred compensation --> DTA Unrealized gains/losses on available-for-sale marketable securities

Analyze disclosures relating to

deferred tax items effective tax rate reconciliation

How disclosures affect FS and ratios

j. IFRS vs. US GAAP (see table in Schweser)

Page 48

Bond terminology a




Par bond a,b. Recognition & measurement

Premium bond

Discount bond (incl. zero-coupon debt)

32.1. Long-term LiabilitiesPart1Financing Liabilities b.

Amortization methods

IFRS: effective interest rate method US GAAP prefers: effective interest rate method allows: straight line depreciation

Issuance costs

IFRS: increase liability --> increase effective i/r US GAAP: capitalize as an asset (prepaid exp.)

Fair value reporting option

c. Derecognition of debt

d. Debt covenants

e. Presentation and disclosures

Page 49
Less costly financing

f. Motivations for leasing vs. purchasing

Reduced risk of obsolescence Less restrictive provisions OBS financing Tax reporting advantages

Operating lease Transfer of title US GAAP: If meets one of the criteria Bargain purchase option Lease period >=75% economic life PV(lease pmts)>=90% fair value


g. Types of lease

Finance lease (capital lease)

IFRS: similar to US GAAP but less specific, with 1 additional criterion: leased asset is specialized collectability of lease payments is reasonably certain lessor has substantially completed performance


US GAAP: like lessee with added conditions:

IFRS: like lessee with added condition: substantially all rights & risks of ownership are transferred to lessee

Operating lease

Finance lease

32.2. Long-term LiabilitiesPart2- Leases & Pension Plans

h1. Reporting by Lessee

FS & ratio effects of finance lease compared to operating lease

Balance sheet Income statement Cash flow

Finance lease

Salestype lease Direct financing lease

h2. Reporting by Lessor's

Operating lease

i. Disclosures of lease
Defined contribution Service cost j. Two types Interest cost Defined benefit Expected return on plan assets Actuarial G/L Prior service costs k. Presentation & disclosure

Pension Plans

l. Leverage & coverage ratios

Page 50

Meet earnings expectations overreport earnings Lending covenants Incentive compensation Trade relief (quotas, tariffs) underreport earnings

a. Incentives to

Negotiable favorable terms from creditors Negotiable favorable terms from labor contracts More solvent

Manage the BS

Less solvent Enhance performance ratios

Select acceptable accounting --> misrepresent economics of transactions

b. Activities--> Low quality of earnings

Structuring transactions --> achieve desired outcomes Aggressive unrealistic assumptions, estimates Exploit intent of an accounting principle: apply narrow rule to broad range of transactions

=motives Threats to financial stability or profitability Incentives or pressure risk factors Excessive third-party pressures Personal net worth of mgmt or BOD is threatened Excessive pressure to meet internal financial goals =weakness in internal control Nature of the firm's industry or operations Opportunity Ineffective mgmt monitoring Complex or unstable organizational structure Deficient internal control

33. Financial Reporting Quality: Red Flags And Accounting Warning Signs

risk factors

c. "Fraud triangle"

=mindset that fraudulent behavior is justified Inappropriate ethical standards Excessive participation by nonfinancial mgmt in the selection of accounting standards Attitudes or rationalization risk factors Known history of violations by mgmt or board members Obsession with increasing firm's stock price or earnings trend Commitments to third parties Failing to correct known reportable conditions Inappropriately minimizing earnings for tax purposes Use of materiality as a basis to justify inappropriate or questionable accounting methods Strained relationship between mgmt & auditor

Aggressive revenue recognition CFO growth rate # Earnings growth rate Abnormal sales growth as compared to economy, industry or peers Abnormal inventory growth as compared to sales growth Boosting revenue with nonoperating income and nonrecurring gains Delaying expense recognition

d. Common accounting warning signs & detecting methods

Abnormal use of operating leases by lessees Hiding expenses by classifying them as extraordinary or nonrecurring LIFO liquidations Abnormal gross margin & operating margin as compared to industry peers Extending the useful lives of LT assets Aggressive pension assumptions Year-end surprises Equity method investments & OBS special purpose entities Other OBS financing arrangements including debt guarantees

Page 51

Stretching Accounts Payables

Financing Accounts Payables

Ways to manipulate CFS

Securitizing Accounts Receivables

34. Accounting Shenanigans On The Cash Flow Statement

Repurchasing stock to offset dilution

Page 52

a. Past financial performance of a company

Evaluating Reflecting company's strategy

b. Basic projection of future net income and CF

Character Three C's Collateral Capacity

35. FSA: Applications

c. FSA in assessing credit quality for DEBT investment

Credit rating agencies use formulas that include

Scale and diversification Operational efficiency Margin stability Leverage

d. FSA in screening for EQUITY investments

e. Adjustments for comparing different companies

Page 53



Capital budgeting process

Step 1: Idea generation Step 2: Analyzing project proposal Step 3: Create firm-wide capital budget Step 4: Monitoring decisions and conducting a post audit Replacement To maintain business For cost reduction

Page 54


Project Categories

Expansion New product/market development Mandatory Other pet project high risk (R&D)

Base on incremental CF

# accounting income sunk cost --> exclude ! externalities Cannibalization --> include !

b. Basic principles

Opportunity cost --> include ! Timing of CF is important After tax basis Financing costs Exclude ! because Reflected in required rate of return

Independent vs. Mutually exclusive projects Project sequencing

c. Interactions

Unlimited funds vs. Capital Rationing

36. Capital Budgeting



d. Methods

Payback period

Discounted payback period


NPV profile Advantage of NPV Advantage of IRR

Conflicting project rankings Problems with IRR Multiple IRR and No IRR problems


Europe: PP more than IRR and NPV Larger: NPV, IRR Private: PP Public: NPV, IRR More educated -> NPV, IRR

Company Size

f. Which methods are popular?

Public vs Private

Management education

g. Relationship between NPV, company value and stock price

a,b. Formula & tax effects:

Page 55

c. Weights = Target capital structure (Market values)

If lack information -->

use Current capital structure + Trend or use Industry average

Yield to maturity approach

f. Cost of fixed rate debt

Debt rating approach

g. Cost of preferred stocks (noncallable, non convertible) WACC

Formula: i. Pure-play method to calculate beta of a project CAPM pure play Relationship between asset beta & equity beta

37. Cost Of Capital

h. Cost of equity capital --> 3 approaches

j. Country equity risk premium CRP =

Sovereign yield spread x (stddev equity/stddev bond)

Dividend Discount Model

g=retention rate * ROE

Bond yield plus risk premium approach

e. Role of MCC in NPV

Discount rate

=WACC if project same risk level

Assumption: same capital structure over the life of project


k. MCC schedule

Upward sloping with additional capital Breakpoints

d. Optimal capital budget

MCC & Investment opportunity schedule


adjust cost of equity adjust initial project cost

l. Treatment of Flotation cost


Page 56

Leverage or Gearing

Business risk

Sales risk Operating risk <-- operating leverage

a. Define

Financial risk <-- financial leverage


38. Measures Of Leverage

b. Calculate



c. Effect of financial leverage on Net income & ROE

d,e. Breakeven quantity

Page 57

Regular dividends Cash dividends Extra/ Irregular/ Special dividends Liquidating dividends

a. Explain

Stock dividends Stock splits Reverse stock splits

Declaration date Ex-dividend date

b. Dividend payment chronology

Holder-of-record date Payment date

39. Dividends And Share Repurchases: Basics

Buy in the open market

c. Share repurchase methods

Buy a fixed number of shares at a fixed price Repurchase by direct negotiation

when the repurchase is financed with company's excess cash

d. Effects of share repurchase on EPS

when the repurchase is financed with debt

if after-tax borrowing cost > earnings yield if after-tax borrowing cost < earnings yield

e. Effect of share repurchase on BV per share

f. Why share repurchase is equivalent to Cash dividend

Page 58
Cash balances (selling goods, collecting receivables, from short term investments) Primary sources Sources of liquidity Secondary sources Short term funding (trade credit from vendors, lines of credit from banks) Effective CF management Liquidating assets (short term or long lived) Renegotiating debt agreements Filing for bankruptcy Reorganizing company Factors that influence company's liquidity position Drags on liquidity: delay/reduce cash inflows or increase borrowing cost Pulls on liquidity: accelerate cash outflows Current ratio = CA/CL Quick ratio = (Cash + ST marketable securities + Receivables) / CL Receivables Receivables turnover = Credit sales/receivables Number of days of receivables = =365/receivable turnover


b. Liquidity measures


Inventory turnover = COGS/average inventory Number of days of inventory = 365/inventory turnover


Payables turnover ratio = purchases/average trade payable Number of days of payables = 365/payables turnover

Operating cycle

turn raw materials into cash proceeds from sales

=days of inventory + days of receivables

c. Working capital effectiveness

Cash conversion cycle or net operating cycle

turn cash investment in inventory back into cash collected

=Operating cycle - days of payables

US T bills

40. Working Capital Management

d. Tools to manage net daily cash position (more details in Fixed Income)

Short term federal agency securities Bank CD Banker's acceptances Time deposits Repurchase agreements Commercial paper MM mutual funds Adjustable- rate preferred stock % discount

e1. Comparable yields (already in Quantitative )

Discount basis yield Money market yield Bond equivalent yield Purpose and objective Guidelines Who does that Responsibilities Steps to make investment Limitations and constraints aging schedule

e2. Cash Management Investment Policy

Receivables weighted average collection period Inventory Accounts payable 2/10 net 60 Trade credit Cost of trade credit Number of days of payables Uncommitted line of credit Lines of credit Committed (regular) line of credit (overdraft) Revolving line of credit From banks Fixed assets Inventory Account receivables Blanket lien

f. Evaluate performance of

g. Short term funding choices

Short term bank loans, collateralized by Banker's acceptances Factoring Non bank

Nonbank finance companies direct placement Commercial paper through dealers

Page 59

Steps to construct sales-drven pro forma FSs

See the example on the next page

average compound growth rate of sales over 5-10 years

41. FSA (Pro Forma IS & BS)

Estimating sales

economic cycles regression analysis of GDP growth and sales growth seasonality new product introductions specific events changes in regulation competing products

pay down debt entirely reduce L+E pay down debt + buy back common stocks L+E > A --> surplus

Reconcile IS and BS
increase A L+E < A --> deficit CAPEX

Page 60


($ millions) Yr 2011 Proportional to sales 500 (200) (100) 10% (50) 150 0% 150 0% 150 0.0% -40.0% -20.0% sales projected to increase 100% 100% 1,000 (400) (200) (50) 350 350 350 Yr 2012 (1st trial) Yr 2012 (2nd trial) Yr 2012 (final)

Sales Cost of goods sold SG&A Interest expense Nonoperating income Earnings before tax Income tax Net income Dividends Increase/Decrease in Retained earnings

Current assets Net PPE Total assets Current liabilities Long-term debt Common stock Retained earnings Total liabilities+equity 100 900 1,000 100 500 100 300 1,000 20.0% 20.0% 180.0% (assume full capacity) 200 1,800 2,000 200 500 100 650 1,450

internal controls Definition processes procedures Describe good CG (p.113)

Page 61

a. Corporate governance

Majority of BOD is independent Meets regularly outside the presence of management Chairman of BOD should not be CEO or former CEO otherwise, independent board members should have a primary or leading board member

Board members should not be closely aligned with supplier, customer, share-option plan, pension adviser b. Independence Able to hire external consultants without management approval firm & subsidiaries, former employees, executives & their families Individuals or groups with a controlling interest c. Define "independence" no material relationship with Executive management & their families Firm's advisers, auditors & their families Entity with a cross directorship with the firm b. Frequency of Board Elections annual, not 2-3 years, not staggered (classified)

Effective BOD

Skills, experience, qualifications Care & competence d. Experience Ethical stances Other board experience Regularly attend meetings If served on the board for more than 10 years --> not very independent c. Resources

Audit Committee

Financial information to shareholders

Remuneration / Compensation Committee

set executive compensation, commensurate with responsibilities and performance make sure independence link compensation to firm performance and profitability

42. Corporate Governance

e. Board committees
Nominations Committee

recruit new independent board members

Other Board Committees

f1. Provisions of a strong corporate code of ethics

Consultancy contracts

f2. Related party transactions and personal use of company assets --> should discourage:

Finder's fees for identifying M&A targets Other compensation Related party transactions Personal use of company's assets

Confidential voting Voting Rules Cumulative voting Voting for other corporate changes

Shareowner-sponsored proposals

Shareowner-sponsored board nominations

proxy statement

Shareowner-sponsored resolutions

g. Evaluate policies

Advisory or Binding Shareowner proposals

Common stock classes

dual classes of common stock

Shareowner Legal Rights Golden parachutes Takeover defenses Poison pills Greenmail

Page 62



a. Portfolio approach to investing

Individual investors

Page 63

DC pension plans DB pension plans Endowment Foundation Bank Insurance companies Investment companies/ Mutual funds Sovereign wealth funds

b. Types of investors

Institutional investors

Planning step

Investment Policy Statement (IPS)

c. Steps in PM process

Execution step Feedback step

What is it?

43. PM- An Overview

d1. Mutual funds

2 categories

Open-end funds Closed-end funds

No-load funds Load funds

Money market funds Types Bond mutual funds Stock mutual funds Index funds Actively managed funds

ETF Separately managed account Long/Short funds Equity market-neutral funds Long bias, Short bias

d2. Other forms of pooled investments

Hedge funds


Event-driven funds Fixed income arbitrage funds Convertible bond arbitrage funds Global macro funds

Buyout funds (Private equity funds) Venture capital funds

HPR Arithmetic mean return

Page 64

Geometric mean return Average returns

a. Major return measures

Money weighted rate of return

Gross return Pretax nominal return Other return measures After tax nominal return Real return Leveraged return

Asset classes with greatest average return also have highest standard deviation

b. Characteristics of major asset classes considered in Mean-Variance portfolio theory:

Real return much more stable than nominal returns Returns distributions are negatively skewed greater kurtosis (fatter tails than normal distribution)

Liquidity is a major concern in emerging markets & thinly-traded securities

44. Portfolio Risk & ReturnPart 1

Mean Variance

c. Calculate

Covariance Correlation

Risk averse investor

d. Risk aversion

Risk- seeking (risk-loving) Risk neutral

e. Portfolio standard deviation

f. If rho<1 --> Effect on portfolio's risk:

Minimum variance frontier of risky assets

g. Interpret

Efficient frontier of risky assets Global minimum variance portfolio

Investor's utility

h. Selection of an optimal portfolio

Capital allocation line (CAL)

Page 65

Return =

a. Risk free asset + Portfolio of risky assets -->

Standard deviation =

CAL (Capital Allocation Line)

CML (Capital Market Line)


c. Risks

Macroeconomic Types of Factors Fundamental Statistical Multifactor models Formula with k factors Factor sensitivity of Factor loading Firm size, Firm B/P, Rm-Rf

45. Portfolio Risk & ReturnPart 2

d. Return generating models

Fama & French three-factor model

Carhart suggest 4th factor: prior period returns --> to measure price momentum Market model

= covar / variance of market portfolio

e. Calculate Beta

Slope of regression of returns on market index

Equation: Sharpe ratio

f,g,h. CAPM & SML

M-square Treynor measure Jensen's alpha

a. Reasons for a written IPS

Page 66

Description of Client

Circumstances & Situation Investment objectives

Statement of the purpose of the IPS Statement of duties & responsibilities of Investment manager Custodian of assets Client Procedures to update IPS & to respond to various possible situations Forms Absolute Relative Ability Willingness

c. Investment objectives
(derived from communications with the client)

Risk objectives d. Risk tolerance Return objective


b. Major components of an IPS

e. Investment constraints

Time horizon Tax situation Legal & regulatory Unique circumstances

46. Basics Of Portfolio Planning & Construction

Investment guidelines (how the policy will be executed, asset types permitted, leverage) Evaluation of performance (e.g..: benchmark) Correlations within a class should be very high Correlations between classes should be low Equities

Definition & Specification


Strategic (baseline) asset allocation

f. Asset classes

Bonds Cash Real estate Alternative Hedge funds, PE funds, commodity funds, artwork, intellectual property rights

Tactical asset allocation (deviate from strategic asset allocation) Rebalancing: how & when

Identify investable asset classes Strategic asset allocation Principles of portfolio construction Tactical asset allocation Risk, Return, Correlation Efficient frontier Identify portfolio which best meets risk & requirement of investor (based on IPS) to take advantage of perceived short term opportunities success depends on manager's ability to identify short term opportunities the existence of such short term opportunities manager's skill opportunities (mispricing or inefficiencies)

Security selection Risk budgeting Role of asset allocation success depends on

Page 67



Saving Borrowing Allow entities to Issuing equity Risk management Exchanging assets Utilizing information Supply & demand determine returns (i/r) Allocate capital to most efficient uses Equilibrium interest rate

Page 68

a. Main functions of financial system

Financial vs. Real assets Public vs. Private securities Debt vs. Equity vs. Derivative Common stock Equity Preferred stock Warrants Fixed income Securities Convertible debt Mutual funds ETFs and ETNs (depositories) ABS Hedge funds Currencies Forward, Futures, Swap, Option Contracts Commodities Real assets Insurance Credit default swap

b1. Classification of assets

c. Asset classes

Pooled investment vehicles

Spot vs. Derivative markets IPO vs. Secondary issues (or seasoned offerings) Primary market Public offerings vs Private placements & other transactions Securities trade after initial offerings provide liquidity

47.1. Market Organization & Structure (part 1)

i. Primary vs. Secondary markets

Secondary market--> importance: Money vs. Capital markets Traditional investment market (debt, equity) vs. Alternative market (hedge funds, commodities, real estate...) Trades occur at specific times

All trades, bids, asks are declared, and then one negotiated price is set to clear the market for the stock

b2. Classification of markets

Call market

Traders/investors indicate their bids and asks NOT a dealer or quote-driven market in smaller markets used to set opening prices and prices after trading halts on major exchanges Trade occur any time the market is open

j1. Distinguish

Continuous market

Price is set by

auction process dealer bid-ask quote

Quote-driven markets (dealer markets, price-driven markets, OTC markets)

j2. Distinguish

Order-driven markets (rules are used to match buyers & sellers) Brokered markets

Order matching rules Trade pricing rules

j3. Market information

Brokers Brokers, Dealers & Exchanges

Pre-trade transparent Post-trade transparent

Block brokers Investment banks Exchanges Alternative trading systems (ATS) Dealers

d. Financial intermediaries

Securitizers Depository institutions Insurance companies Arbitrageurs Clearinghouses and Custodians Clearinghouses Custodians

Long position

Page 69

e. Positions

Short position Leveraged position

The investor pays for the stock with some cash and borrow the rest through the broker The broker keeps the stock as collateral Leverage ratio Margin lending rate The proportion of total transaction value that must be paid in cash Initial margin (IM) Maintenance margin (MM) -->margin call

f. Margin transaction

Margin requirement

Margin call price = Po * (1 - IM) / (1 - MM)

Bid-ask Market order Limit order Execution instructions All-or-nothing order Hidden order Iceberg order Stop order Stop loss orders To prevent losses or To protect profits

day order Validity instructions

Stop-buy & Stop-sell orders

good-till-cancelled immediate or cancel order (fill or kill order) good-on-close order market-on-close order

47.2. Market Organization & Structure (part 2)

good-on-open order Clearing instructions

Commissions Operationally efficient low trading costs Bid-ask spreads Price impact Prices that rapidly adjust to new info The prevailing price is fair since it reflects all available info regarding the asset Investors can save at fair rates of return Creditworthy borrowers can obtain funds Hedgers can manage risks Traders can obtain assets they need Having financial intermediaries that

Informationally efficient

k. Characteristics of well- functioning financial system

Allocationally efficient Allowing entities to achieve their purposes

Without regulation --> Problems

Fraud & theft Insider trading Costly information Defaults


liquidity declines, firms shun risky projects, new ideas go unfunded, economic growth slows

l. Objectives of market regulation

Regulation can be provided by

Governments Industry groups Protect unsophisticated investors --> preserve trust

Market regulation should

Require minimum standards of competency and make it easier for investors to evaluate performance Prevent insiders from exploiting other investors Financial reporting requirements Require minimum levels of capital

Page 70

a. Describe a security market index


b. Calculate for an index

Price return Total return

Which target market Which securities

c. Index construction & management

Weighting Rebalancing frequency Re-examining selection & weighting

48.1. Security Market Indices (part 1)

Price weighted index

arithmetic average

=sum of stock prices / number of stocks adjusted for splits -->Index movements are influenced by the differential prices of the components

A percentage change in a high-priced stock will have a relatively greater effect on the index 30 stocks arithmetic 2 major indexes DJIA criticisms limited number of stock downward bias large growing firms --> splits --> lose weights

Nikkei Dow Jones Stock Average arithmetic average return of the index stocks

225 stocks

d,e. Weighting methods

Equal weighted index

equivalent to a portfolio that has equal dollar amounts invested in each stock in the index The Value Line (VL) Composite average Examples Financial Times Ordinary Share Index 30 stocks on LSE 1695 stock returns

Market- cap weighted index (or value weighted index)

= Criticism: large company has greater impact Float-adjusted market cap- weighted index

Fundamental weighting (earnings, dividends, cash flow) Example

Page 71

f. Rebalancing & reconstitution

Reflection of market sentiment Benchmark of manager performance

g. Uses of security market indices

Measure of market return and risk Measure of beta and risk-adjusted return Model portfolio for index funds

Broad market index Multi-market index

h. Types of equity indices

Multi-market index with fundamental weighting Sector index Style index

48.2. Security Market Indices (part 2)


Large universe of securities Dealer markets and infrequent trading

i. Types of fixed income indices

Sectors, geographic regions, levels of country economic development, type of issuers or collateral, coupon, maturity, default risk, inflation protection Broad market indexes, sector indexes, style indexes & other specialized indexes

Commodity indexes

j. Indices representing alternative investments

Real estate indexes Hedge fund indexes

k. Compare & contrast types of security market indices

Page 72

a. Concepts a

Market value

b. Distinguish

Intrinsic value

Number of market participants

c. Factors affecting a market's efficiency

Availability of information Impediments to trading Transaction and information costs

Weak form

d. Forms of EMH

Semi-strong form Strong-form

Fundamental analysis

e. Implications of each form of EMH for

Technical analysis Choosing between active and passive portfolio management

January effect (or turn-of-the-year effect) Turn-of-the-month effect Anomalies in Time-series data Calendar anomalies Day-of-the-week effect Weekend effect Holiday effect Overreaction and momentum anomalies

49. Market Efficiency

f. Market pricing anomalies
Anomalies in cross-sectional data

Size effect Value effect

Other anomalies

Closed-end investment funds Earnings announcements IPO Economic fundamentals

Implications for investors

Loss aversion Investor overconfidence Representativeness Gambler's fallacy

g. Behavioral finance

Conservatism Disposition effect Narrow framing Information cascades Herding behavior

Page 73
Common shares Callable common shares

Putable common shares

a. Characteristics of

Preference shares Cumulative preference shares Convertible preference shares

b. Equity classes

Public equity securities Characteristics Private equity securities 3 main types Venture capital Leveraged buyouts (LBO) Private investment in public equity (PIPE)

c. Distinguish

Direct investing

50. Overview Of Equity Securities

Depository receipts (DRs)

d. Methods for investing in non-domestic equity securities

Global depository receipts (GDRs) American depository receipts (ADRs) Global registered shares (GRS) Basket of listed depository receipts (BLDR)

e. Risk and Return characteristics of various types of equity securities

f. Role of equity securities in financing company's assets & creating company value

Market value of equity securities

g. Distinguish

Book value of equity securities

Company's accounting ROE = Company's cost of equity rate of return required by investors

h. Contrast
Investors' required rates of return depends on estimates of firm's future CF & risk

Page 74

a. Industry analysis

Grouping companies by

Products & services Sensitivity to business cycles Statistical methods (cluster)

different sectors Cyclical Non-cyclical firms with highly correlated returns --> same group Limitations GICS Systems RGS Industry Classification Benchmark by DJ & FTSE Basic material and processing firms

b. Industry classification

Industry classification systems

Commercial classifications Classification

Consumer discretionary Consumer staples Energy Financial services Industrial and producer durables Technology Telecommunications United Nations

Government classifications

European Community Australia & New Zealand North America (US, Canada, Mexico)

51.1. Introduction To Industry And Company Analysis (part 1)

Firms Cyclical firms Non-cyclical firms

c. Sensitivity to business cycle

Cyclical sectors Sectors Non-cyclical sectors Defensive (stable) Growth

d. Peer group

e. Elements of an industry analysis

Macroeconomic factors Technology Demographic factors Governments Social influence

f. External influences on industry growth, profitability and risk

Slow growth Embryonic stage High prices Large investment required High risk of failure Rapid growth Growth stage Limited competitive pressures Falling prices Increasing profitability Growth has slowed Intense competition Increasing industry overcapacity Declining profitability Increased cost cutting Increased failures Slow growth Consolidation Mature stage High barriers to entry Stable pricing Superior firms gain market share Negative growth Decline stage Declining prices Consolidation

Page 75

g. Product & industry life cycle

Shakeout stage

Industry concentration

51.2. Introduction To Industry And Company Analysis (part 2)

h. Effects on return on invested capital and pricing power of

Ease of entry Capacity Market share stability

Rivalry among existing competitors Threat of new entrants

i. Principles of strategic industry analysis- Michael Porter's five forces

Threat of substitute products Bargaining power of buyers Bargaining power of suppliers

j. Example of the candy/confections industry

Financial condition Analyze Products and services Competitive strategy Should include

ROE (DuPont)

k. Elements of a company analysis

Defensive vs. Offensive Cost leadership vs. Product differentiation

Firm overview, Industry characteristics, Product demand, Product costs, Pricing environment, Financial ratios, Projected financial statements and firm valuation

Page 76

Size of differences between market price and intrinsic value

a. Factors to consider when exploiting mispricing

Confidence about valuation model Confidence about the inputs Why stock is mispriced If market price will move toward intrinsic value

c. Rationale

d. Preferred stock

Dividend discount models Discounted cash flow models

Types of models

e. Common stock

f. Appropriate for companies that are

Stable & mature Non-cyclical Dividend-paying

52. Equity Valuation: Concepts And Basic Tools


Free cash flow to equity models

Advantages Disadvantages

b. Equity valuation models g. Rationale

h. Stock price / fundamentals

Types of models

Multiplier models (or market multiple models)

e. Enterprise value / EBITDA or revenue




j. Assetbased models



Page 77



Rights and obligations

Page 78

a. Bond's indenture


Negative Affirmative

Basic features of a bond Zero coupon Coupon rate structures Step-up notes Deferred coupon bonds

Floating-rate securities

Coupon formula Inverse floater Inflation-indexed bonds Caps and floors

Full (dirty) price = Clean Price + Accrued interest

c. Bond trades between coupon dates

Cum coupon vs. Ex-coupon Trading flat

Nonamortizing/ Bullet bond/ Bullet maturity

Amortizing securities

Prepayment options

53. Features Of Debt Securities

Call provisions

d. Provisions for redemption and retirement of bonds

Nonrefundable bonds

Sinking fund provisions

Cash payment Delivery of securities

Accelerated sinking fund provision

Redemption price

Regular Special

Security owner (bondholders) options

Conversion option Put provision Floors

e. Embedded options

Security issuer (borrowers) options

Call provision Prepayment options Accelerated sinking fund provisions Caps

Margin buying

f. Methods to finance the purchase of a security


Interest rate risk Yield curve risk Call risk Prepayment risk Coupon Reinvestment risk i. Factors affecting reinvestment risk Call feature Amortizing Prepayment option

Page 79

Default risk Credit risk j. Forms Credit spread risk Downgrade risk j. Meaning and role of credit rating

a,i,j,k,l,m,n,o. Risks

Liquidity risk

k. why important even hold to maturity

l. Exchange-rate risk m. Inflation risk n. Volatility risk Disaster o. Event risk Corporate restructuring Regulatory issues Sovereign risk

54. Risks Associated With Investing In Bonds

Coupon rate Market yield

b. Relations among

Bond's price relative to par value

Discount Premium Equal to par

Maturity Coupon Embedded options Yield

c. Effect on interest rate risk of

Call Put

value of option-free bond Value = minus value of embedded call

d,h. Callable bond

h. Disadvantages of a callable or prepayable security to investors

Less certain CF- call risk/prepayment risk Reinvestment risk Potential price appreciation < option free securities

Interest rate risk

e. Floating rate security

Reasons Price # Par

Cap risk Margin

Duration = Dollar duration =

f,g. Duration
g. Duration and Yield curve risk for a portfolio of bonds

Features Credit risk characteristics

Page 80

a. Government securities (sovereign debt)

Regular cycle auction- single price Distribution methods Regular cycle auction- multiple price Ad hoc auction system Tap system


Instruments T- notes T- bonds TIPS

b,c. Treasury securities (Treasuries)

Two categories (vintage)

On-the-run Off-the-run

c. Stripped Treasury securities

Coupon strips Principal strips STRIPS

55.1 Overview Of Bond Sectors And Instruments

d. Types of US Fed agencies

Federally related institutions (owned by US Gov.)

Ginnie Mae (Government National Mortgage Association) TVA (Tennessee Valley Authority)

GSEs (Government Sponsored Enterprises) (privately owned, publicly chartered) (commonly issue debentures)

Federal Farm Credit System Federal home Loan Bank System Federal National Mortgage Association (Fannie Mae) Federal Home Loan Bank Corporation (Freddie Mac) Student Loan Marketing Association (Sallie Mae)

Debentures (unsecured, not backed by collateral) Characteristics Periodic interest



Scheduled repayments of principal Principal repayments in excess of scheduled principal payments


e,f. MBS (Mortgagebacked securities)


Mortgage passthrough security Tranche I 3 tranches CMOs (Collateralized mortgage obligations) Tranche II Tranche III f. Motivation for creating CMO Stripped mortgage-backed securities


Tax exempt Taxable

Page 81

Limited tax GO debt

g. MUNIS (Municipal securities)

Tax- backed bonds or GO (General Obligation) bonds Instruments Revenue bonds Insured bonds Prerefunded bonds

Unlimited tax GO debt Double-barreled bonds Appropriation-backed obligations (or Moral obligation bonds)

Rating agencies and Credit ratings

Secured vs. Unsecured Debt

Credit enhancements

Medium term notes

Shelf registration (sold over time) Maturity ranges Best effort underwriting

55.2 Overview Of Bond Sectors And Instruments (cont.)

= typical bond + derivative Purpose: get around restrictions Step-up notes Structured notes Inverse floaters Structured medium term notes Deleveraged floaters Dual-indexed floaters Range notes Index amortizing notes



Commercial paper

Directly placed Dealer placed

Negotiable CDs Bankers Acceptances Role of a SPV i. Asset-backed securities Motivation External credit enhancements Corporate guarantees LC Bond insurance j. CDO (Collateralized debt obligation)

k. Bonds

Primary market Secondary market

Mechanism for placing bonds

Page 82
Discount rate OMO Banks borrow reserves from Fed

Buy/Sell Treasuries by Fed Most commonly used

a. Interest rate policy tools

Bank reserve requirement

% of deposits banks must retain

Persuading banks to tighten/loosen credit policies

Normal / Upward Inverted / Downward

b. Yield curve / Term structure of interest rate

Flat Humped

Pure expectation

c. Basic theories of term structure of interest rate

Liquidity preference Market segmentation theory

56. Understanding Yield Spread

d. Define a spot rate

Absolute yield spread =

e. Measures

Relative yield spread = Yield ratio =

= yield difference b/c of credit rating

f. Credit (quality) spread Yield spread g. Effect of embedded options

Relation with the well-being of the economy

Issue size

h. Liquidity spread

Maturity spread

After tax yield of a taxable security

i. Tax

Tax equivalent yield of a tax-exempt security


Page 83

1. Estimate CFs

Coupons Principal

a. Steps in bond valuation process

2. Determine appropriate discount rate 3. Calculate present value

Defaults and potential credit problems Embedded options -> uncertain principal repayment

b. Difficulties in estimating CFs

Floating rate securities -> uncertain coupons Convertible or Exchangeable bonds

57. Introduction To The Valuation Of Debt Securities

Compute value of bonds


Value of zero coupon bonds

d. Time and value of bond

Price-yield profile

e. Yield and value of bond

f. Arbitrage free valuation approach

Page 84


a. Sources of return from investing in bond

Principal + Capital gain/loss Reinvestment income

Current yield

d. Calculate BEY and EAY Assumptions CF will be reinvested at YTM Bond will be held till maturity Reinvestment income YTM Limitations

c. Reinvestment

Reinvestment risk increases with

Higher coupons Longer maturities

b,c,d. Traditional yield measures

Realized yield can be different from YTM


58. Yield Measures, Spot Rates And Forward Rates

Yield to call

Yield to worst

Yield to refunding



e. Theoretical Treasury spot rate curveBOOTSTRAPPING

Nominal spread

Zero-volatility spread (Z-spread)

f. Spreads
Option-adjusted spread (OAS) OAS = Z spread - Option cost

g. Spot rates, Forward rates, Value of bonds

Full valuation approach (scenario analysis)

Page 85

a. Measuring interest rate

Duration/ convexity approach

Option-free bonds

Callable bonds

b. Price volatility characteristics for

Prepayable bonds

Putable bonds

d,e. Effective duration d,e. Types of duration

Macaulay duration

Modified duration

59. Introduction To The Measurement Of Interest Rate Risk


f. Interpreting duration

g. Portfolio duration

Relationship to duration

What is it? Positive Negative Relation to bond price and yield h. Calculation Modified convexity Effective convexity

Can be

c,h,i. Convexity

i. Types

k. Impact of yield volatility on i/r risk of bonds

Page 86



Page 87



Exchange- traded vs. OTC

Forward contracts Forward commitment Futures contracts Swaps

Calls Contingent claim Options Puts Convertible, callable bonds

60. Derivatives Markets And Instruments


c. Derivative markets

Purposes -

Law of one price

2 securities/portfolios with identical cash flows

d. Arbitrage
2 securities with uncertain returns combined in a portfolio

Page 88
Long position

a. Positions
Short position


Deliverable forward contracts Cash settlement

b. Settling Basics
Terminating a position prior to expiration with same party (offsetting) with other party


Banks/Financial institutions Bid-ask prices

c. Parties
Corporations End user Gov. units Non-profit

Single stocks

1. Equity forward (LOS d)

Portfolio of stocks Stock index With or without dividends

Settled before bonds mature Quote: annualized % discount from FACE

Zero-coupon bonds (T-bills)

61. Forward

2. Bond Forward (LOS d)

Types Coupon bonds

Quote: yield to maturity Exclusive of accrued interest Include provisions for default, embedded options Can be on individual or portfolio of bonds

Large banks outside of US Denominated in U$ Published daily by British Banker's Association Eurodollar time deposit Compiled from quotes from large banks E.g..: LIBOR Annualized 360-day/year Add-on rate (# T-bill) = reference/benchmark rate

e. Rates


Euro lending rate, established in Frankfurt, published by ECB

3. Loan forward (FRA) f. Features

Settle in cash No actual loan Long=borrower


g. Payoff of an FRA

Term of FRA # Term of loan Quote E.g.: 2x5 FRA Off-the-run FRA

4. Currency Forward (LOS h)

Page 89

Similar to forward

Deliverable or cash settlement Zero value at beginning

Differ from forward

Futures : exchange- traded >< Forwards are private, do NOT trade Futures are highly standardized >< Forwards are customized Futures: clearinghouse as counterparty --> reduce credit risk Futures market regulated by government

a,b. Characteristics of futures (vs. Forward)

Standardization Long vs. Short

Quality, Quantity, Delivery time, manner, minimum price fluctuation Uniformity promotes market liquidity

Hedger vs. Speculator

# margins in securities markets Initial margin Types of margins Maintenance margin Variation margin Settlement price How a futures trade takes place

c. Margins

Price limits

Limit move Locked limit

Limit up Limit down

62. Futures
Marking to market

adjust margin balance on daily basis (or more frequent in chaotic situations)

Delivery 4 ways Cash settlement Reverse/ Offsetting/ Closing out

e. Terminate a futures

Ex-pit transactions

Delivery options in futures contracts

For short position What (T-bonds), where (gold, corn), when to deliver

T-bill futures

Eurodollar futures


T-bond futures

Stock Index futures

Currency futures

Definition Call vs. Put

Page 90

a. Options characteristics

Long vs. Short Option premium

b. American vs. European options


c. Moneyness

Out-of-the-money At-the-money

d. Exchange-traded vs. OTC options

63.1. Option (part 1)

Equity Financial options Bond Interest rate Currencies Options on futures Commodity options Stock indices contract multiplier

e. Underlying instruments

interest rate options f. Compare FRAs


g. Interest rate ...

Floor Collar

Page 91

for a stock option

h. Option payoffs

for interest rate options

Intrinsic value

i. Option value =

+ Time value

European call European put

j,k. Rules for minimum values and lower bounds

American call American put

63.2. Option (part 2)

Exercise price Time to expiration

l,o. Option price affected by

Interest rate Volatility

m. Put- Call parity

Put-Call parity

n. CF on the underlying asset affect

Lower bounds

Page 92


Mutual termination


How swaps are terminated

Offsetting contract Resale Swaption

64. Swap
Currency swaps


Plain vanilla interest rate swaps

Equity swaps

Page 93

Value at expiration Profit Maximum profit/loss

a. Simple Call & Put

Breakeven underlying price General shape of the graph Market outlook of investors

b1. Covered call

b2. Protective put

Page 94



Page 95

Open- end vs. Closed- end NAV

a. Managed investment companies (mutual funds)

Investment company fees

one-time fees ongoing annual fees

Style Sector

b. Strategies

Index Global Stable Value


mimic an index

In-kind process


price tax


66.1. Alternative InvestmentsPart 1


Exchange traded Better risk management Composition is known Operating expense ratio No trading at a discount or premium Tax

b,c,d. ETF

Dividend Few indices Disadvantages Intraday trade Inefficient markets Larger investors Market risk Asset class/ sector risk Risks Trading prices # NAV (depth and liquidity) Tracking errors Derivative risks --> credit risk Currency and country risks

Outright ownership Leveraged equity position Mortgages Aggregation vehicles

Page 96



e,f,g. Real Estate Investment

Cost method

f,g. Approaches to the valuation of real estate

Sales comparison method

Income method

Discounted after tax cash flow model

Seed stage


66.2. Alternative InvestmentsPart 2

Formative stage Early stage

Start-up financing

Initial marketing


Balanced stage

First stage financing Second stage investing

Commercial production

Producing and selling products Not yet generating income

Later stage

Expansion stage financing

Third stage financing

Major expansion

h,i. Venture capital investing

Illiquidity Long term horizon

Mezzanine (bridge financing)


Difficulty in valuation Limited data Characteristics Entrepreneurial / Management mismatches Fund Manager incentive mistakes Timing in the business cycle Requirement for extensive operations analysis i. NPV of a venture capital project

Absolute return Limited partnership Forms Limited liability corporation Offshore corporation Long/short funds Classifications Market-neutral funds Global macro funds Event- driven funds Leverage Illiquidity Potential for mispricing

Page 97

j. Hedge fund


Unique risks

Counterparty credit risk Settlement errors Short covering Margin calls

Performance Self-selection bias Backfilling bias Survivorship bias Smoothed pricing Option-like strategies Fee structures and gaming Effect of survivorship bias



66.3. Alternative InvestmentsPart 3

k. Fund of funds investing

Fund to invest in hedge funds Benefits Drawbacks

n. How legal issues affect valuation

n,o. Closely held companies

o. Valuation methods

Cost approach Comparable approach Income approach


p. Distressed securities investing

compare with VC

Commodities Motivation for investing in Commodities derivatives Commodity-linked securities

q,r Commodities

Sources of return on Collateralized commodity futures position

Page 98

a. Relationship between spot prices and expected future prices

Contango Backwardation

67. Investing In Commodities

Sources of return b. Commodity investment Risk Effect on portfolio

c. Commodity index strategy

Active investment