CFA Master Study List

commodity swaps:
basis =

spot price - near term futures price

commodity swaps:

calendar spread =

near term futures price - longer term future price

futures contracts:

total return =

price return + roll return + collateral return

commodities contracts:

basis swap

a bet on one price versus another

commodities contracts:

volatility swap

long vol means volatility is higher than strike

commodities contracts:

excess return swap

a bet on the level of an index

futures contracts:

insurance theory

backwardation; producers sell futures because they want to lock in prices

futures contracts:

hedging pressure hypothesis

dominant force between producers and consumers hedging wins

futures contracts:

theory of storage

high storage costs - contango; low storage costs - backwardation

commodities indexes:

a production-weighted fund will have a heavy exposure to:

energy

REITs

no corporate tax; must distribute 90% of taxable income; high dividend yield

REOC

taxed as regular corporation; can retain earnings; riskier projects; lower dividend yield; growth oriented

Equity REITs

own and operate properties; income mostly from rent

Mortgage REITs

hold mortgages or MBS; leveraged; highly sensitive to interest rates

real estate investment:

apartments

short leases; rents adjust quickly

real estate investment:

office/retail

long leases; rents adjust slowly; more stable

real estate investment:

lodging/hotels

daily pricing; most cyclical

real estate investment:

self storage

short leases; rents adjust quickly

NAV Calculation Steps

estimate forward NOI, subtracting non-cash rent; divide by cap rate; add other assets; subtract liabilities; divide by diluted shares outstanding

Funds From Operations(FFO) Calculation

net income + depreciation + amortization + losses on property sales - gains on property sales

Adjusted FFO Calculation (better proxy for sustainable cash flow)

FFO - non cash rent - recurring capex and leasing costs

Real Estate Valuation:

A premium or discount to NAV depends on these 3 things:

market sentiment; growth expectations; asset quality

REIT Valuation:

Cap rate =

discount rate - estimated growth rate

REIT Valuation:

3 absolute value methods:

NAV; dividend discount; DCF

REIT Valuation:

3 relative value methods:

P/FFO; P/AFFO; EV/EBITDA

Real Estate Investment:

NOI =

effective gross income - operating expenses - property maintenance allowance

Real Estate Investment:

gross rent =

rent per unit or space x rentable space

Real Estate Investment:

effective gross income =

gross rent + other income - vacancy/concessions

Real Estate Investment:

LTV =

mortgage principal outstanding / current property value

Real Estate Investment:

debt service coverage(DSC) ratio =

NOI / debt service

Real Estate Investment:

debt service =

principal + interest payments

Real Estate Investment:

equity dividend rate =

pre-tax cash flow / initial equity investment

Real Estate Investment:

pre-tax cash flow =

NOI - debt service

Real Estate Investment:

initial equity =

property purchase price - mortgage amount

Real Estate Investment:

depreciable base =

property cost + qualifying improvements - land value

Real Estate Investment:

annual depreciation =

depreciable base / useful life

Real Estate Investment:

taxable income =

NOI - interest expense - depreciation expense

Real Estate Investment:

core-plus

stable but requires some improvements

Real Estate Investment:

value-add property

vacancies/upgrades; more execution risk

Real Estate Investment:

Lessor =

property owner

Real Estate Investment:

lessee =

tenant

Real Estate Investment:

first lien

lender has priority claim on property upon default

Real Estate Investment:

Appraisal-based indexes have…

appraisal lag which overstates the diversification benefits of real estate

Real Estate Investment:

Transaction-based indexes …

lead appraisal-based indexes but introduce noise in the index measurement

Real Estate Investment:

loss to lease =

difference between current market rent and rent being charged on existing leases

Real Estate Investment:

Stable NOI —>

direct capitalization

Real Estate Investment:

changing/predictable NOI —>

DCF

Real Estate Investment:

Income Approach:

income generation; large, unique commercial properties

Real Estate Investment:

Cost Approach:

investor shouldn’t pay more than the cost to build an equivalent property

Real Estate Investment:

sales comparison approach:

recent transaction prices of comps; single family residential

Real Estate Indexes:

2 types of indexes:

repeat sales; hedonic(one sale is fine; regression controls for differences)

Real Estate Investment:

holding period return =

NOI - capex + ending value - beginning value / beginning value

Real Estate Investment:

MBS —> rate increase means duration

increases

Real Estate Investment:

Cost Approach Property Value =

building replacement cost + land value - depreciation

Econ:

labor productivity =

TFP + Capital deepening

Econ:

Club convergence:

only countries with proper institutions converge toward rich country income levels

Econ:

conditional convergence:

Converge if they have the same savings rate, population growth rate, and technology

Econ:

Absolute convergence:

all developing countries catch up regardless of differences

Econ:

Scale effect:

larger markets allow greater economies of scale

Econ:

Backwardness effect:

Poorer countries catch up through knowledge spillovers and tech adoption

Econ:

Classical growth theory:

GDP per capita growth is temporary; higher income results in population growth causing a return to subsistence level

Econ:

Neoclassical growth theory

diminishing returns to capital; exogenous technology; supports convergence; free trade speeds up convergence, but doesn’t permanently increase steady-state growth rate

Econ:

Endogenous growth theory

internal technology/knowledge improvements can fuel long run growth; selection effect; scale effect; backwardness effect

Econ:

Higher potential GDP growth —>

Higher real interest rates

Econ:

Solow GDP Growth accounting equation - GDP growth =

TFP growth + (capital elasticity * capital growth) + (labor elasticity * labor/population growth)

Econ:

In the neoclassical model, as a country approaches its steady state, capital deepening…

Approaches 0

Econ:

Substantive laws:

Define people’s rights, duties, and obligations

Econ:

Cobb-Douglas Production Function: economic output =

technology * (capital ^ capital share of output) * (labor ^ labor share of output)

Econ:

Cobb-Douglas production function insights

diminishing returns to capital individually; constant returns to scale when all inputs increase together

Econ:

Open trade encourages more…

Domestic r&d

Failure of a major financial institution can threaten the broader financial system

Systemic risk

Financial problems spread from one institution/market/economy to others

financial contagion

Basel III 3 pillars

Minimum capital requirement; minimum liquidity requirement; stable funding requirement

Basel III Minimum capital requirement

Requires banks to hold equity against risk-weighted assets

Basel III minimum liquidity requirement

Hold enough high quality liquid assets to survive a 30-day stress period

Basel III stable funding requirement

Maintain sufficient stable funding over a 1 year horizon

CAMELS framework

Capital adequacy, asset quality, management, earnings. Liquidity, sensitivity to market risk

FSA:

P&C insurers: loss ratio =

losses + loss adjustment expenses / net premiums earned

FSA:

A lower loss ratio indicates …

Greater success in estimating insured risks

FSA:

P&C insurers: underwriting expense ratio =

underwriting expenses / net premiums written

FSA:

P&C insurers: combined ratio =

loss ratio + underwriting expense ratio; less than 100% indicates underwriting profit

FSA:

Net benefit plan obligation decreasing:

Is good because the obligation is less underfunded

FSA:

Capital Adequacy: Three Key Capital Ratios

common equity tier 1 capital; tier 1 capital; total capital

FSA:

If short term interest rates surprisingly increase, banks’ net interest margin will most likely …

Decrease

FSA:

Higher trading incomes results in …

Lower quality of earnings

FSA:

These 2 activities provide more sustainable earnings than trading:

service income; net interest income

FSA:

Capital Adequacy Requirements: Common Equity Tier 1 / RWA >=

4.5%

FSA:

Capital Adequacy Requirements: Tier 1 Capital / RWA >=

6%

FSA:

Capital Adequacy Requirements: Total Capital / RWA >=

8%

FSA:

Depository institutions that function like banks and offer many of the same services as banks; owned by their members; organized as non-profits; don’t pay income tax

credit unions; cooperative and mutual banks

FSA:

originate, sell, and service mortgages; are usually active participants in the securitization markets

mortgage bank

FSA:

depository institutions that specialize in financing long-term residential mortgages

savings and loan association

FSA:

Insurance category that is largely international

Reinsurance

FSA:

Insurance: hard market -

tighter underwriting; higher premiums; higher profitability

FSA:

Insurance: soft market -

heavy competition; lower premiums; lower profitability

FSA:

Basel III Enhancements:

increased level of equity funding of risk-weighted assets; increased stable funding from deposits

FSA:

Bank assets are predominantly measured at:

Fair market value

FSA:

What accounting standards do insurance companies follow?

Statutory accounting rules that differ from GAAP and IFRS

FSA:

Fixed income assets =

Debt securities + loans and deposits

FSA:

When banks borrow short term and lend long term

Maturity transformation