Exam B

Explain the duties to employer standard relating to additional compensation compensation agreements

Candidates must not accept or undertake any situation that may conflict with the employer’s interest, unless written consent from all parties is obtained

What’s an example of poor earnings quality in relation to discretionary decisions?

If, for example, provisions for credit losses was increase with or in excess of the reduction in revenue, this would hide the decline in pretax income, indicating a decrease in earnings quality

For the effect on pension obligation, what is the impact of a reduction of the discount rate on the debt-to-equity ratio?

A reduction of the discount rate means a decrease in pension obligation, meaning additional equity is available, increasing the equity component of the D/E ratio

DDM reminder:

Make sure to include the first period if it’s given

Reminder for FCFE discount model

FCFE for each period is the starting FCFE x g^t, with the adjustments from the financial data made after

Between IG, HY and Government bonds, how would I expect them to perform after the business cycle has peaked and the yield curve has inverted?

If the business cycle has peaked and the yield curve has inverted, this means that the economy is likely heading towards a recession. This means that the HY will likely perform the worst, followed by the IG bonds, and the Government Bond should perform best

A sharp decline in real earnings nearly always coincides with what?

A recession

A leading indicator of the business cycle is the trend in

Corporate profit margins

What are the characteristics of short-biased funds?

They are naturally exposed to greater volatility, and therefore do not make use of significant leverage

What are the characteristics of long/short equity funds?

They buy/sell any stock they deem to be under/overvalued. They may use leverage but it depends on the strategy and risk involved

What are the characteristics of market-neutral strategies?

Take long and short positions in securities with similar characteristics, allowing them to maintain a market neutral position, tend to have a diverse portfolio adjusted over short time horizons with the use of derivatives and indexes to achieve neutral beta

What do distressed securities and merger arbitrage have in common?

They are both event-driven strategies, that have binary outcomes

What do I need to remember for Conditional Factor Risk Models that provide exposures to the normal exposure, and alternative exposure?

The normal exposure is the base case, the alternative exposure is a second part of the same model, so I need to include the base case within the alternative as well

What’s a key point to pathways valuation?

It can be done two ways, forwards and backwards:

• Sequential, path-by-path discounting along a single pathway, or

• Discounting the bond’s cash flows by the spot rate inferred from the 1-period rates

Simple way to think of binominal tree valuation of a FRN with a coupon floor

Essentially works as normally, except that the coupon is the discount rate, unless it is less than the floor, in which case the floor is used as the coupon

What is a busted convertible?

The conversion value is so deep out of the bond that the bond characteristics mimics that of an otherwise identical nonconvertible bond

Formula for conglomerate discount

EV - (Sum of the Parts), where sum of the parts is essentially the EV of the other components

When is a control discount/premium applied?

A control premium is applied when an individual has a controlling interest i.e. they have control over decisions, and vice-versa for discount when noncontrolling

When is an excessive earnings method used for valuation?

small firms with significant intangible assets and positive normalised earnings

What are the two types of synergies I should be aware of?

Revenue synergies and cost synergies

Golden rule for Ethics

Check every claim - i.e. if they say only CFA institute people work there, make sure that’s true

What is an important concept in relation to representation of the CFA charter?

Members cannot misrepresent or exaggerate the meaning or implication of the CFA charter, for example saying that due to the Charterholders enhanced skillsets, the fund should continue to outperform benchmarks

What is the standard requirements in relation to limitations?

In communication with clients and prospective clients, candidates must discuss all limitations and risks within an investment strategy or process, regardless if they are relevant

What’s the Grinold Scaling Rule?

Forecasted Active Return = IC * Volatility * Scores

What does a greater uncertainty of the Information Coefficient (IC) relate to?

A more ambitious managers forecast of active return, and the IC could either increase or decrease depending on superior skill or lack thereof

Price Return, Roll Return, and Collateral Return Formulas:

Price: (P₁ - P₀) / P₀ - (As of today)

Collateral: Yield * Time Period

Roll: (Near-term - Farther-term) / Near-term

Total = Sum of all

What does backwardation mean?

Spot Prices are greater than Futures Prices, and the basis between these is positive

What can be said about precious metals (i.e. gold and silver) futures?

Historically they have had negative average rolle returns and are associated with contango, due to storage costs and investment appeal

What’s the basis swap for

related for two different commodities

What’s the total return swap for?

return on the commodity index

What’s the excess return swap for?

price of commodity in excess of the reference rate

What’s the variance swap for?

Difference between commodities actual and expected variance

What’s the volatility swap for?

difference of the commodity and its actual volatility

What’s the difference between a variance and volatility commodity swap?

variance = volatility squared, volatility = standard deviation

What’s the effective duration of a zcb?

Approximately it’s maturity

What’s the effective duration of a fixed-rate coupon bond?

< maturity

What’s the effective duration of a callable bond?

<= duration of straight bond

What’s the effective duration of a putable bond?

<= duration of straight bond

What’s the effective duration of a floater bond?

approximately it’s time to next reset

When is one-sided duration the appropriate duration measure?

When you are measuring a upward or doward (parralel) shift in the benchmark yield curve

What does a dickey-fuller test failing to reject the null hypothesis indicate?

error term has a unit root and is not covariance stationary

In terms of shareholder voting rights, what is the standard of an industry leading policy?

Straight voting, over dual-class, because in straight voting, all shareholders have equal say, while as with dual-class is can be disproportionately weighted towards founders etc.

What is vertical integration?

Adding distinct stages into the companys supply chain within its company itself

Credit Rating Transition Matrix

YTM - Sum of(Credit Spread * Duration * Probability)

Why would it be innapropriate to cite as marketing material the track record of a previous employer that you worked at?

Because it might overstate the individuals contribution of that track record, particularly if they were not a significant contributor (i.e. not a decision maker)

Is it a violation for a member or candidate to transact within clients trades in their own fund?

Providing they do not specifically benefit from the clients transactions, they are paying members of the fund, and do not disadvantage the client

What does an increase of dividend likely mean for a companys valuation?

Valuation will likely lower, because while the dividend itself will be higher, the sustainable growth rate will be lower which impacts the rest of the valuation