Formulas

Question 1

What is the ACB of a Whole life policy?

Answer 1

ACB = (Premiums + Loan int Paid) - Dividends received - NCPI

Question 2

What is the formula for Portfolio Expected Return?

Answer 2

E(Rp) = ∑(wi × Ri)

Measures: Weighted average return of all holdings. Usually asked: Find portfolio return given weights & returns (sometimes solve for missing weight).

Question 3

What is the formula for Portfolio Variance (2 assets)?

Answer 3

σp² = wA²σA² + wB²σB² + 2wAwBσAσBρAB

Measures: Portfolio volatility (risk), adjusted for diversification. Usually asked: Find portfolio standard deviation; test effects of correlation (ρ = +1 → no diversification, ρ = −1 → perfect hedge).

Question 4

What is the formula for the Sharpe Ratio?

Answer 4

S = (Rp - Rf) / σp

Measures: Excess return per unit of total risk (volatility). Usually asked: Compare portfolios → higher Sharpe = better risk-adjusted performance.

Question 5

What is the formula for CAPM (Capital Asset Pricing Model)?

Answer 5

E(Ri) = Rf + βi(E(Rm) - Rf)

Measures: Theoretical required return given systematic risk (β). Usually asked: Find expected return of a stock, or solve for β if return is known.

Question 6

What is the formula for Beta?

Answer 6

βi = Cov(Ri, Rm) / σm²

Measures: Systematic risk (sensitivity to market). Usually asked: Calculate beta from covariance & variance; interpret (β > 1 = aggressive, β < 1 = defensive).

Question 7

What is the formula for Jensen’s Alpha?

Answer 7

α = Rp - [Rf + βp(Rm - Rf)]

Measures: Fund manager’s skill/performance vs. CAPM prediction. Usually asked: Positive alpha = outperformance; negative = underperformance.

Question 8

What is the formula for the Treynor Ratio?

Answer 8

T = (Rp - Rf) / βp

Measures: Excess return per unit of systematic risk (β). Usually asked: Compare portfolios when diversifiable risk is not relevant.

Question 9

What is the formula for Coefficient of Variation (CV)?

Answer 9

CV = σ / E(R)

Measures: Risk per unit of return. Useful when comparing assets with very different returns. Usually asked: Lower CV = more efficient investment.

Question 10

What is a key difference between Sharpe and Treynor ratios?

Answer 10

Sharpe = total risk (σ), Treynor = systematic risk (β)

CFP exam tip: Alpha → directly tests manager skill. CAPM & Beta → test required returns and risk premium.

Question 11

Formula, risk used, and what Sharpe measures?

Answer 11

Formula: (Rp - Rf) / σp.
Risk: Total risk (σ).
Measures: Excess return per unit of total volatility.

Question 12

Formula, risk used, and what Treynor measures?

Answer 12

Formula: (Rp - Rf) / βp.
Risk: Systematic risk (β).
Measures: Excess return per unit of market risk.

Question 13

Formula and what Jensen’s Alpha measures?

Answer 13

Formula: α = Rp - [Rf + βp(Rm - Rf)].
Measures: Portfolio manager’s skill vs. CAPM benchmark. Positive α = outperformance.

Question 14

Formula and what CV measures?

Answer 14

Formula: CV = σ / E(R).
Measures: Risk per unit of expected return. Lower CV = more efficient.

Question 15

What is the formula for valuing a stock with growing dividends?

Answer 15

𝑃₀ = 𝐷₁/(𝑟 - 𝑔)

where 𝐷₁ = next dividend.

Question 16

If given last dividend (D₀), what must you do before using DDM?

Answer 16

Convert: 𝐷₁ = 𝐷₀(1 + 𝑔)

Question 17

Rearrange DDM to find required return?

Answer 17

𝑟 = 𝐷₁/P₀ + 𝑔

Question 18

Rearrange DDM to find growth (g)?

Answer 18

𝑔 = 𝑟 - 𝐷₁/𝑃₀

Question 19

What formula gives the required return based on market risk?

Answer 19

𝐸(𝑅) = 𝑅p-[Rf + β (Rm -Rf)]

Question 20

How do CAPM and DDM work together?

Answer 20

Use CAPM to find required return (r), then plug r into DDM to find fair stock price.

Question 21

Using DDM, how do you decide if a stock is overvalued or undervalued?

Answer 21

If DDM price > market price → undervalued (buy). If DDM price < market price → overvalued (sell).

Question 22

What 2 components make up required return (r) in DDM?

Answer 22

Dividend yield D₁/𝑃₀ + growth (g).

Question 23

Formula for the Current Ratio?

Answer 23

Current Ratio = Current Assets / Current Liabilities

Measures liquidity: higher = stronger ability to pay short-term debts.

Question 24

Formula for the Quick Ratio (Acid-Test)?

Answer 24

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

Stricter liquidity test (excludes inventory).

Question 25

Formula for Working Capital?

Answer 25

Working Capital = Current Assets - Current Liabilities ## Footnote Measures absolute cushion for short-term obligations.

Question 26

Formula for EPS (Earnings per Share)?

Answer 26

EPS = Net Income / Weighted Avg. Shares Outstanding ## Footnote Key measure of profitability per share.

Question 27

Formula for P/E Ratio?

Answer 27

P/E = Price per Share / EPS ## Footnote Shows how much investors pay for $1 of earnings.

Question 28

If EPS rises, what usually happens to the stock price (all else equal)?

Answer 28

Stock price tends to increase, since higher earnings per share make the company more valuable.

Question 29

If P/E is high, what does that signal?

Answer 29

Investors expect high growth (growth stock).

Question 30

If P/E is low, what does that signal?

Answer 30

Investors expect lower growth (value stock).