1
Q
Accruals Ratio and Accruals Calc
(Operating Assets and Liabilities)
A
- Accruals Ratio = Accruals / Net Operating Assets
- Net Operating Assets:
- Operating Assets : Total Assets - Cash & equivalents - marketable securites
- Operating Liabilities: total Liabilities - total Debt
- Net Operating Assets:
- OR:
- (YoY increase in Net Operating Assets) / (Avg Net Operating Assets)
- Accruals = NI - CFO - CFI
2
Q
Bracketing Rates
A
3
Q
Periodic Pension Cost (IFRS and GAAP)
A
IFRS:
+ Service Cost
+/- NET interest expense (BGN Funded Status * Discount Rate, or BGN Plan Assets - BGN PBO)
+/- Past Service Costs
= Periodic Pension Expense (INCOME STATEMENT)
GAAP:
+Service Cost
+ Interest Cost
- expected return on plan assets
+/- Amort of Actuarial G/L
+/- Amort of Prior Service Costs
= PPC –> (INCOME STATEMENT)
(bottom three are smoothed events)
4
Q
PBO
A
BGN PBO
+ Service Cost
+ Interest Cost
+/- Actuarial G/L
+/- PSC
- Benefits Paid
END PBO
5
Q
TPPC (plus difference between GAAP and IFRS)
A
Contributions - CHANGE in funded status
- same calc for GAAP and IFRS, but for IFRS it’s in OCI, not IS
Interest + service cost + plan amendments + actuarial G/L - Actual Return on Plan Assets
6
Q
Net Premium Written vs. Earned
A
- Written = premiums earned over coverage period (net of reinsurance)
- Earned = premiums earned over accounting period
7
Q
Expense Ratio
A
Underwriting Expenses (including commissions)
_______________________________________
Net Premium WRITTEN
8
Q
UW Loss Ratio
A
Incurred Losses + Loss Adjustment Expenses
___________________________________________
Net Premium EARNED
- Incurred Losses = Claims + change in loss resreves*
- Loss Adjustment Expenses = cost of investigating claims*
9
Q
Combined Ratio
A
Total Incurred Losses + Expenses
___________________________________-
Net Premium EARNED
- sum of UW loss and expense ratios
- High Ratio = soft market
- Low Ratio = hard market
- >100% = underwriting loss
10
Q
LIFO Liquidation
A
- When a firm slows the purchase of inventory items so that older, lower costs are used to calculate COGS
- Leads to:
- Lower COGS
- Lower Inventory
- Artificially increase Gross and Net Margins
11
Q
Cash Conversion Cycle
A
- DSO + Days Inventory on Hand - Days of Payables
- DSO = 365 / Receivables turnover
- Receivables Turnover = Rev / AR
- Days Inventory on Hand = 365 / Inventory Turnover
- Inventory Turnover = COGS / Avg Inventory
- Days of Payables = 365 / Payables Turnover
- Payables turnover = Purchase / Avg Payables
- DSO = 365 / Receivables turnover
12
Q
Cash Ratio
A
Cash + Marketable Securities
_____________________________________
Current Liabilities
13
Q
Hyperinflation
A
If cumulative 3-yr inflation is >100%
Inflation =
1+ Nominal Rate
_________________
1+ real rate
- During Hyperinflation, you want to reduce net monetary assets or increase net monetary liabilities
- issue debt in the local currency, and buy fixed assets using the proceeds
- GAAP: adjusting for nonmonetary A&L is not allowed - functional currency needs to be parent Currency
- IFRS: restate financials for inflation, then use current rate method (translate)
14
Q
Treatment of Bonds under Amortized Cost
A
- Interest is calculated using yield at hte purchase date
- Find the yield at purchase date using the calculator (solve for i)
- (NOTE: if semiannual, DIVIDE RATE BY 2, and payments happen twice a year)
- Bond value at each date (every six months if semiannual) = original value - coupon + amortized discount
15
Q
A
16
Q
Lidquidity Coverage Ratio and # days of Stress Cash
A
- Liquidity Coverage Ratio =
- High Quality Liquid Assets / Net Outflows
- # days of stress volume Cash=
- Liquidity Coverage Ratio x # of days
- # of days will be given on exam eg “x-day liquidity needs”
- Liquidity Coverage Ratio x # of days
17
Q
Adjusted Operating Profit
A
Reporting Operating Profit
+Reported Pension Expense
-Service Cost
_______________
Adjusted Operating Profit
18
Q
FVPA Build
A
BGN FVPA
+/- ACTUAL return on plan assets
+ Contributions
- Benefits Paid
__________________
END FVPA
19
Q
WCInv
A
Change In (Current Assets - Cash & Investments) - Current L’s - ST Debt & Dividends payable)
Or BGN WC - END WC
20
Q
FCInv
A
Ending Net PPE
-BGN Net PPE
+Depreciation
- gain (loss) on sale of PPE
21
Q
Unlever and Relever Beta
A
Unlever:
[1 / (1+DE)] * b
Re-lever
1+D/E * b
22
Q
QM Terms (SEE, SST, etc.)
A
Terms: know what they measure and how you use them to construct ANOVA table
- Standard Error of Estimate (SEE): measures degree of variability of the actual Y-values relative to estimated Y-values from a regression equation à gauges “fit” of regression line à it is the standard deviation of error terms in the regression, or standard error of the regression à it’s the StDev of the residualsà strong relationship = low SEE – you want low
- Total sum of squares (SST): measures the total variation in the dependent variable (different from variance) à equal to sum of the squared differences between the actual Y-values and mean of Y
- Regression sum of squares (RSS): measures variation of the dependent variable that is explained by the independent variable à sum of the squared distances between predicted Y-values and the mean of Y
- Sum of squared errors (SSE): measures the unexplained variation in the dependent variable à sum of squared vertical distances between the actual Y-values and the predicted Y-values on the regression line à it’s the sum of the squared residuals (sum of squares not explained)
- SSE + RSS = SST: total variation = unexplained variation + explained variation
- R Squared: the percentage of total variation in the dependent variable that is explained by the independent variable
- = explained variation (RSS) / total variation (SST)
- ANOVA Table: all it does is show the difference between what is or isn’t explained by the model à the total variability that is or isn’t explained à partial table will be given on exam
23
Q
Heteroskedasticity and Correcting It
A
Heteroskedacity: when error term variance is non-constant
- Two types:
- Unconditional—not related to independent variablesàcauses no problems
- Conditional—related to independent variables (see scatter plot)àIS a problemàt-stats (And f-stat) are unreliable
- Note: heteroskedacity does not impact the estimate, but standard error is messed up, and therefore so are the T and F stats
Detecting: Scatter (see right) or Breusch-Pagan Test
- Know what Breusch does, nothing else:
- Regress squared residuals on “X” variablesàtest significant of resulting R2 (do the independent variables explain a significant part of the variation in squared residuals?
Correcting:
- Use robust standard errors (just memorize that this is how to fix it—don’t need to know what it is)
- Or use generalized least squares (modifying original equation to eliminate heteroskedasticity)
24
Q
Serial Correlation
A
Serial Correlation: Positive autocorrelationàeach error term tends I nthe same direction as previous term
- Common in financial data
- T-ststas are to ohigh (type I errors)
- Coefficients still consistent and unbiased
Detecting
- Scatter Plot
- Durbin-Watson statistic: formal test of error term correlation (don’t blow this off but no need to be an expert)
- DW Test: three cases: no correlation, positive correlation, and negative correlation: DW = 2 times correlation – so “how close to 2” does DW have to be to conclude no serial correlation?
Correcting:
- Use robust standard errors (just memorize that this is how to fix it—don’t need to know what it is)
Or use generalized least squares (modifying original equation to eliminate heteroskedasticity)
More detail in slide deck
25
Forward Integration
vs
Vertical Merger
vs
Horizontal Merger
* Forward Integration
* extends acquirer down the value chain - allows them to sell directly to consumer if they were not previously
* Vertical Merger
* augments existing manufacturing operations and development department, or gives them access higher up the supply chain
* Horizontal merger
* eg purchase a residential lighting company by an industrial lighting company - not related to acquirer's value chain
26
When to prefer FCFF vs FCFE
* FCFE when dividends differ significantly from company's capacity to pay difidends
* FCFE when change of control anticipated
* FCFF when capital structure is unstable or ever-changing
27
Calculate Market Conversion Premium Ratio
Current conversion ratio = par value of the bond divided by current conversion price
eg (100,000 / 25) = 4000
Market conversion price = convertible bond price divided by the conversion ratio
eg (127,000 / 4000) = 31.75
Market Conversion premium is the conversion price premium over the market price of the stock
31.75 - 30.20 = 1.55
The market conversion premium ratio is the market conversion premium divided by the current share price
1.55/30/20 = 5.13%
28
Active Return and Information Ratio
**Active Return:**
Rp - Rb
**IR:**
Rp - Rb
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
StDv (Rp - Rb)
or Active return
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
StDv of RA
**Active Risk = StDev (or standard error? - sigma) of active return**
**You want a HIGH Information Ratio**
29
Fundamental Law 3 components Definitions
Information Ratio
Information Coefficient
Breadth
* measures productivity of manager - depends on both skill level and how many opportunities are identified and put to use in teh funds
* model can measure both ex ante and ex post value added
* **Information Ratio**
* measures how much active return has been earned for level of risk taken
* active return / active risk, or (Rp - RB) / (Stdv(Rp-Rb)
* **Information Coefficient**
* correlation between forecasted active returns and realized active returns.
* **Transfer Coefficient**
* measures degree to which a fund manager's forecast is translated into active weights
* **Breadth**
* equal to the number of independent decision made per year by the investor in constructing the portfolio
30
Residual Income Models
31
MVA and
Invested Capital
MVA = Mkt Value Debt + Mkt Value Equity - Invested Capital
Invested Capital = LTD + Shareholders Equity
32
Convertibles
Convertible to fixed # of shares
Intuition: option on stock held by hondholder
Important Point: conversion option is NOT affected by interest rates
IMPORTANT: KNOW THE TERMINOLOGY:
Conversion Ratio = # shares / bond
Conversion Price = issue price / conversion ratio
Market Conversion Price = Effective price per share when converting
Conversion Value = market price of stock after conversion X conversion ratio
Straight value = PV of all CFs if not convertible
\* Minimum Value of a convertible bond = greater of conversion value (AKA stock value) and straight value (AKA bond value)
Market conversion premium ratio = market conversion premium / market price
Premium over straight value = (MV of bond / Straight Value) - 1
33
Backwardation and Contango
* Backwardation
* FP less than spot
* term structure negative slope
* Roll return is positive
* Contango
* FP greater than spot
* term structure positive slope
* Roll Return is negative
* purchase fewer, higher-priced contracts to replace expiring lower-priced contracts
34
Commodities Theories:
Insurance
Storage
Hedging Pressure
* Insurance Theory
* producers take short hedges
* speculators earn premium
* Long position earns a positive return
* implies backwardation is normal
* Storage Theory
* commodities that are difficult to store have high convenience yield
* Hedging Pressure Hypothesis
* Producers as well as users hedge
* Long OR short positions may earn premium
* Depends on balance of hedgers vs speculators
35
QM Errors / Violations and Correcting Them
36
Spread Measures
Swap Spread
I sPread
Z spread
TED spread
LIBOR OIS Spread
* Swap Spread
* swap fixed rate - treasury yield of the same maturity
* I-spread
* bond rate - interpolated swap fixed rate of the same maturity
* Z-spread
* Constant spread added to spot rate curve to force PV(CF) to equal mkt price of bond
* TED Spread
* LIBOR - Tbill yield of same maturity
* LIBOR-OIS Spread = LIBOR - overnight indexed swap rate (index rate can be fed funds rate)
37
DPI
RVPI
TVPI
LP Return
* DPI
* cumulative distributions to LP's (net of fees & carry) / cumulative invested capital
* measures REALIZED return
* net of mgmt fees and carry
* cash on cash return
* RVPI
* (total capital called + total operating results - total fees & carry - total distributions) / total capital called
* measures unrealized return, net of fees and carry
* TVPI
* sum of DVPI and RVPI
* total value to PIC
* measures realized and unrealized, also net of fees and carry
* LP Return:
* (Gross return - Mgmt fees) - (net return x carry)
38
For PE determine if hurdle hit
IRR on Calculator:
cash flows:
- invested capital(pic) + gross return y1 ... + (gross return final year + return of PIC)
--\> IRR on calc will get you the IRR of the investment - if above hurdle, they get carry
39
CVA terms
* Exposure: amount at risk before factoring in recovery
* Recovery rate: % amount recovered NOTE don't mix up with Loss Severity...it's 1- loss severity
* LGD: exposure x loss severity
* Hazard rate: INITIAL probability of default
* probabilty of survival: (1- hazard rate)^t
* prob or default = hazard rate x probability of survival at t-1
* Expected Loss = prob of default x LGD
* PVEL: expected loss X discount factor (sum these to get CVA)
40
Equivalent Annual Annuity
* Take NPV of project - that's the PV in calculator
* discount rate = cost of capital or hurdle rate of project
* N = years of life used to get the NPV
* FV = 0
* CALC --\> PMT: this is your EAA
41
Growth in potential GDP
TFP growth + (share of Labor x growth in labor) +(share of capital x growth in capital)
42
Absolute Convergence
Conditional Convergence
Club Convergence
* Absolute:
* developing countries (Regardless of characteristics) will catch up in **per capita output** over time
* Conditional:
* only if same population growth, savings rate, and production function
* Club:
* members of the club will catch up with richest nations in the club, but outsiders will continue to fall behind
* you can join the club my making the necessary institutional changes
43
Conditional VaR
Incremental VaR
Marginal VaR
* Conditional
* expected loss given that loss exceeds VaR
* Incremental
* estimated change in VaR from a specific change in size of a portfolio position
* Marginal
* estimated change in VaR for a small changei na portfolio position
* used as an estimate of the position's contribution to overall VaR
CFA Level II
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