**Unformatted text preview: **Computing Index Prices
Critical relationship between &, and g
full price = PV at last coupon date x (1 + YTM) UT
Forward Contract Value
At time :
Each security in the put-call parity relationship can
stock falls.
accrued interest = coupon payment x (t/T)
Modified duration is the approximate change in a
be expressed as:
bond's price given a 1% change in its YTM:
C = S+ p - T
LEVEL I SCHWESER'S QuickSheet
adjusted divisor
= days from most recent coupon payment to
( 1 + Rf ) T -
(1+ RF)T P
Value-weighted Index
. Small changes in difference between k, and g
( 1 + Rf )
2Vo ( Ay )
At expiration (time t = 1):
CRITICAL CONCEPTS FOR THE 2017 CFA EXAM
L(current prices)(# shares)
Matrix pricing: For illiquid bonds, use yields of bonds
payoff to long = S, - F.(T)
X
[(base year prices)(# base year shares)"
nt growth rate
Effective duration is required if a bond has
Futures vs. Forwards
(1 + RF) T
T = S+ p - c
(1 + RF) T
estimate yield; adjust for
ETHICAL AND PROFESSIONAL
Approximation formula for nominal required rate:
STANDARDS
E(R) = RFR + IP + RP
Expected return, variance of 2-stock portfolio:
Put-Call-Forward Parity
E(RP) = WAE(RA ) + WBE(RB)
Types of Orders
maturity differences with linear interpolation.
embedded options:
Execution instructions: how to trade; e.g., market
Earnings Multiplier Model
(V_) -(V+)
Exchange-traded
2Vo (curve)
Unique contracts
Standardized contracts
The present value of the forward price of the
underlying asset, F,(T) / (1 + Rf), can be
Means
Guaranteed by clearinghouse
substituted for S, in any of the put-call parity
Knowledge of the Law.
sample/population, divided by # of observations.
var (RP) = WAG?(RA) + who?(RB)
Validity instructions: when to execute; e.g., stop
PQ = /En _ payout ratio
Default risk
Price change estimates based on duration only are
Little or no regulation
Regulated
relationships at time 0.
Independence and Objectivity.
Misrepresentation
Geometric mean: used when calculating investment
+2WAWBO(RA)O(RB)P(RA.RB)
. Domestic bonds. Domestic issuer and currency.
Clearing instructions: how to clear and settle; for sell
improved by adjusting for convexity:
Forward Rate Agreements (FRA)
ns over multiple periods or to measure
Normal Distributions
Integrity of Capital Markets
Normal distribution is completely described by its
Market Structures
Price Multiples
lend money at a certain rate at some future date.
ALTERNATIVE INVESTMENTS
I(A) Material Nonpublic In
leading P/E =
II(B) Market Manipulation.
mean and variance.
Interest Rate Swaps
Duties to Clients
RC= (1+R, )x...x(1+RN)|"-1
68% of observations fall within + lo.
Order-driven markets: buyers and sellers matched
forecast EPS next 12 mo.
Asset-Backed Securities
price per share
Residential MBS: home mortgages are collateral.
May be replicated by a series of off-market FRAS
Event-driven strategies: merger arbitrage; distressed/
Loyalty, Prudence, and Care.
Suitability.
harmonic mean =
trailing P/E =
EPS previous 12 mo.
Bond Issuance
Forms of EMH
Underwritten offering: Investment banks buy entire
loans and need credit enhancement.
book value per share
. Buyer of a call option-long asset exposure.
III(E) Preservation of Confidentiality.
Prepayment risk: contraction risk from faster
asset-backed fixed income; general fixed income;
Variance and Standard Deviation
Z-score: "standardizes" observation from normal
. Writer (seller) of a call option-short asset
Variance: average of squared deviations from mean.
distribution; represents # of standard deviations a
Shelf registration: Register entire issue with
volatility; multi-strategy.
Equity strategies: market neutral; fundamental
ional Compensation Arrangements.
given observation is from population mean.
P/S = price per share
regulators but sell over a period of time.
CMOs: pass-through MBS are collateral. May have
observation - population mean _x-
Investment Analysis, Recommendations,
price per share
exposure.
Macro strategies: based on global economic trends.
population variance = 02 = i-
V(A) Diligence and Reasonable Basis.
Binomial Models
cash flow per share
intrinsic value of a put option = Max[0, X - S]
V(B)
Communication with Clients and
Convertible: Bondholder may exchange bond for
Credit card ABS: credit card receivables are
a stock, movements (up/down). A binomial model
FIXED INCOME
Conflicts of Interest
can describe changes in the value of an asset or
Assumes perfect markets in which all information
Hard hurdle rate: incentive fee only on return
Retention.
is cost free and available to everyone at the same
CDOs: Bonds, bank loans, MBS, ABS, or other
above hurdle rate.
time. Even with inside info, investor cannot
Basic Features of Bonds
CDOs are collateral.
Standard deviation: square root of variance.
Issuer. Sovereign, non-sovereign, quasi-government,
but only paid if return is greater than hurdle rate.
VI(C) Referral Fees.
Holding Period Return (HPR)
supranational, corporate, SPE.
Effective yield depends on periodicity. YTM =
Secured bonds are backed by specific collateral and
Responsibilities as a CFA Institute
Member or CFA Candidate
RAPID, P, +D._
Sampling distribution: probability distribution of
EQUITY INVESTMENTS
Maturity. Money market (one year or less); capital
effective yield for annual-pay bonds.
Par value. Bond's principal value (face value).
Semiannual bond basis: YTM = 2 x semiannual
Unsecured bonds are general claims to issuer's cash
Factors that Affect Option Values
Private Equity
VII(A) Conduct as P
product as Participants in CFA Institute
Coefficient of Variation
Internal credit enhancement: Excess spread,
Coefficient of variation (CV): expresses how much
Pists
managers), management buy-ins (new managers)
Designation, and the CFA Program.
Increase
Global Investment Performance Standards
dispersion exists relative to mean of a distribution
External credit enhancement: Surety bonds, letters of
Formative stage: angel investing, seed stage, early
(GIPS")
Central Limit Theorem
Growth: rapid growth, falling prices, limited
. Compliance statement: "[Insert name of firm] has
Central limit theorem: when selecting simple
prepared and presented this report in compliance
standard deviation of a distribution by the mean or
er growth, intense competition,
Price, Yield, Coupon Relationships
Credit Analysis
expected value of the distribution:
declining profitability, cost cutting, weaker firms
Bond prices and yields are inversely related.
Investment grade: Baa3/BBB- or above
Global Investment Performance
Time to
Increas
are: slow growth, consolidation, stable prices,
ncrease*
comparables; discounted cash flow; asset-based.
Sharpe Ratio
high barriers to entry.
expiration
Standard Error
Decline: negative growth, declining prices,
Holding costs
Increas
Decreas
construction, disclosures, presentation and
Sharpe ratio: measures excess return per unit of risk.
Standard error of the sample mean is the standard
future date. "ly3y" = 3-year forward rate 1 year
loss severity = percent of value lost if borrower
Increase
reporting, real estate, private equity, and wrap
Five Competitive Forces
from today.
defaults
Includes residential property; commercial property;
feel separately managed account portfolios.
Example of spot-forward relationship:
expected loss = default risk x loss severity
real estate investment trusts (REITs); farmland/
recovery rate = 1 - expected loss percentag
"Except some deep-in-the-money European puts.
Bullet: All principal repaid at maturity.
Yield Spreads
Put-Call Parity
QUANTITATIVE METHODS
5. Power of suppliers.
Fully amortizing: Equal periodic payments include
G-spread: Basis points above government yield.
The put-call parity relationship for European
I-spread: Basis points above swap rate.
DERIVATIVES
options at time .
Time Value of Money Basics
For both ratios, larger is better.
One-Period Valuation Model
Expected Return/Standard Deviation
Confidence Intervals
Partially amortizing: Periodic payments include
Z-spread: Accounts for shape of yie
Option-adjusted spread: Adjusts Z-spread for effects
Arbitrage and Replication
( 1 + RF )
Contango: futures price > spot price.
Confidence interval: gives range of values the mean
Expected return: E(X) = _P(x; ) X,
value will be between, with a given probability (say
Interest Rate Risk
ts with identical cash
flows in the future, regardless of future events,
V/(1 + I/Y)N.
E(X) = P(x1 ) x, + P(x2 ) * 2 + ... + P(x) x,
90% or 95%). With known variance, formula for a
Sinking fund: Schedule for early redemption.
confidence interval is:
Be sure to use expected dividend D, in calculation.
as two components: reinvestment risk
. Collateral yield: return on T-bills posted as margin.
Floating-rate: Coupon payments based on reference
Price return: due to change in spot price.
Probabilistic variance :
rate plus margin.
and market price risk from YTM changes. These risks
Supernormal growth model (multi-stage) DDM.
Ordinary annuity: cash flow at end-of-time period.
futures price & spot
= P( x, ) [ x, - E(X ) ] + P( x2 ) [ x2 - E(X) ]
Zo2 = 1.645 for 90% confidence intervals
- convenience yield
(YTM) to find PV. This is a bond's flat price (does
Infrastructure
Long-lived assets for public use, including
Standard deviation: take square root of variance.
transportation, utility, communications, social
Correlation and Covariance
Correlation: covariance divided by product of the
(significance level 1%, 0.5% in each tail)
Constant growth model:
Full price includes accrued interest. Government
duration. This is the weighted average of times
until a bond's cash flows are scheduled to be paid.
Greenfield: Infrastructure to be built
2. Expected inflation rate premium (IP).
two standard deviations .
initiation. Value may change during the contract's
life with opposite gains/losses to the long and short.
E(R) = (1 + RFReal)(1+IP)(1 + RP)-1
U.S. $29.00 @ 2016 Kaplan, Inc. All Rights Reserved....

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- Summer '18