2014 CFA Level 1 Quicksheet

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PRINTED BY: Daniel Smith . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

CRITICAL CONCEPTS FOR THE 2014 CFA® ETHICAL AND PROFESSIONAL STANDARDS I I (A) I (B) I (C) I (D) II II (A) II (B) III III (A) III (B) III (C) III (D) III (E) IV IV (A) IV (6) IV (C) V

V (A) V (B) V VI VI VI VI VII

(C) (A) (6) (C)

VII (A) VII (B)

Professionalism Knowledge of the Law, Independence and Objectiviry Misrepresentation. Misconduct. Inregrity of Capiml Markers Material Nonpublic Information. Market Manipulation. Duties to Clients Loyalty. Prudence. and Care. Fair Dealing. Suitability, Performance Presentation. Preservation of Confidenrialiry, Duties to Employers Loyalty. Additional Compensation Arrangements. Responsibilities of Supervisors. Investment Analysis, Recommendations, and Action Diligence and Reasonable Basis. Communication wirh Clients and Prospective Clients. Record Rereruion. Conflicts of Interest Disclosure of Conflicrs. Priority of Transacrions. Referral Fees, Responsibilhies as a CFA lnstirute Member Or CFA Candidate Conduct as Members and Candidates in the CFA Prograrn. Reference to CFA Institute. the CFA Designation. and the CFA Program.

Global Investmenr (GIPS®)

Performance

Standards

• Compliallcntatnllmr:

"[Insert name of firm) has prepared and presented rhis reporr in compliance with rhe Global lnvesrmene Performance Standards (GIPS)." Compliance must be applied on a firm-wide basis. • Nine S~CliOTU:fundamenrals of compliance, input data. calculation methodology. composite construction. disclosures. presentation and reponing, real estate, private equity. and wrap fee/separately managed account ponfolios.

Approximation

formula for nominal required rate:

E(R) ~ RFR + fP + RP

•. (I.R,)]-1 N

harmonic mean

t[l]

+ wBE(Rs)

,.ar(Rp)= wl\u!(R\)+w~u2(R8) +2w \ w8(7{RA )U(RR)P(R Normal Distributions Norma] distribution i~ completely mean and variance. 68% of observations fall within 90% fall within t 1.650 95% fall within t 1.960. 990" fall within ;t 2.58(7. Computing

X,

, I

Exprctrd return, variance of2-S1ock portfolio:

E(Rp) = w"E(RA)

Means Arithmetic mean: sum of all observation values in sample/population. divided by II of observations. Geometri« "mill: used when calculating investment returns over multiple periods or ro measure compound growth rates. Geonmrir /liMn return:

R •. 1(I+R)x

ExAM

\.Ra)

described by irs t

1(1.

Z-Scores

L-scol7: "standardizes" Variance

and Standard Deviation l17riallc~:avcrage of squared deviations

from mean.

observarion from normal distribution; represents /I of standard deviations a given observation is from population mean.

N

l)Xi-ld population

variance:

(12_-'i-"'I

N

f)x, sample variance _

c;2

-x)l

.i_I --

_

n

S","dard

deoimion: square root of variance.

Holding

Period

Return

R _ P, P, , 1', Coefficient

I .

(IIPR)

+ DJ. -I

D, or 1'.

1',

I

I

of Variation

Co4Jirirllf of variation (CV): expresses how much dispersion exists relative to mean of a distribution; allows for direct comparison of dispersion across different data sets. CV is calculated by dividing standard deviation of a distribution by the mean or expected value of the distribution: CV=~

X Sharpe

Z

= observation

- population standard deviation

_

Ratio

Sbarp« ratio: measures O:fm return per unit of risk.

Sharpe ratio

m~-an

= x -I' a

Binomial Models Binamia! distribution: assumes a variable can take one of tWO values (success/failure) or. in the case of a stock, movements (up/down). A binomial model C:1I1 describe changes 111 the value of an asset or portfolio; it can be used to compute it~ expected value over several periods. Sampling

Distribution

SampllIIg distribution.

probability distribution of all possible sample S{d{IStlC computed from a set of equal-size samples randomly drawn from the same population. The samplillg distribution of'''~ mean is the distribution of estimates of the mean.

Central limit Theorem Central limit theorem: when selecting simple random samples of size 11from POp"lntiOIl with mean II and finite variance CT1, the sampling distriburion of sample mean approaches normal probability distribution with mean It and variance equal to 0'1/11 as the sample size becomes large. Standard Error Sl,l1ItUlrd fTTOr of II" wmpl~ mean i, the srandard devurion of disrriburion of the sample means. (1

known population

QUANTITATIVE METHODS lime •

• • • • • •

Value of Money Basics FUNlr( Ult/'IL (FV): amount to which investment grows after one or more compounding periods. Future ualu«: FY = PV(J + I/Y)'. Present ualu« (PV): current value of some future cash Aow PV = FY/(I + I/Y)N. Annuities: series of equal cash Aows that OCCurat evenly spaced intervals over time. Ordinary annuity: cash Aow at md-of-time period. Al1IlIIity due: cash Aow at brginnillg-of-rime period. Pt'rpel1liliff: annuities with infinite lives. PMT/(discount rate). PVI"".

Required Rare of Return Components: I. Real risk-f ...:e rate (RFR). 2. Expected inflation rate premium (lP). 3. Risk premium. E(R) ~ (I + RFR...J)(I + IP)(1 + RP)-I

Roy i slIfi'ty-fim

rp

ratio: -'---"-

Expected

Exprcud return:

E(X)

IS

berrcr,

Return/Standard

= P(xi

unknown Confidence

Deviation

E(X) = 2::P(Xi) x. )xl + P(X2)X2 + ... + P(x.}x.

Probabilistic uariance:

(12(X)= 2::P(x,)lx, - E(X)t = P(X')[: O. • Two-railed rest: Ho: I' ·0 versus H.: II " O. Ont-ltIikd

teu: rests whether

Type I and Type II Errors • 7jpt I error: rejecuon of null hypothesis when it is actually true. • Ijpr /I error: failure to rejecr null hypothesis when it is ncrually fahe. Types of Hypothesis Tests Use t-stntistic for test> involving the population mean (location of mean, difference in means, paired comparisons). Usc chi-square JII1NIlic for tests of a single population variance. Usc Fssmtistic for rests comparing tWO population variances, Technical Analysis Rtl~rsnl pnrums: had and shoulders. inverse H&S. double/triple tOP or boreom. Continuation pauons. triangles. rectangles. pennants. flags. Prier-based illdirnlon: moving averages, Bollinger bands. momentum oscillators (rate of change. RSI. stochastic, MAC D). Sentiment indicaton: opinion polls. pur/call ratio. VI X, margin debt. short interest ratio. HoUJ offilllds indirators: TRIN, margin debt. mutual fund cash position. new equity issuance. secondary offerings.

ECONOMICS tlllSlidry

%Ll. quantiry demanded %Ll.price

If absolute value> I. demand is elastic, If absolute value < I. demand is inelastic. On a Jlrnight lin« demand curve, total revenue i~ maximized where pnce elauiciry I. %Ll. quanriry demanded

Income einsliclry

%6 income If positive. the good i, a normal good. If negative, the good is an inferior good. %6 quantity demanded

Cross price tlllSlWry

Expansionary and Conrracrionary Policy M01ltM? policy is expansionary when the policy rate is less than the neurral inreresr tate (real trend rare of economic growth + inflation rarget) and conrracrionary when the policy rate is greater than the neutral interest rate. Fiscal policy is expansionary when a budget deficit is increasing or surplus is decreasing, and contracrionary when a budget deficit is decreasing or surplus is increasing.

Breakeven

Balance of Payments Curmn account: merchandise and services; income receipts; unilateral rransfers. Capi/l1/ nr TVC. SI"'I doton ill short TIm if'TR < TVC. Bl'I'nkl'l'm:

Market

Structures

Pnfm competition: Many firms with no pricing power; very low or no barriers 10 entry; homogeneous product. Monopolisric rompetuion: Many firm.; some pricing power; low barriers to entry; differentiated products; large advertising expense. Oligopoly: Few firms mat may have significant pricing power; high barriers to entry; products may be hornogcneous or differentiated. MOllopoly: Single firm with significanr pricing power; high barriers to entry; advertising used to compere with subsrirure products. In all marker strucrures, profit is maximized at the ourpm quanriry for which marginal revenue = marginal COSt. Gross Domestic Product Real GOP. consumption spending + investment government spending + ncr exportS.

%Ll. price of related good

If positive. related good is a substitute. If negative. related good is a complement. Types of Auctions Asemding price (EngIisIJ): Highest bid wins. pays amount bid; all bids known to .11 bidders. &nkd bid: Highest bid wins. pays amount bid; bids are unknown to other bidders. &rolld price unkd bid (Vickrry): Highest bid wins, pal's amount bid by second.high bidder. Dacmdil1g priu (DllulJ): Price declines until .tll units can be M)ld; each bidder PJYS price bid. Modifid Dlileh: Price declines until all units can be sold; all bidders pay last bid price. Revenues and Costs Torl1/ r~vmllt - price x quantiry, summed across all units sold.

+

Savings, Investment. Fiscal Balance. and Trade Balance Fiscal budget deficit (G - T) • excess of saying over domestic investment (S -I) - trade balance (X - M) Equation of Exchange MV = PY, where M = real money supply. V = velocity of money in transactions. P ~ price level. and Y = real GOP. Business Cycle Phases Expansion; peak: contracrion:

Elasticity Own price

Al!rrtlgt reoenue » toral revenue I quantiry sold. Mnrgil1nl retenue » ~ total revenue Ill. quantiry sold. Iota! fi:. and restructuring COSts. • lntcgration expenses associared wim b~inesses recently acquired.

PRINTED BY: Daniel Smith . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

Held-to-maturity: amortized cost on balance sheet: interest, realized GfL recognized on income

linal assn, fi:'(td-ass~t, and tl!orking capnal tumatxr Extraordinary

Both

unusual

expropriation extraordinary

ratios:

Items (U.S. GAAP only) and mfrequcnt (e.g., losses from of assets). IFRS does not allow

total asset turnover =

Gross, operating; and

. fi . operallng pro II margin

Remr»

opemling profil revc;uc

=

EBIT

= -n-c,-s-a1-es-

(ROTC)]: Therefore.

~ ----

/1lIt7'Nf eOIJrrag~and ford

Growth rate (g): g. RR retmtion raft' = 1-

X

--==:..:.:.:=-===-dividends

operating

short-term

declared

]-[:~~er;;:n] cony. debt

stock opnons

You may

= (net

ROE = (net incomeJx( EBT

purchases

m::~~~cr net

EBT Jx( EBIT J EBIT revenue

revenue J [avg. total assers J x [ avg. tOtal assetS x avg. equity

365

You may also see it presented as: ROE ~ tax burden x inrerest burden x EBIT margin x asset turnover x leverage

365

.

rallo

Marketable

Security

2.

)(cost-accum.

Classifications

H~M-for-trt/(Iillg: fair value on 1,.I.lllcc sheet; dividend" inrcrl"il, rC-Jlil.ed and ullreali,ed GIl. recognized on i,,,omc ~13temCIll. Al'Oilnb/~-for-sa/t: fair ";!Iue on balance \hect; dividends, inrcr~'St, realized GIL recognized on income statement; unrealized GIL is other comprehensive income.

depreciation)

useful life

x ourput

.

ururs

useful life in units

see it presented as: lu~,::er][

value

Revaluation of Long-Lived Assets IFRS: revaluation gain recognized in net income only to the extent it reverses previously recognized impairment loss; further gains recognized in equity JS revaluation surplus. (For unvstmrnt prop"'Y' all gains and losses from marking 10 fuir value arc recognized as income.l U.S. GMP: revaluarion is not permitted.

income J( -salesJ[ --.assets) sales assets eqUlry

Exlmded /)1I?OI/l equation furrher decomposes profit margin:

average rrade parables

residual

COSt- salvage value

operates the business.

31\0

Capitalizing VB. Expensing income variability and profits. Increase assets, eqUlI)'. effect.

Units of 'production:

liabilities.

. return on equIty

--...£..~==--

+[days of ~es]_[number of daYS] outstanding of parables

(

income after taxes

Oputlfing p"formana ratios indicate how well

return on equiry - [n::;~tl(

. I (days of inventOry] conversIon eye e • on hand

[COnvertible] debt (I-t) interest

useful life [)ollbl,. dtdillillg balanc«

DuPont Analysis Traditional DIIPolll eqtmtion:

days of inventory on hand = -.----'---mventory turnover

h

COSt

Sml1glll-lill~: --------

ROE

receivables turnover

cas

+

Depreciation

+ lease payment~ = -.'--'-'-'-'-''---'mterest + lease payments EBIT

uquldity ratios indicate company's ability to pay its

management

365

cony. pfd. sh s

Assets lowers increases near-term Exptllsillg: opposite

J

parables lurnover

convertible preferred dividends

Caplfaftzmg:

t"llOrg~cOI'mlg~:

fixed charge coverage

cosr of goods sold . average Inventory

of days of payables =

iv

Long-Lived

. EBIT mteresl coverage - -.-mterest

average receivables

=

fd]

-~. +

[:;).,.[~:~e~f~~~f +[iss~i~m]

. total debr rallo = . roral eqwty

annual sales

days of sales outstanding

diluted EPS is:

net . [income

total assets

~uivilblrs. IfIWIlIOry. pa)'ab/~s IlIrI10'~r, and tlnys' SIIpply ratios- -.1Ilolu-hieh are used ill th~ (fish conrenion rydr-

. rauo =

adj. income avail. for common shares wtd, avg. common shares plus potential common shares outsranding

roral debr

securities current liabiliries

=

nct income preferred dividends WId. avg. no. of common shs, outstanding

diluted EPS

[return 011/0111/ (IIpiltll

roral-debr-rario

securilies + receivables current liabilities

receivables turnover

basic EPS _

sh s

defensive interval = cash + mkt. sec. + receivables daily cash expenditures

parables turnover

on flsms

. debc-ro-equiry

current assets current ratio = -----current liabilities

. Invelllory turnover

&"IIi( EPS calculadon does not consider effects of any dilutive sccuriries in computation of Frs:

Debt to tqllity ratio and tota! deb, ratio:

MilOS:

+ maskerable

projiT IIInrghlJ:

return on assets EBIT (rotal capital) = average roral capital

Horizontal common-size jil/lll/cilll statemenr analysis:

cash ratio = cash

revenue average working capital

. net income net profit margin - .:..:..:.:....:.:.;.::.= revenue

Critical Ratios Common-size finO/wal statement analysIs: • Common-size balance sbut expresses all balance sheer accounts 3S 3 percentage of rotal assets. • Common-size income statement expresses all income statement items as ;1 percentage of sales. • Common-size cash Aow statement expresses each line item as a percentage of tOIJI cash inAows (outflows). or as a percclll.lge of net revenue.

+ marketable

IW

FIFO results ill: Lower COGS Higher gross profit Higher invenrory balances

UFO TTSUlts ill: HigberCOGS Lower gross profit Lower inventory balances Basic and Dilured EPS

. gross profit gross profit margin = .!2....:.:..:...!~.:.: revenue

Free Cash Flow Fre« cashflow (FCF) measures cash available for discretionary purposes. It is equal to operating cash How less net capital expenditures.

.ck . cash qUI rano =

r:_:ev=en:_:u::_e:::_ __ avcrage net fixed assets

working capital turnover =

Cash Flows From Operations (CFO) Direct method: Start with cash collections (cash equivalent of sales): cash inputs (cash equivalent of COStof good, sold); cash operating expen5CS; cash interest expense: cash taxes. /ndi"u/lI/~tlJod: ~tart with net income, subtracting back gains and adding back losses resuhing from financing or investment cash flow~, adding back .111 noncash charges. and adding and subtracting asset and liability accounts that result from operations.

exprcsses each line item relaeivc to its value in common base period.

=

fixed asset turnover

Compute

number

Inventory Accounting In periods of rising pnces and stable or increasing inventory quantities:

items.

Discontinued Operations To be accounted for as a discontinued operation, 3 business-assets, operations, investing, financing acrivities-s-musr be physically/operationally distinct from rest of firm. Incomellosses are reported ner of tax after ner income from continuing operations.

LIquidity

statement.

r_ev_c_n_u_c _ average total net assets

1

Deferred Taxes • Created when taxable income (on lax return) '" prctax income (on financial statements) due to tempowy differences. • Dif""d tax liflbilitlN are created when taxable income < pretax income. Treat DTL as equity if nor expected [0 reverse. • Dif""d lax IlSStIS are created when taxable income > pretaX income. Musr recognize valulltion alkrwallct if mOre likely than noc Ihat DTA will nor be realized. Long-Term

Liabilities

• PrrmiulII bOlld: coupon rate> market rate al i~uance.

• DiJeoll1l(bOlld: coupon ratc

< markct rate JI

"Suancc. n.PtllJf equals book value at the begrnning of Ihe year multiplied by the market rate of interesl at the lime the bonds were issued.

• IlIuml

mnll"utd on not p.19O-

PRINTED BY: Daniel Smith . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

Working

Capital

Management

Finanrialstnrementimno impact of I~ accounting from the lessee perspective. capital leases resulr in: • Hig/m: assets, liabilities, CFO. debt/equity • LoI/J~r: net income (early years), CFF. current ratio, working capital, asser turnover, ROA,

% discount) (1+ 1-% discount

E(R..J

Corporate Governance FIII'OrS"o""oltl~r interests: independent

strong code of ethics, conlidemial Harm sbn"boldtr interats: managemenr-ahgned board. voting rcsrricriens, takeover defenses,

WACC

(wd)[kd(l-t»)+

(wl")(k",)+(wriced. • A return plot under the line is ov~rpriccd.

11II'~I1I1~1II Obj~cliM:

Cosr of Preferred

Srock

• Return objectives, • Risk tolerance. Conura ints: • liquidiry needs. • Time horizon. • Tax concerns. • Legal and rcgularory maors. • Unique needs and preferences.

Drs kp=-pCost of Equity

Capital

D k =_!.+g , Po Cost of Equity

k,

Using CAPM

RFR+,3(Rm~.-RFR)

Cli

C ¥

~+.J:!L(I+k)2

0-1 (I+k)1

Method

6"",.=

1 6"1u1IY X

(

,, ,

..

~ : r

0.8

R company:

1)1110

Returns and M-s'll","'

R

1

i'" lrcvnor m for Por'lolio P

DJ

1+ (I-r)i

+

k

1.2

measure excess return per unit of 1(1((11,ilk. Trryllor measure and Jmsmj olplJIImeasure excess return per unit of sysumolic ri1/(.

Project Beta

asset beta for comparable

RI'R

Sharp«

IRR: discount me: that makes NPV equal 10 Pure-Play

/

Risk-Adjusted

CFII ... ···+(I+k)n

zero. Delevered

i~

:

Combining Preferences with the Optimal Ser of Ponfolios Markowirl efficient fromier is rhe scr of porrfelios rhar have highes. rerum for given level of risk.

Capital Budgeting NPV

B

u

~ML

Relevcred project bera for subject firm:

f3pro1ect= ~l.UM"jO_X __ '(I + RfR)'

S

,

I

X

(I+RFR)'

P• .,Max[O. X - S,I

X

= time 10 expiration.

Pm-Call Parity Put-call parity holds lhat portfolios with identical payo(fs must sell for the same price to pre-.·ent arbitrage. The put-call parity relationship: X C+ S+I' (1+ RFR)' Each security in the pur-call parity relationship be expressed as: S-C+

p=c+

X (I +RFR)t

can X

P

(I+RFR)t

X

S

(I + RFR)I

X

=S+P-C

(1+ RFR)'

PPN: 32004021 ISBN-13: 9781427749208 ISBN-IO: 1427749205

Forward Contracts • Long InU,! p.lY ~ certain amount at specific future dare to short, who will deliver the underlying asset. • A cash settlement forward contract does nor require actual delivery of the underlying asset. but a cash payment to the party disadvanraged by rhe

u.s. $29.00 0

1

20B Kaplan. Inc. AllRights Reserwd.

me:rger arbirrage: distressed/ activist shareholder; special

slral~il'>:

restructuring; situations.

R~fJlln't: I'O/II~ slraugin: convertible arbitrage; asset-backed fixed income; gencrallixccl income: volatility; multi-strategy. Eqlllty stralq,i~s: marker neutral; fundamental growth; fund.lIllcntai value; quantitative directional; shorr bias. Macro ttra/~gi~s:based on global economic trends. Hedge: fund fees: • "2 and 20": 2% management fce plus 200/0 incentive fee. • Hard hurdle rare: incentive fee only on rerum above hurdle rate. • Sofr hurdle rate: incentive fee on whole rerum, bur only paid if rerum is grealer than hurdle rate. • High Water mark: no incentive fee until value exceeds previous high.

Private J\.lnxWIIIIII

VII/U~

p, -

American pur (P) Nate:

Bounds

Funds

Eoeut-drioen

EffiCli/)~ duration

embedded

Buyer of a call option-long position. Writer (seller) of a call option-short position. Buyer of a put option-long poslrlon. \'('riter (seller) of a PUI option-short position. intrinsic value of a call option = MaxIO. S - X] intrinsic value of a put option = Max[O. X-51

Equity

ul'n-ilgl'd buyouts: management

buyouts (existing managers), management buy-ins (new managers) Vt'IIllIrt" raplta] stages of development: • Formative stage: angel investing. seed stage. early stage. • Liter stage: finance product development. marketing. market research. • Mezzanine stage: prepare: for 11'0. Portfolio compally ualuation methods: market/ comparables; discounted cash Aow; asset-based. Exit SImIq,iN: trade sale; IPO; recapitalization; secondary sale; write-off. Real Estate I ndudes residential property; com mercial property; real estate investment IIUSts (REITs); F.umlandl timberland; whole loans; consrrucrion loans. Propnty tsthuuion methods: comparable sales; income approach; COStapproach. Commodities COl/MillO: futures price> spot price. Barkumrdatknr: futures price < spot price. Sources of investment return: • Collatem! yi~fd: return on T-bill, posted as margin. • Pnr« "'11m/: due to change in lpot price. • Rofl JMd: positive for backwardation. negative for contango. furures price se spot price{1 + R,) + storage costs - convenience yield