ETHICAL

AND PROFESSIONAL STANDARDS IV(C) Responsibilities of Supervisors Annuities

Supervisors must adequately train and monitor Annuity: Finite set of level sequential cash flows,
I(A) Knowledge of the Law subordinates. Responsibilities may be delegated. valued using calculator’s TVM function

Obey strictest applicable law. Disassociate Ordinary Annuity: 1st cash flow received in one year
V(A) Diligence and Reasonable Basis
immediately from any illegal or unethical activity. Annuity Due: 1st cash flow received immediately

Exercise diligence and thoroughness. Support
Perpetuity: Ordinary annuity with payments that
I(B) Independence and Objectivity actions with research and investigation.
012
Do not offer or accept gifts that might impair

continue forever, PV.%-.%#,+#/ =
-
V(B) Communication with Clients and
independence and objectivity. Gifts from clients
Prospective Clients
may be permissible. STATISTICAL CONCEPTS AND MARKET
Make appropriate disclosures. Distinguish between

RETURNS
I(C) Misrepresentation fact and opinion in analysis and recommendations.
Cite sources. Do not plagiarize or omit important
Arithmetic Mean Return
V(C) Record Retention *
information. Act quickly to correct any errors. 1
Maintain records to support recommendations and Sample mean, E
X= F X + ; n = sample size

n
I(D) Misconduct decisions. 7-year retention period recommended. +34

Does not apply to personal behavior unless it Geometric Mean Return

VI(A) Disclosure of Conflicts &
reflects poorly on the investment profession. R 5 = I(1 + R4 )(1 + R 6) … (1 + R * ) − 1
Disclose any matters that may impair

II(A) Material Nonpublic Information independence and objectivity, prominently and in Harmonic Mean Return (Cost Averaging)
Do not act or cause others to act on material plain language. n
E7 =
X , where X > 0 for i = 1, 2, … , n
nonpublic information. Seek public dissemination. * 1

∑+34
VI(B) Priority of Transactions X+
II(B) Market Manipulation Execute clients’ transactions before accounts in E8-+#9. > X
If returns are volatile, X E5%). > E
X 7$-.

Do not take any actions that distort prices or which you have a beneficial interest. Percentiles
trading volume. Market making and legitimate y
VI(C) Referral Fees Location of y #9 percentile, L/ = (n + 1)
trading strategies are allowed. 100
Disclose referral fees to clients and employer, If L/ is not an integer, use linear interpolation.
III(A) Loyalty, Prudence, and Care
including non-monetary arrangements. Distributions may be divided into quarters
Place clients’ interest above yours. Disclose
(Quartiles), fifths (Quintiles), or tenths (Deciles)
policies on proxy voting and soft commissions. VII(A) Conduct as Participants in
E.g., 50th percentile = 2nd quartile = 5th decile
CFA Institute Program
III(B) Fair Dealing
Do not share confidential exam details. Expressing Mean Absolute Deviation
Treat all clients fairly. Treat non-immediate family 4
opinions about CFAI policies is permissible. E|
MAD = ∑*+34|X + − X
like other clients. Communicate investment *

recommendations and changes simultaneously. VII(B) Reference to CFA Institute, the CFA Variance and Standard Deviation
III(C) Suitability Designation, and the CFA Program !
1
Use a regularly updated IPS during investment Do not misrepresent the meaning of CFA Institute Population variance, σ6 = F(X + − µ)6
N
decisions. Evaluate decisions in a portfolio context. membership, designation, or candidacy. +34
*
1
Sample variance, s 6 = E)6
F(X + − X
III(D) Performance Presentation n−1
+34
Performance data should be fair, accurate, and
QUANTITATIVE METHODS Standard deviation is square root of variance
complete. Do not promise returns for risky assets.

Semivariance and Semideviation

III(E) Preservation of Confidentiality THE TIME VALUE OF MONEY
Calculated like variance and standard deviation,
Keep all client information confidential unless:
Required Rate of Return but observations above threshold are given zero
client is involved in illegal activity, you are legally interest rate = real risk-free rate weight to isolate downside risk
required, or you have the client’s permission.
+ inflation premium
Coefficient of Variation
IV(A) Loyalty required inter + default risk premium
CV = s⁄EX; measures dispersion relative to mean
Get permission before taking outside work (even required inter + liquidity premium

unpaid) that competes with employer. Abide by required inter + maturity premium Skewness
non-compete agreement (if applicable) and do not
Future Value (FV) and Present Value (PV)
take employer’s property.
FV = PV(1 + r)!
IV(B) Additional Compensation Arrangements
Effective Annual Rates
Obtain written permission from all parties before
r"#$#%& '!
receiving any compensation for outside work. EAR = >1 + ? − 1
m
-!"#"$%
EAR ()*#+*,)," = 𝑒 − 1
Kurtosis (Excess Kurtosis = Kurtosis – 3) Expected Value & Variance of Portfolio Return Normal Distribution (µ = mean, σ = SD)
* 6
Distribution 𝑇𝑎𝑖𝑙𝑠 Peaked Kurtosis ~50% of observations are within ± 𝜎 of µ
EdR . e = F w+ E[R + ] @
Leptokurtic Fatter More >3 +34 ~68% of observations are within ±𝜎 of µ
* * ~95% of observations are within ±2𝜎 of µ
Mesokurtic Normal Normal 3
σ6 dR .e = F F w+ w; CovdR + , R ; e ~99% of observations are within ±3𝜎 of µ
Platykurtic Thinner Less <3 +34 ;34
Market value of investment i Observed value − Population mean X − µ
w+ = Z= =
Market value of portfolio Standard deviation σ

For portfolio with 2 investments: EdR . e − shortfall level

Shortfall Ratio =
EdR . e = w8 R 8 + w< R < σ0
Lognormal Distribution
Cov(R 8 , R < ) = σ(R 8)σ(R < )ρ(R 8 , R <) - eA where X is normally distributed

- Used to model asset prices
σ6 dR .e = w86 σ6 (R 8 ) + w<6 σ6 (R < )
- Positively skewed
+ 2w8 w< Cov(R 8 , R < )
PROBABILITY CONCEPTS
Continuously compounded return from t to t + 1:
Correlation S#B4
Odds r#,#B4 = ln q r = lnd1 + R #,#B4 e
CovdR + , R ; e S#
P(E) ρ+,; = CorrdR + , R ; e = ; min −1, max 1
Odds of E = σ(R + )σdR ;e where R #,#B4 is the effective annual rate
1 − P(E)

Bayes’ Formula Simulation Techniques

Probabilities
P(Info|Event) × P(Event) Monte Carlo simulation: Generate many random
Unconditional: P(A), probability of A
P(Event|Info) = samples to produce a distribution of outcomes
Conditional: P(A|B), probability of A given B P(Info)
Updates prior probabilities to give posterior Historical simulation: Sample from a historical
Joint: P(AB), probability of A and B
probabilities based on new information record of returns to simulate a process
Probability Rules

Counting Rules
Conditional: P(A|B) = P(AB)/P(B)
Factorial: n! = n(n − 1)(n − 2) … 1 SAMPLING AND ESTIMATION
Multiplication: P(AB) = P(A|B) × P(B)
j! Sampling
Addition: P(A or B) = P(A) + P(B) − P(AB)
Multinomial:
j! !j" !…j# !
Simple random sampling: Subset of population is
Total: P(A) = P(A|S4)P(S4) + ⋯ + P(A|S* )P(S* ) chosen at random
Counts ways to label n items with k labels
where S4 , S6 ,… S* is an exhaustive set of mutually Systematic sampling: Every kth observation is
exclusive probabilities n %! chosen until desired sample size is achieved
Combination: %C$ = # & =
r (%($)!$!
Independence Stratified sampling: Simple random samples are
Counts ways to choose r items from n if order does
If A and B are independent events, drawn from each subpopulation (strata)
NOT matter
P(AB) = P(A) × P(B) "! Sampling error = Sample mean – Population mean
Permutation: "P! = ("%!)!
Expected Value Data Used in the Sampling Process
* Counts ways to choose r items from n if
Time-series data: A sequence of returns collected at
E(X) = F P(X + )X + order does matter
discrete and uniform intervals of time
+34
E(X) = E(X|S4)P(S4) + ⋯ + E(X|S* )P(S* ) Cross-sectional data: Observations over individual
COMMON PROBABILITY DISTRIBUTIONS

units at discrete time intervals
Variance Discrete Uniform Distribution
* 1 Central Limit Theorem (CLT)
σ 6 (X)
= F P(X + )[X + − E(X)] 6 p(x) = , x = x4 , x 6 , … , x *
n For a sample of size n ≥ 30 from a population with

+34
mean µ and variance σ6 , the sample mean XE
Binomial Distribution
Covariance n approximately follows a normal distribution with
p(x) = > ? p> (1 − p)*?> , where
* * x mean µ and variance σ6⁄n
Cov(X, Y) = F F P(X + , Y+ )[X + − E(X)][Y+ − E(Y)] n = number of Bernoulli trials

+34 ;34 p = probability of success Standard Error of Sample Mean

An asset’s covariance with itself is its variance E(X) = np Population variance is known: σ>C = σ⁄√n

σ6 (X) = np(1 − p) Population variance is not known: s>C = s⁄√n

Continuous Uniform Distribution Properties of Estimators

1 A point estimator is:
f(x) = ; a ≤ x ≤ b
b−a - Unbiased if its value matches the value of the
x−a parameter it estimates
F(x) = ; a ≤ x ≤ b
b−a - Efficient if it has the lowest variance of all

unbiased estimators
- Consistent if its value approaches the parameter
as the sample size increases

Confidence Interval Hypothesis Testing Decision Errors Nonparametric Tests
Point estimate ± Reliability factor × Std error Decision 𝐻G True 𝐻G False Test that is not concerned with parameter and is
Point estimate: Estimate of population parameter implemented in situations such as:
Do not reject HG Correct Type II (b)
Reliability factor: Value from distribution of point - Data do not meet distributional assumptions
estimate, such as normal or t-distribution Reject HG Type I (a) Correct - Data are given in ranks
E ± zD⁄6 × σ⁄√n
E.g., X Power of a test = 1 − P(Type II error) = 1 - b - Hypothesis does not concern a parameter
p-value: smallest value of a at which 𝐻G is rejected
Reliability factors for normal distributions

Significance Confidence Tests Concerning a Single Mean
𝑧F⁄6 ECONOMICS
level interval Population is normal with known variance:
xy − µG
10% 90% 1.645
z-statistic = TOPICS IN DEMAND AND SUPPLY ANALYSIS
σ⁄√n
5% 95% 1.960
Large sample from any population with unknown Own-Price Elasticity of Demand
1% 99% 2.575 variance (2 choices): %ΔQ&> ΔQ&> P>
E.&( = =€ • q r
If the population is not normally distributed xy − µG %ΔP> ΔP> Q&>
t-statistic = , df = n − 1
and/or variance is unknown, the t- or z- s⁄√n Q&> = quantity demanded, P> = price per unit
distributions may be used to get reliability factors. xy − µG
z-statistic = ‚E.&( ‚ > 1: elastic
Normally Variance Small Large s⁄√n
‚E.&( ‚ < 1: inelastic
Distributed? known? Sample Sample Small sample from normal population with
Yes Yes z z ‚E.&( ‚ = ∞: perfectly elastic
unknown population variance:
Yes No t t or z xy − µG E.&( = 0: perfectly inelastic
No Yes n/a z t-statistic = , df = n − 1
s⁄√n E.&( = −1: unit elastic
No No n/a t or z
Income Elasticity of Demand
Biases Tests Concerning Differences between Means
%ΔQ&> ΔQ&> I
Data mining bias: “Drilling” data to find any Normal populations with unknown variances that EI& = =€ • q & r
%ΔI ΔI Q>
statistically significant relationship are assumed equal:
where I = consumers’ income
Sample selection bias: Excluding unavailable data (xy4 − xy6) − (µ4 − µ6)
t-statistic = 4⁄6
EI& > 0: normal good; EI& < 0: inferior good
Survivorship bias: Excluding the impact of failed s.6 s.6
q + r
funds or companies that no longer exist n4 n6 Cross-Price Elasticity of Demand

Look-ahead bias: Information needed is not known (n4 − 1)s46

+ (n6 − 1)s66 %ΔQ&> ΔQ&> P/
s.6 = E.&) = =€ • q r
on the date the observation was recorded (n4 − 1) + (n6 − 1) %ΔP/ ΔP/ Q&>
Time-period bias: Using data from an era that df = n4 + n6 − 2 where P/ is the price per unit of another good Y
makes the results time-period specific E.&) > 0: substitutes; E.&) < 0: complements
Normal populations with unknown variances that

are assumed unequal: Income and Substitution Effects
HYPOTHESIS TESTING (xy4 − xy6) − (µ4 − µ6)
t-statistic = Impacts of a reduction in a good’s price:
Steps in Hypothesis Testing s6 s6
4⁄6
q 4 + 6r Substitution
1. State hypotheses (null and alternative) n4 n6 Type of good Income effect
effect
2. Select test statistic 6
3. Specify significance level s46 s66 Normal Buy more Buy more
qr
n4 + n6
4. State decision rule Modified df = 6 Inferior Buy less Buy more
(s4 ⁄n4 ) 6 (s 6 ⁄n )6
5. Collect data; calculate test statistic n4 + 6n 6
6
Goods with positively sloped demand curves:
6. Make decision regarding hypothesis

Tests Concerning Mean Differences Giffen goods: Negative income effect is greater than
7. Make economic or business decision positive substitution effect if good’s price falls
Normal populations with unknown variances:
Veblen goods: Demand for a status symbol good
Test Statistic (General) dy − µ&G
t-statistic = , df = n − 1 falls if its price is reduced
Sample statistic − Hypothesized value s&H

Standard error of sample statistic Revenue Terms
Tests Concerning a Single Variance Total revenue (TR): Price times quantity; P × Q
Hypothesis Test Results Normal population (df = n – 1):
Average revenue (AR): TR⁄Q
Reject H! if test *
Type Hypotheses (n − 1)s 6 1 Marginal revenue (MR): ΔTR⁄ΔQ
statistic is χ6 = , s6 = F(x+ − xy)6
σ6G n−1
+34
One-tailed H! : µ ≤ µ! Cost Terms
> critical value

(upper) H" : µ > µ! Tests Concerning Two Variances Total fixed cost (TFC): Sum of fixed costs
One-tailed H! : µ ≥ µ! Normal populations: Total variable cost (TVC): Sum of variable costs
< critical value *'
(lower) H" : µ < µ! Total costs (TC): TFC + TVC
s46 1 6
F = 6, s;6 = Fdx+; − xy; e for j = 1, 2 Average fixed cost (AFC): TFC⁄Q
< lower critical s6 n; − 1
Two- H! : µ = µ! +34 Average variable cost (AVC): TVC⁄Q
value or > upper df1 = n4 − 1; df2 = n6 − 1
tailed H" : µ ≠ µ! Average total cost (ATC): AFC + AFV or TC⁄Q
critical value
Tests Concerning Correlation Marginal cost (MC): ΔTC⁄ΔQ
𝑟√n − 2
t-statistic =
√1 − r 6
Profit Measures AGGREGATE OUTPUT, PRICES, AND ECONOMIC
Accounting profit = Revenue − Accounting costs GROWTH
Economic costs = Accounting costs + Implicit costs Gross Domestic Product (GDP)
Economic profit = Revenue – Economic costs Nominal GDP: GDP in terms of current prices
= Accounting profit−Implicit costs Real GDP: GDP in terms of base-year prices
Normal profit = Zero economic profit GDP deflator: (Nominal GDP⁄Real GDP) × 100
Profits maximized if MR = MC and MC isn’t falling GDP = C + I + G + (X − M)
Breakeven Analysis C = consumption
Economic breakeven occurs if a firm’s accounting I = investment
profit is enough to cover its implicit opportunity Oligopoly G = government spending
costs (i.e., normal profit). In the long run, firms X = exports; M = imports
- Firms: Few
cannot earn positive economic profits.
- Products: Similar (close substitutes) GDI
Shutdown Decision (Short-term vs. Long-term)
- Barriers to entry: High = Net domestic income
Short-Term Long-Term - Pricing power: Some or considerable + Consumption of fixed capital
TR ≥ TC Stay in Stay in
Profit maximization: MR = MC + Statistical discrepancy
TVC < TR < TC Stay in Exit market

TR < TVC Shut down Exit market GDI

= Compensation of employees
Economies of Scale
+ Gross operating surplus + Gross mixed income
Each stage of expansion has its own short-run ATC
curve. Minimum efficient scale is the low point on + Taxes (net of subsidies) on production
the long-run average total cost curve. + Taxes (net of subsidies) on products and imports

Personal household income

= Compensation of employees
Kinked demand curve: A price increase will impact
sales more than an equivalent price decrease + Net mixed income from unincorporated businesses
+ Net property income
Cournot assumption: Competitors will maintain
current output levels if one firm changes its price Expenditure and Income Equality
Game theory: If one firm changes its prices,
(G − T) = (S − I) − (X − M)
competitors will adjust to maximize their profits,
resulting in a Nash equilibrium G − T = fiscal balance

S − I = savings minus domestic investment
Price collusion is more likely to happen if:
- Few firms or one dominant firm X − M = trade balance
THE FIRM AND MARKET STRUCTURES
- Products are relatively similar IS and LM Curves
Perfect Competition - Firms have similar cost structures
- Firms: Many - Orders are frequent and relatively small
- Products: Identical - Credible threat of retaliation for breaking pact
- Barriers to entry: Very low - The threat of external competition is high
- Pricing power of firms: None
Monopoly
Profit maximization: - Firm: One
- P = MR = MC - Products: Unique (no close substitutes)
- P > ATC economic profit, P < ATC economic loss - Barriers to entry: Very high
- Pricing power of firm: Considerable (price
discrimination possible) IS curve: Negative relationship between real
Profit maximization: MR = MC interest rates and real income (goods market)
LM curve: Positive relationship between real
interest rates and income (money market)
Quantity theory of money: MV = PY
M = real money supply; V = money velocity
P = price level; Y = real GDP

Factors Increasing Aggregate Demand (AD)

- Higher household wealth
Monopolistic Competition
Price discrimination by monopolists: - Higher business and consumer confidence
- Firms: Many
- 1st degree: Different price for each customer - Higher capacity utilization
- Products: Differentiated (via advertising)
- 2nd degree: Quantity-based menu options - Expansionary monetary and fiscal policies
- Barriers to entry: Low
- 3rd degree: Pricing for demographic groups - Depreciating domestic currency value
- Pricing power of firms: Some
- Faster global economic growth
Profit maximization: MR = MC Market Power Measures
N-firm concentration ratio: Sum of market share
of the N largest firms in the industry
Herfindahl-Hirschman Index (HHI): Sum of squared
market share of the N largest firms
 Late Expansion MONETARY AND FISCAL POLICY
- Economic activity: Accelerating growth Monetary Policy
- Employment: Full-time rehiring, more overtime Required reserves
Required reserve ratio =
- Spending: Increasing in all sectors Total deposits
- Inflation: Moderate, but increasing Money multiplier = 1⁄Reserve requirement
Peak Fisher effect: R *)'+*$J = R -%$J + π%
- Economic activity: Growth decelerates

Central Bank Roles

- Employment: Increasing, at a slower rate
- Sole currency supplier
- Spending: Strong capital spending, but inventory
- Lender of last resort
starts building up as sales growth slows
- Bank for commercial banks and government
- Inflation: Accelerating
Shifts in Aggregate Supply (SRAS and LRAS) - Regulate and supervise payments system
Contraction/Recession
SRAS LRAS - Gold and foreign exchange reserves holder
Increase in - Economic activity: Declining to trough level
Shift Shift - Oversee monetary policy
- Employment: Hiring freezes, then layoffs
Labor supply Right Right - Spending: Falling, particularly for housing, Monetary Policy Tools
Natural resources Right Right consumer durables, and business equipment Expansionary monetary policy measures:
Human capital Right Right - Inflation: Decelerating, but with a lag - Policy rate: Set policy rate below neutral level

Physical capital Right Right - Reserve requirement: Reduce reserves for
Business Cycle Theories
Productivity/Tech Right Right commercial banks
- Neoclassical: “Invisible hand” lets markets reach a
Nominal wages Left None - Open market operations: Buy bonds from
natural equilibrium; Great Depression impossible
Input prices Left None commercial banks
- Austrian: Like Neoclassical, focus on loose
Price expectations Right None monetary policy causing credit-fueled booms Fiscal Policy: Spending Tools
Business taxes Left None - Keynesian: Countercyclical fiscal policy should be Transfer payments: Redistribution of wealth (e.g.,
Business subsidies Right None used to support aggregate demand unemployment benefits)
Foreign currency - Monetarist: Oppose Keynesian fiscal focus, call for Current spending: Spending on goods and services
Right None
values steady growth of money Capital spending: Spending on infrastructure

- New classical: Extrapolate macroeconomic

Inflationary Gap Fiscal Policy: Revenue Tools

conclusions from assumption that rational
Direct taxes: Tax on income (e.g., income taxes,
individuals will maximize their utility
corporate taxes, capital gains taxes)
Unemployment Indirect taxes: Tax on goods and services
- Unemployed: Jobless people who are seeking jobs

Fiscal Multiplier
- Labor force: People with a job or unemployed
1
- Unemployment rate: Unemployed⁄Labor force = , where MPC = marginal
1 − MPC(1 − t)
Type Result of
propensity to consume; t = tax rate
Temporary
Frictional Difficulties Executing Fiscal Policy
transitions
Long-run changes Recognition lag: Government must see need
Structural Action lag: Time needed to choose policy
in economy
Impact lag: Policies do not have immediate impact
Changes in
Effect of Combined Changes in AS and AD Cyclical
economic activity
Changes in
Real GDP Prices

INTERNATIONAL TRADE AND CAPITAL FLOWS
AS and AD Inflation Basics of International Trade
AS ↑, AD ↑ Increase Unclear Deflation: Negative inflation rate Terms of trade: Price of exports/Price of imports
AS ↓, AD ↓ Decrease Unclear Disinflation: Declining inflation rate Autarky: No trade with other countries
AS ↑, AD ↓ Unclear Decrease Hyperinflation: Extremely high inflation rate Absolute advantage: Lower total cost of production
AS ↓, AD ↑ Unclear Increase Cost-push: From decrease in aggregate supply Comparative advantage: Lower opportunity cost
Demand-pull: From increase in aggregate demand
International Trade Models
Laspeyres index: Use base consumption basket
UNDERSTANDING BUSINESS CYCLES Ricardian: Labor is the only factor of production,
Paasche index: Use current consumption basket
comparative advantage due to labor productivity
Business Cycle Phases Fisher index: ILaspeyres × Paasche Hecksher-Ohlin: Both labor and capital are factors,
Early Expansion (Recovery)
income redistribution is possible through trade
- Economic activity: Increase from trough level Economic Indicators
- Employment: Layoffs slow, but firms prefer Leading: Stock indexes, building permits Trade Restrictions
extending overtime to rehiring full-time Coincident: Real income, industrial production Tariffs: Taxes on imported goods
- Spending: Increasing, especially for housing, Lagging: Unemployment rate, prime lending rate Quotas: Limits on quantity of imported goods
consumer items, light equipment Export subsidies: Payments to exporters
Minimum domestic content requirements
- Inflation: Low, possibly still falling
Voluntary export restraints: Self-imposed
limitations by foreign producers
Impact of Trade Restrictions Crawling peg: Peg rate is periodically adjusted Separately Reported Items
Crawling bands: Margin increases over time, - Discontinued operations
usually to transition from fixed peg to floating - Unusual or infrequent items (US GAAP only)
Managed floating: Monetary authority intervenes, - Non-operating items
but no official target exchange rate
Basic Earnings per Share
Independently floating: Market sets exchange rate
Net income − Preferred dividends

Marshall-Lerner Condition Weighted average of shares outstanding
Currency devaluation can improve a country’s
Diluted Earnings per Share
trade balance if demand elasticities cause export Convertible Convertible
Net Preferred
receipts to increase more than import − + preferred + debt (1 − 𝑡)
income dividends
expenditures dividends interest
Weighted Shares from Shares from Shares issuable
average + preferred + convertible + from stock
shares shares debt options

∗ FINANCIAL REPORTING AND ANALYSIS Must be equal to or less than basic EPS
- Price increases from 𝑃 to 𝑃L

- Domestic production increases from 𝑄4 to 𝑄6
- Domestic consumption falls from 𝑄M to 𝑄@ FINANCIAL REPORTING STANDARDS UNDERSTANDING BALANCE SHEETS
- Imports fall from (𝑄M − 𝑄4 )to (𝑄@ − 𝑄6 ) FASB, IASB, and IOSCO Classified Balance Sheet
- Loss of consumer surplus = (A + B + C + D) FASB: Sets forth US GAAP Current Assets: To be used within one year
- National welfare loss = (B + D) IASB: Establishes IFRS - Cash and equivalents
- Increase in producer surplus = A IOSCO: International body of regulatory authorities - Marketable securities
- Tariff revenue/Quota rent = C SEC: US capital markets regulator - Accounts receivable, net of bad debt expense
Regional Trading Blocs Fundamental Qualities of Financial Reports - Inventories
Free trade area (FTA): Free trade among members 1. Relevance 2. Faithful Representation - Other (e.g., prepaid expenses)
Customs union (CU): FTA + common trade policy Enhancing Characteristics Non-Current Assets
Common market (CM): CU + free movement of 1. Comparability 2. Verifiability - Property, Plant, and Equipment (PP&E)
factors of production within bloc 3. Timeliness 4. Understandability - Investment property
Economic union (EU): CM + common economic - Intangible assets
institutions and coordination of economic policies UNDERSTANDING INCOME STATEMENTS - Goodwill
Monetary union (MU): EU + common currency Revenue Recognition - Financial assets

Balance of Payments Components Revenue must not be recognized unless: Current Liabilities: To be settled within one year
Current account: Merchandise and services, income - Risks of ownership have been transferred - Accounts payable
receipts, unilateral transfers - Amount of revenue can be reliably measured - Notes payable
Capital account: Capital transfers, non-financial - Customer is likely to pay - Accrued expenses
assets sales/purchases - Transaction is unlikely to be reversed - Deferred income (Unearned revenue)
Financial account: Government-owned assets Service revenue may be recognized as earned Long-term Liabilities
abroad, foreign-owned assets in the country Allowance for doubtful accounts: Contra-asset - Long-term debt
account, estimated based on historical experience - Deferred tax liabilities
CURRENCY EXCHANGE RATES Equity
Expense Recognition
Exchange Rate Calculations - Contributed capital
Matching principle: Expenses must be recognized
CPIN - Preferred shares
Real ex. rate&⁄N = Nominal ex. rate&⁄N × q r in the same period as associated revenue
CPI& - Treasury shares
Forward exchange rate&⁄N 1 + i& Income Statement Line Items - Retained earnings
=
Spot exchange rate&⁄N 1 + iN Revenue - Accumulated other comprehensive income (OCI)
Cross rate: S8⁄< = S8⁄O × SO⁄< − Cost of goods sold (COGS) - Non-controlling (minority) interest
Forward exchange rates in points: Gross Profit
- Unit of points is last decimal place in the rate − Selling, General & Admin. (SG&A) UNDERSTANDING CASH FLOW STATEMENTS
quote (e.g., 1.5301 to 1.5302 is a 1-point increase) EBITDA

Cash Flow Statement Classifications
Ideal Currency Regime − Depreciation and Amortization CFO: Cash flows from regular operations
1. Exchange rates are credibly fixed EBIT (Operating profit) CFI: Cash flows for buying/selling long-term assets
2. Fully convertible currencies, free capital flows − Interest CFF: Financial transactions with capital providers
3. Countries pursue independent monetary policies EBT (Earnings before taxes) Item US GAAP IFRS
Such an ideal currency regime is NOT possible − Taxes Dividends paid CFF CFO/CFF
Exchange Rate Regimes Net Income (NI) Interest paid CFO CFO/CFF
Dollarization: Adopt another country’s currency
Dividends received CFO CFO/CFI
Monetary union: Adopt a common currency Interest received CFO CFO/CFI
Currency board: Commitment to exchange Tax expenses CFO CFO*
domestic currency at fixed exchange rate
*IFRS treat tax expenses for investing or financing
Fixed peg: Currency is pegged to foreign currency transactions as CFI or CFF
(or basket of currencies) within ±1% margin
Target zone: Fixed peg with wider margin
CFO Direct Method Working capital Revenue DuPont Analysis
=
- Convert each accrual-based item in the income turnover Average working capital Net income Assets
ROE = q rq r
statement to cash inflow/outflow Assets Book Value of Equity
Liquidity Ratios
- CFO is net of cash inflows and outflows Current assets Leverage
Current ratio = = (ROA) > ?
Current liabilities ratio
CFO Indirect Method
- Start with net income Marketable NI Revenue Assets
Cash + + Receivables =q rq rq r
securities Revenue Assets Equity
- Add noncash expenses (e.g., Depreciation) Quick ratio =
Current liabilities
- Subtract gains/add losses Net profit Asset Leverage
Cash + Marketable securities =q r> ?> ?
- Add increases in current liabilities margin turnover ratio
Cash ratio =
- Subtract increases in (non-cash) current assets Current liabilities
NI EBT EBIT Revenue Assets

Marketable =/ 5/ 5/ 5/ 5/ 5
Cash + + Receivables EBT EBIT Revenue Assets Equity
Beginning accounts receivable Defensive securities
= Tax Interest EBIT Asset Financial
+ Revenue interval Average daily expenditures =+ 5+ 59 ?+ 59 ?

burden burden margin turnover leverage
− Ending accounts receivable Cash Days of Days of Number
Cash collected from customers conversion = sales + inventory − of days INVENTORIES
cycle outstanding on hand payables
Cost of goods sold Inventory Valuation Requirements
+ Increase in inventory Solvency Ratios IFRS: Lower of cost or net realizable value
Purchases from suppliers Total debt US GAAP: Lower of cost or market value
Debt-to-equity =
Total shareholders' equity Reversals of inventory write-downs are allowed
− Increase in accounts payable

Cash paid to suppliers Total debt under IFRS, but not under US GAAP
Debt-to-capital =
Total shareholders' Inventory Valuation Methods and Systems
Free Cash Flow (FCF) Total debt +
equity
Free cash flow to the firm (FCFF): Cash available to US GAAP IFRS
Total debt FIFO Allowed Allowed
equity owners and debt holders. Debt-to-assets =
Total assets LIFO Allowed N/A
FCFF = NI + NCC + I × (1 − t) − FCI − WCI

FCFF = CFO + I × (1 − t) − FCI Average total assets Weighted Allowed Allowed

Financial leverage =
Average total equity average
Free cash flow to equity (FCFE): Cash flow available

EBIT Specific Allowed Allowed

to common shareholders
Interest coverage = Identification
FCFE = CFO − FCI + Net Borrowing Interest payments
Fixed EBIT + Lease payments Impact of Inventory Valuation Method
charge =
FINANCIAL ANALYSIS TECHNIQUES coverage Interest payments + Lease pmts If prices are rising FIFO LIFO
Common-Size Analysis
Ending Inventory Higher Lower
Profitability Ratios
Vertical: COGS Lower Higher
Net income
- State income statement items as % of revenue Net profit margin = Net income Higher Lower
Revenue
- State balance sheet items as a % of total assets
Income Tax Expense Higher Lower
- State each cash flow statement item as a % of Gross profit
Gross profit margin = Operating cash flow Lower Higher
Revenue
total cash inflows/outflows

Horizontal (Trend) Analysis: EBIT Perpetual vs. periodic inventory system:

Operating profit margin = - Periodic system matches total units sold for the
- State each item relative to its base-year value Revenue

period with total purchases for the same period
Activity Ratios EBT
Pretax margin = - Perpetual system updates after each transaction
Annual sales Revenue
Receivables turnover = - Under FIFO, ending inventory and COGS are the
Average receivables Net income
Return on assets (ROA) = same for periodic or perpetual
Average total assets
Days of sales 365 - Weighted average and LIFO will show differences
=
outstanding Receivables turnover EBIT
Return on total capital = LIFO Reserve
Cost of goods sold Average total capital
Inventory turnover =
Used to adjust LIFO COGS and ending inventory
Average inventory Net income (EI) to FIFO-equivalent values
Return on equity (ROE) =
365 Average total equity
Days of inventory EIPIPQ = EIRIPQ + LIFO Reserve
=
on hand Inventory turnover COGSPIPQ = COGSRIPQ − ΔLIFO Reserve

Valuation Ratios
Purchases Dividends declared TaxPIPQ = TaxRIPQ + ΔLIFO Reserve × t
Payables turnover = Dividend payout ratio =
Average trade payables NI available to common
LIFO Liquidations
Number of days 365 Retention rate (RR) = 1 − Dividend payout ratio - Happen when units sold exceed units purchased
=
of payables Payables turnover Sustainable growth rate (g) = RR × ROE - May result in higher gross profit than otherwise
Revenue
Total asset turnover = Price per share
Average total assets P/E Ratio =
Earnings per share
Revenue
Fixed asset turnover =
Average net fixed assets
LONG-LIVED ASSETS INCOME TAXES Conditions requiring a lease to be a finance lease:
Long-Term Assets Temporary Taxable Differences - Ownership of the leased asset is transferred to
Property, plant, and equipment (PP&E): Deferred tax assets (DTA): Created when taxes the lessee at the end of the lease term
IFRS payable exceeds income tax expense - Lessee option to purchase the asset for less than
- Both cost model and revaluation model allowed Deferred tax liabilities (DTL): Created when taxes its expected fair value
- Recoverable amount is greater of: payable is less than income tax expense - Lease term covers most of asset's useful life
(1) fair value less selling costs, and Tax base of assets: Amount that will be deducted on - The present value of lease payments at inception
(2) value in use (PV of asset’s future cash flows) the tax return as asset’s benefits are realized is close to the asset’s fair value
- Loss recoveries are allowed Tax base of liabilities: Carrying value of liability - The leased asset is so specialized that only the
minus amount that will be deductible lessee can use it without modification
US GAAP
– Only cost model is allowed Asset carrying amount > Tax base DTL IFRS require all leases to be treated in the manner
– Loss recoveries not allowed Asset carrying amount < Tax base DTA that is prescribed by US GAAP for finance leases.
Liability carrying amount > Tax base DTA Operating leases are not permitted.
Depreciation Methods

EFGH%IJKLJMN LJKON Liability carrying amount < Tax base DTL Lessor Accounting
Straight-line: =
PNQ!NRSJTKN KSUN - IFRS allow lessors to treat a lease as either an
Impact of tax rate changes
Double-declining balance (DDB): If tax rate increases, DTA and DTL will increase operating lease or a finance lease
Book value# If tax rate decreases, DTA and DTL will decrease - Under US GAAP, lessors may choose to classify a
Depreciation# = q r × 2 lease as operating, sales-type, or direct
Depreciable life Income tax exp. = Taxes payable + ΔDTL − ΔDTA
Units-of-production: financing. Lessor must use sales-type lease
Valuation Allowance accounting if any of the criteria for lessees are
Cost − Salvage
Depreciation# = × Output units# Contra account used if it is unlikely that future
Total output met and it is likely that payments will be made
profits will be sufficient to use DTAs and credits - For operating leases (under both IFRS and US
Intangible Assets

Deferred Tax Charges Directly to Equity GAAP), the lessor retains the leased asset on its
Purchased: Record at fair value (purchase price)
- Revaluation of PP&E (IFRS only) balance sheet and incurs the associated
Developed internally:
- Impact of changes in accounting policies depreciation expense. Lease income from the
IFRS
- Impact of exchange rate fluctuations lessor is recorded as revenue.
- Research expenditures are expensed
- Changes in fair value of certain investments - Finance leases (IFRS) and sales-type leases (US
- Development expenditures are capitalized
GAAP) have similar requirements. The lessor
US GAAP
removes the leased asset from its balance sheet
- Generally, both R&D costs are expensed NON-CURRENT (LONG-TERM) LIABILITIES
and creates an asset with a value equal to the
Acquired in business combination: Long-Term Liabilities
lease receivable and any residual value.
Purchase price is allocated to each asset on fair Premium bond: Coupon rate > yield at issuance
- Under a direct financing lease, the lessor
value basis; excess recorded as goodwill Discount bond: Coupon rate < yield at issuance

removes the asset from its balance sheet and
Capitalizing vs. Expensing Issuance costs: creates an asset for the lease receivable.
- Capitalizing increases assets on the balance sheet US GAAP – capitalized as an asset

Pensions
and investing cash outflows IFRS – reduces initial bond liability
Defined benefit (DB): Firm makes periodic
- Expensing reduces net income by the after-tax Derecognition of debt: If an issuer redeems a bond payments to employee after retirement.
expenditure amount in the period it is incurred before maturity, a gain/loss (book value minus

Overfunded (underfunded) plan is recognized as
Impairment of PP&E and Intangible Assets redemption price) is recognized an asset (liability).
US GAAP Debt covenants: Affirmative – borrower promises
- Asset tested for impairment only when firm may to do certain things; negative – borrower promises
not recover carrying value through future use to refrain from certain things CORPORATE FINANCE
- Asset is impaired when carrying value exceeds Lessee Accounting
asset’s future undiscounted cash flows US GAAP INTRODUCTION TO CORPORATE GOVERNANCE
- Impaired asset’s value is written down to fair Finance (Capital) lease: AND OTHER ESG CONSIDERATIONS
value and a loss is recognized and cannot be - Lessee purchases the asset, financed by the lessor Corporate governance can be described as:
subsequently reversed - Lessee's periodic lease payments have separate - A system of internal controls and procedures for
depreciation and interest components managing organizational business
IFRS
Operating lease (like a rental agreement): - A framework for defining the rights and
- Assets are tested annually for impairment
- Single lease expense, not separated into different responsibilities of individuals and groups within
- Impaired if carrying value > recoverable amount
components for depreciation and interest the organization
- Impaired asset’s value is written down to
- The value of an operating lease payment is - An arrangement of checks, balances, and
recoverable amount and a loss is recognized
calculated as a straight-line allocation of total incentives to minimize and manage conflicts
- Loss can be reversed if asset value recovers, but
payments over the term of the lease between the interests of insiders and external
only up to pre-impairment carrying value
stakeholders

Shareholder theory is based on the concept that

the primary responsibility of corporate managers
is to maximize returns for shareholders.
Stakeholder theory is a broader interpretation of CAPITAL BUDGETING COST OF CAPITAL
corporate governance. Shareholders are just one of Typical Steps in Capital Budgeting Weighted Average Cost of Capital (WACC)
the stakeholder groups whose interests must be 1. Generate investment ideas WACC = w& r&(1 − t) + w." r." + w(% r(%
2. Analyze individual proposals
balanced. w& = percentage of debt in capital structure

3. Plan projects in the context of an overall capital
budget w." = percentage of preferred stock
Company Stakeholders
4. Monitor and audit results w(% = percentage of common stock
- Shareholders

Key Capital Budgeting Assumptions t = tax rate

- Creditors
- Managers and employees - Model incremental operating cash flows, not r& = cost of debt
- Directors accounting income r." = cost of preferred stock = D." ⁄P
- Customers - Ignore sunk costs and financing costs r(% = cost of common stock
- Suppliers - Include opportunity costs and externalities k (% = D4 ⁄PG + g (dividend discount model)
- Governments and regulators - Financing costs are accounted for by the discount k (% = R P + β[E(R ' ) − R P ] (CAPM)
The frameworks that define the rights and rate k (% = R P + β4 Factor4 + ⋯ + β; Factor;
responsibilities of various stakeholders include: - Decisions must be made on an after-tax basis (Multifactor Model)
- Legal infrastructure r(% = r& + Risk Premium
Net Present Value (NPV)
- Contractual infrastructure (Bond Yield plus Risk Premium)
Sum of present values of expected future cash
- Organizational infrastructure inflows, net of initial cash outlay Optimal Capital Budget
- Governmental infrastructure
NPV Decision Rules Invest in projects until the incremental expected
Mechanisms for managing stakeholder - Accept if NPV is positive, reject if negative return is less than the marginal cost of capital
relationships include: - If only one of multiple mutually exclusive projects
- General meetings can be accepted, accept project with highest NPV
- Board of directors - If subject to capital rationing, choose the highest
- Auditing NPV combination of projects
- Reporting and transparency - Projects that are negative NPV in isolation may be
- Policies on related-party transactions accepted as part of project sequencing
- Remuneration policies (e.g., say-on-pay

Internal Rate of Return (IRR)

provisions)
IRR is r such that NPV = 0 Pure-Play Method Project Beta
- Contractual arrangements with creditors,
Accept a project if its IRR > required return Unlevered beta for comparable company:
customers, employees, and suppliers
- Laws and regulations - NPV and IRR may give contradictory ⎡ ⎤
1
β$""%# = β%S,+#/ ⎢ ⎥

recommendations due size and timing of CFs
Board Composition ⎢1 + d1 − t D()'.$-$TJ% ⎥
- If NPV and IRR are in conflict, go with NPV ()'.$-$TJ% e E
One-tier: Executive and non-executive directors ⎣ ()'.$-$TJ% ⎦

Two-tier: Independent supervisory board oversees BA II Plus NPV Worksheet Function Levered project beta for subject firm:
management board - Cash inflows are positive; outflows are negative D",T;%(#
β.-);%(# = β$""%# ™1 + d1 − t ",T;%(# e š
Staggered: Multiple classes of directors elected at - F01, F02, etc. refer to cash flow frequencies E",T;%(#

different times; Replacing entire board takes years - CPT + NPV to compute NPV; CPT + IRR for IRR Country Equity Premium
CEO Duality: When the CEO also chairs a

Payback Period Country equity premium =

company's board
- Number of years required for cumulative cash (Sovereign yield spread) x
Key Board Committees flows to equal initial investment
Annualized SD of local equity index
- Audit - Does not take into account time value of money › œ
Annualized SD of local sovereign bond market
- Governance

Discounted Payback Period in terms of developed market currency

- Remuneration/Compensation
- Nomination Number of years required for cumulative Dividend Discount Model
- Risk
discounted cash flows to equal initial investment D4 D
- Investment r% = + g → g = q1 − r ROE
PG EPS
Factors Affecting Stakeholder Relationships Average Accounting Rate of Return (AAR)

and Corporate Governance Average net income Impact of Flotation Costs

AAR =
Market factors Average book value r% adjusted for flotation costs (amount):
- Shareholder engagement through forums such as
D4
AGMs and analyst calls Profitability Index (PI) r% = + g
PG − F
- Shareholder activism to influence a company's PV of future cash flows NPV
actions PI = =1+ r% adjusted for flotation costs (percentage):
CFG CFQ
- Competition and takeovers to gain control of a D4
Accept if PI > 1; reject if PI < 1 r% = + g
company
PG − [1 − f]
Non-market factors Crossover Rate
- Legal protections for stakeholders such as Subtracting flotation costs from NPV is preferable
shareholders and lenders - Rate at which NPV profile of two projects cross
to adjusting the cost of equity
- Media coverage of corporate activities - Calculated as IRR of difference in cash flows
- Corporate governance consultants to advise
institutional investors and develop metrics
to rate companies based on their
governance practices
MEASURES OF LEVERAGE Yields on Short-Term Investments EQUITY
Leverage FV − PP 360
Money Market Yield = q rq r
PP DTM MARKET ORGANIZATION AND STRUCTURE
FV − PP 365 Functions of the Financial System
Bond Equivalent Yield = q rq r
PP DTM - Saving
FV − PP 360 - Borrowing
Discount Basis Yield = q rq r - Raising Equity Capital
FV DTM
FV = face value, PP = purchase price, - Managing Risks
DTM = days to maturity - Exchanging Assets

- Information-Motivated Trading
Business Risk Short-Term Investment Strategies

Two components of business risk are: Matching: Aligning maturities of investments with Securities Markets
- Sales risk: determined by the elasticity of demand expected timing of cash outflows; conservative - Spot vs. Forward Markets: Spot market trades are
for products and services Mismatching: Choosing investments without settled within 3 days.
- Operating risk: determined by the share of fixed regard to expected timing of cash outflows; riskier - Primary vs. Secondary Markets: Primary market
costs as a share of total operating costs Laddering: Systematically spacing out maturities transactions are done directly with the issuer,
while secondary market trades take place on
Measures of Leverage Typical Trade Credit Terms
organized exchanges.
Degree of operating leverage (DOL): - Ordinary: 1/10, net 30 means 1% discount if
- Capital vs. Money Markets: Money markets are
%Δ Operating income Q(P − V) payment received within 10 days or full amount
DOL = = used for securities with maturities of less than
%Δ Units sold Q(P − V) − F due before 30 days
one year, while longer-dated securities are traded
- Cash before delivery: Check must clear first
Degree of financial leverage (DFL): in capital markets.
- Cash on delivery: Customer pays upon delivery
%Δ Net income Q(P − V) − F
DFL = = - Bill-to-bill: No new delivery if prior bill is unpaid Positions
%Δ Operating income Q(P − V) − F − C
- Monthly billing: 3/8th Prox net 28th means 3% Long positions: Benefit from price appreciation
Degree of total leverage (DTL): discount if payment received by 8th of next month, Short positions: Benefit from price depreciation
%Δ Net income Q(P − V) otherwise full amount due on the 28th

DTL = = Leveraged Positions

%Δ Units sold Q(P − V) − F − C
Float Factor Position
DTL = DOL × DFL Leverage ratio =
Average number of days for checks to clear Equity

Average Daily Float 1
Breakeven = Maximum initial leverage ratio =
Average Daily Deposit Intial margin
F+C
Breakeven: Q <U = Maintenance margin: minimum amount of equity
P−V Disbursement float: Time between check issuance
F and clearance required
Operating breakeven: Q Q<U =
P−V Margin call is triggered if the equity falls below the
Inventory Costs
Q = quantity; P = price; V = variable cost/unit maintenance margin. Additional equity will be
- Ordering: Machine setup, freight, labor, admin
F = fixed operating cost; C = fixed financial cost requested to bring the account balance back to the
- Carrying: Storage, insurance, obsolescence
initial margin.
- Stock-out: Lost sales, back-order, substitution
WORKING CAPITAL MANAGEMENT
- Policy: Cost of gathering data Execution Instructions (How to fill)
Working Capital Liquidity
- Market: Fill immediately at market price
Primary sources of liquidity: Inventory Management Approaches
- Limit: Buy below maximum price or sell above
- Ready cash balances (bank accounts) - Economic Order Quantity: Safety stock cushion
minimum price specified in order
- Short-term funds (lines of credit) based on predictable demand and lead time;
- All-or-nothing: Cancel order if not fully filled
- Cash flow management (centralized collection) Common for smaller items with low unit costs
- Hidden: Visible to brokers and exchanges, but
Secondary sources of liquidity: - Just-in-time: Based on resource planning systems;
invisible to other traders
- Negotiating debt contracts minimizes in-process inventory stock
- Iceberg: Only a fraction of order amount is visible
- Liquidating assets Cost of Trade Credit (CTC)
- Filing for bankruptcy Validity Instructions (When to fill)
Cost of not taking the discount for early payment
Drag on liquidity: Delayed cash inflows, such as @VW - Day orders: Cancelled if unfilled at end of day
uncollected receivables and obsolete inventory %discount &$/" .$"# &+"(),*#
- Good-till-cancelled: No set expiry date
CTC = q1 + r − 1
1 − %discount - Good-on-close: Filled at end of day
Pull on liquidity: Accelerated cash outflows, such as

settling payables earlier Managing Short-Term Financing - Stop-loss: Sell if prices fall below specified level
Operating cycle = # days of inventory + # days of Interest + Commitment Fee
Cost = Clearing Instructions
receivable Loan Amount
Settlement/clearing typically done by brokers for
Interest
Net operating cycle (a.k.a. cash conversion cycle) = Cost = retail trades; brokers or custodians for
Loan Amount − Interest
Operating cycle – # days of payable institutional trades
Interest + Commission + Backup cost
Cost =
Loan Amount − Interest


Primary Market Transactions Equally Weighted Indexes Selected Behavioral Biases
- Initial Public Offerings (IPOs) 1 - Loss aversion: Disliking losses more than liking
w+U =
- Private placements N equivalent gains
- Shelf registrations: Part of issue is held back to be - Like investing the same amount in each stock - Information Cascades: Those who act first will
sold directly to secondary market investors later - Advantage is simplicity convey information that influences others
- Dividend reinvestment plans (DRIPs): Investors - Disadvantages are that the impact of large - Representativeness: Rely too much on current
can roll over dividend payments to purchase new companies is underrepresented and frequent state when assessing probabilities
shares, possibly at a discount rebalancing is required - Mental accounting: Keep track of gains and losses
- Rights offerings: Current shareholders gain right separately for different investments/goals
Capitalization-Weighted Indexes
to purchase additional shares at below-market Q + P+ - Conservatism: Failing to incorporate new
price; dilutes value of existing shares w+1 = !
∑;34 Q ; P; information in a timely manner
Market Structure - Like holding all stocks in proportion to their - Narrow framing: Focusing on certain issues in
Quote-driven: Investors trade with dealers market values isolation
Order-driven: Exchanges use order matching rules - Float adjustment may be used to reflect the
Brokered: Trades arranged by brokers number of shares that may be actively traded OVERVIEW OF EQUITY SECURITIES
Call markets: Conduct periodic single price - Advantage is that the asset classes’ performance Common Share Voting Methods
auctions, otherwise completely illiquid is well-represented Statutory: One vote per share
Continuous Trading markets: Allow trades - Disadvantage is that returns are heavily driven by Cumulative: Votes can be bundled
whenever market is open, may use call market large-cap (possibly overvalued) firms Example: 10 board positions
auction at beginning and/or end of each day Statutory: 1 share votes for 10 different candidates
Fundamentally Weighted Indexes
Cumulative: 10 votes may go to 1 candidate
Trade Pricing Rules - Built like price-weighted indexes, but using a
Cumulative method advantages small shareholder
Uniform pricing rules: Used by call markets, all fundamental measure such as sales or cash flows
trades executed at the price that maximizes total - Contrarian effect of rebalancing by selling off top Preference Shares
quantity traded - Cumulative: Accrue dividends if payments missed
performers and buying underperforming stocks
Discriminatory pricing rules: Used by continuous - Non-cumulative: Missed dividends do not accrue,
produces a value tilt
markets, fills most aggressively priced orders first but no common dividends allowed if preferred
Types of Equity Market Indexes shareholders do not receive their dividend
Derivative pricing rules: Used by crossing networks
- Broad market indexes: Covers one equity market - Participating: May receive additional dividend if
to trade at midpoint of quotes from other markets
- Multi-market indexes: Covers equity markets in firm is profitable or in the event of liquidation
Complete Markets multiple countries - Non-participating: No compensation beyond
- Facilitate savings/investment
- Sector indexes: Important for assessing a dividends and face value in a liquidation
- Facilitate lending to creditworthy borrowers
manager’s performance (selection vs. allocation)
- Allow risk exposures to be hedged Private Equity Securities
- Style indexes: Large/small cap; Value/growth
- Facilitate exchange of currencies/commodities - Venture capital (VC): Start-up, early-state, or

An ideal financial system is complete (see above), mezzanine financing with IPO as exit strategy
MARKET EFFICIENCY
operationally efficient (low transaction costs), and - Leveraged buyouts (LBO): Debt-financed deals to
Forms of Efficient Market Hypothesis (EMH)
informationally efficient (prices reflect all info.) take undervalued listed companies private
Market Prices Reflect:
- Private investment in public equity (PIPE):
Past
SECURITY MARKET INDEXES Public Private Companies can raise new capital quickly,
Form market
Price Return over Single Period info info investors can negotiate discounts
!
data
P+4 − P+G Weak ✔
PR + = PR I = F w+ PR + Depository Receipts (DRs)
P+G
+34 Semi- Sponsored DRs: Issued directly by foreign
✔ ✔
strong company; Investors receive same voting rights and
Total Return over Single Period
! Strong ✔ ✔ ✔ dividends as other common shareholders
P+4 − P+G + Inc+
TR + = TR I = F w+ TR +
P+G Implications of EMH Unsponsored DRs: Foreign company not involved;
+34
- If weak form holds, investors will not earn Depository bank purchases shares, issues DRs, and
Price Return Index over Multiple Periods
abnormal profits from technical analysis retains voting rights
V0YI2 = V0YIG (1 + PR I4 )(1 + PR I6 ) … (1 + PR I2)
- If markets are semi-strong efficient, investors
Global DRs: Issued outside company’s home
Total Return Index over Multiple Periods must have a comparative advantage to earn
country to avoid limits on capital flows; May be
V2YI2 = V2YIG (1 + TR I4 )(1 + TR I6 ) … (1 + TR I2 ) abnormal profits from fundamental analysis
denominated in any currency, but USD is common;
Price-Weighted Indexes Market Anomalies Cannot be listed on US exchanges, but US investors
P+ Changes in a security’s price that are not can purchase them via private placements
w+0 = !
∑;34 P; attributable to known information
American DRs: USD-denominated GDRs that can be
- Like buying one share of each stock

traded on US exchanges; Underlying securities,

- Advantage is simplicity
American depository shares, trade in issuer’s
- Disadvantage is arbitrary weights
domestic market
- A stock’s weight is halved due to a stock split,
requiring an adjustment to the divisor
Global Registered Shares: Traded on multiple FIXED INCOME Convertible Contingent Bonds (CoCos)
exchanges, including issuer’s domestic market; - Automatically convert to equity if a condition is
Denominated in multiple local currencies; Unlike FIXED-INCOME SECURITIES: DEFINING met (e.g., capitalization ratio falls)
DRs, GRS represent an actual ownership interest ELEMENTS - Lender does not control if option is exercised
Types of Bonds - Primarily issued by financial institutions
INTRODUCTION TO INDUSTRY AND COMPANY - Collateral Trust Bonds: Backed by financial assets
ANALYSIS - Equipment Trust Bonds: Backed by physical assets FIXED-INCOME MARKETS: ISSUANCE, TRADING,
Porter’s Five Forces Framework - Covered Bonds: Backed by a segregated pool of AND FUNDING
- Threat of substitute products loans that are replaced if they stop performing Bond Markets
- Bargaining power of customers - Primary bond markets: Markets in which issuers
Principal Repayment Structures
- Bargaining power of suppliers initially sell bonds to investors to raise capital
- Bullet Bonds: Full principal repaid at maturity
- Threat of new entrants - Secondary bond markets: Markets in which bonds
- Fully Amortizing: Equal annuity-like payments
- Intensity of rivalry are subsequently traded among investors; Most
contain a mix of interest and principal
trading is OTC rather than on organized
Industry Life Cycle Stages - Partially Amortizing: Some principal is amortized,
exchanges
- Embryonic: Slow growth, high prices, high failure remainder repaid as a lump sum at maturity
- Grey market: Informal forward market to gauge
risk, significant investment required - Sinking Funds: Certain percentage of principal
interest in upcoming bond issues and set prices
- Growth: Rapidly increasing demand, improving retired each year
for the primary market
profitability, falling prices, low competition
Coupon Structures
- Shakeout: Slowing growth, intense competition, Sovereign Debt
- Fixed-rate bonds: Set percentage of principal
declining profitability - Issued by national governments, zero default risk
- Floating-rate (FRNs): Reference rate + spread
- Mature: Little or no growth, industry - Bills mature < 1 year; Bonds mature > 1 year
- Step-up: Coupon rate increases on schedule
consolidation, high entry barriers - On-the-run: Most recent issues of a given
- Credit-Linked: Coupon rate is increased if issuer is
- Decline: Negative growth, excess capacity, high maturity; more liquid than off-the-run issues
downgraded, reduced if upgraded
competition
- Payment-in-kind: Coupons may be paid with more Non-Sovereign Debt
Key Competitive Strategies bonds rather than cash - Municipal bonds (sub-national issuers)
- Low-cost leadership: To hold/gain market share - Deferred (Split) Coupon: No coupons in early - Quasi-government bonds (gov’t-backed agencies)
- Product differentiation: To charge premium prices years, high coupons in later years - Supranational bonds (i.e., IMF, World Bank)
Corporate Debt
Inflation-Indexed Bonds
EQUITY VALUATION: CONCEPTS AND BASIC - Commercial paper (CP) used for < 1 year, but
- Zero-coupon: Principal amount is adjusted
TOOLS carries rollover risk
- Interest-indexed: Coupons are adjusted
Dividend Discount Model (DDM) - Long-term bonds ~12+ years
Z *
- Capital-indexed: Fixed rate, adjusted principal
D# D# P* - Bilateral/syndicated bank loans are also used
VG = F =F + - Indexed-annuity: Amortizing bonds with annuity
(1 + r)# (1 + r)# (1 + r)* payments adjusted for inflation Medium-Term Notes (MTNs)
#34 #34
Perpetual preferred stock; constant dividend: - Used to bridge gap between CP and L/T bonds
Credit Enhancements
DG - Offered to investors through an agent in a range
VG = Internal: Subordination, over-collateralization,
r of maturities
Gordon constant growth model (GGM): excess spread
- Lower registration/underwriting costs than
Z External: Surety bonds, letters of credit, guarantees
DG (1 + g)# DG (1 + g) D4 bonds, but relatively illiquid
VG = F = = from financial institutions
(1 + r)# r−g r−g
#34 USCP vs. Eurocommercial Paper
Bonds with Contingency Provisions
g = (Retention rate) × ROE = (1 − D⁄E) × ROE USCP ECP
Multistage DDM: Callable Bonds
Currency US dollar Any currency
* May be recalled by issuer if rates fall
D# P* Maturity Overnight Overnight to
VG = F + VO$JJ$TJ% T)*& = VNon-callable bond − VO$JJ
(1 + r)# (1 + r)* to 270 days 364 days
#34
D*B4 Putable Bonds Interest Discount Interest-
P* =
r − gR May be sold back to issuer if rates rise calculation basis bearing or
D*B4 = DG (1 + g [ )* (1 + g R ) V0,#$TJ% T)*& = VNon-putable bond + V0,# discount

Price Multiples basis

Convertible Bonds
PG D4 /E4 Settlement T + 0 T + 2
Conversion price: Price per share at which bond
= Negotiable Can be sold Can be sold
E4 r−g can be converted into shares
P⁄B = Price per share⁄Book value per share Conversion ratio: Number of common shares
P⁄CF = Price per share⁄Cash flow per share each bond can be converted into
P⁄S = Price per share⁄Sales per share Conversion value:
Asset-Based Valuation Models Current share price × Conversion ratio
Useful for companies with natural resource or a Conversion premium:
large share of current assets/liabilities; Not useful Convertible bond’s price − Conversion value
if company has a large share of PP&E/intangibles
Warrants: Options to buy equity, lowers debt costs
Enterprise Value (EV)
= MV(Common equity) + MV(Preferred stock)
+ MV(Debt) − (Cash + Short term investments)
Structured Financial Instruments Yield Measures for Money Market Instrument Collateralized Mortgage Obligations (CMO)
- Guarantee certificate: Zero-coupon bond with a Discount Rate (DR) Basis - Unlike pass-through securities, CMOs have
call option on the issuer’s equity Days tranches to redistribute cash flows and risks
PV = FV × q1 − × DRr
- Credit-linked note: Seller earns a premium for Year - Sequential-pay CMOs have principal and

providing credit protection on underlying bond prepayments paid to the tranches sequentially
Add-on Rate (AOR) Basis
- Participation Instruments: Coupon payments - Planned amortization class (PAC) CMOs have
Days
based on underlying rate (e.g., FRNs) PV = FVŸq1 + × AORr support tranches to absorb prepayment risk
Year
- Leveraged Instruments: Modify returns

Implied Forward Rate (IFR) Non-Mortgage ABS

Leveraged floater: 2 × (Reference rate) - Amortizing: E.g., auto loan ABS
<?8
Deleveraged floater: 0.5 × (Reference rate) (1 + z8 )8 × d1 + IFR 8,<?8e )<
= (1 + z<
- Non-amortizing: E.g., credit card receivable ABS
Leveraged inverse floater: Max coupon − 2 × (RR)
Collateralized Debt Obligations (CDO)
Factors Increasing Repurchase (Repo) Rates Securities backed by pool of debt obligations, such
- Higher Collateral risk as corporate bonds, leveraged bank loans, or credit

- Longer term default swap on securities
Yield Spreads over Benchmark Yield Curve
- Delivery requirement
G-spread= YTM − Government bond yield
- Low quality collateral
I-spread= YTM − Swap rate UNDERSTANDING FIXED-INCOME RISK AND
- Higher rates for alternative sources of funds RETURNS
Z-spread
PMT PMT PMT + FV Constant Yield Price Trajectory
INTRODUCTION TO FIXED-INCOME VALUATION PV = + + ⋯+
(1 + z# + Z)# (1 + z$ + Z)$ (1 + z% + Z)%
Bond Pricing with Spot Rates (Can only be calculated by trial-and-error)
PMT PMT PMT + FV
PV = + + ⋯+ Option-adjusted spread (OAS)
(1 + z4 )4 (1 + z6 )6 (1 + z! )!
OAS = Z-spread − Option value (in basis points)
CR: Coupon Rate; MDR: Market Discount Rate

CR = MDR Price = Par Value Par
INTRODUCTION TO ASSET-BACKED SECURITIES
CR < MDR Price < Par Value Discount
Parties to a Securitization
CR > MDR Price > Par Value Premium
- Seller/Depositor: Originates loans (assets)

Bond Pricing Relationships - Issuer: Special purpose vehicle (SPV) established

- Inverse effect: Price moves opposite to yield to create asset-backed securities (ABS)
- Servicer: Collects payments on underlying loans Yield Duration vs. Curve Duration
- Convexity effect: Falling yield has greater price
Yield duration: Sensitivity to YTM
impact than equivalent increase in yield ABS Tranching
Measures: Macaulay duration, modified duration,
- Coupon effect: Yield changes have greater impact - Credit tranching: Certain tranches absorb credit
money duration, price value of basis point (PVBP)
on lower coupon bonds losses before others
Curve duration: Sensitivity to benchmark yields
- Maturity effect: Yield changes have greater impact - Absolute priority rule: Senior claims outrank
subordinated claims in the event of a liquidation (e.g., effective duration); for bonds with options
on longer-term bonds (may not apply to low-
coupon bonds trading at very deep discounts) - Time tranching: Certain tranches are exposed to Macaulay Duration
prepayment risk 1+r 1 + r + N(c − r) t
Flat Price, Accrued Interest, and Full Price D1$( = q − r−
Securitization Example r c[(1 + r)! − 1] + r T
PV P,JJ = PV PJ$# + AI = (PV)(1 + r)#⁄2
- Firm sells equipment on credit r: YTM
AI = (t⁄T) × PMT
- Firm creates bankruptcy-remote SPV c: Coupon rate
Yield Measures - SPV issues debt to purchase loans from firm N: Number of periods to maturity
Annual cash coupon payment t: Number of days since last coupon payment
Current yield = - SPV creates securities backed by loans
Flat price T: Number of days in each coupon period
- Investors purchase securities from SPV
Annual cash Amortized
+ - SPV collects loan payments from firm’s customers
coupon payment gain/loss
Simple yield = - SPV distributes cash flows to investors
Flat price
Yield-to-call (YTC) = IRR assuming bond is called Residential Mortgage Loans
Yield-to-worse = min[YTC, YTM] - Interest: fixed, adjustable, convertible

- Amortization: full, partial, interest-only
Yield Measures for FRNs
- Prepayment: penalty, no penalty
Quoted margin (QM): Spread paid by FRN
- Foreclosure: non-recourse, recourse
Discount margin (DM): Spread required by market
If QM > DM, FRN will trade above par Residential Mortgage-Backed Securities
FRN pricing formula: - Agency RMBS: Issued by government agencies;
(Ref + QM)(FV) (Ref + QM)(FV) must have conforming loans
+ FV
= m … + m - Non-agency RMBS: Issued by private companies
4
(Ref + DM) (Ref + DM) !
q1 + r q1 + r and may have non-conforming loans
m m
- Pass-through rate: MBS coupon rate
- Prepayment risk: Contraction (faster-than-
expected); extension (slower-than-expected)
- Prepayment rates are relative to PSA benchmark
Modified Duration Credit Ratings Forward Price vs. Futures Price
D1$( Investment grade: Baa3/BBB- and above The relationship between forward prices and
ModDur =
1+r
P,JJ
Non-investment grade: Ba1/BB+ and below futures prices depends on the correlation between
%ΔPV = −AnnModDur × ΔYield
futures prices and interest rates:
(PV? ) − (PVB ) Four C’s of Credit Analysis
ApproxModDur = - Capacity Correlation Relationship
2(ΔYield)(PVG )
- Collateral None Futures price = Forward price
Money Duration and PVBP Positive Futures price > Forward price
- Covenants
MoneyDur = AnnModDur × PV P,JJ - Character Negative Futures price < Forward price
ΔPV P,JJ ≈ −MoneyDur × ΔYield

(PV? ) − (PVB ) Corporate Bond Yield Components Option Moneyness

Price value of a basis point = - Real risk-free interest rate
2 Option Moneyness Call Put
Basis point value = D1)& × 0.0001 - Expected inflation rate In-the-money S# > X S# < X
- Maturity premium
Effective Duration At-the-money S# = X S# = X
- Liquidity premium
(PV? ) − (PVB ) Yield spread Out-of-the-money S# < X S# > X
EffDur = - Credit spread
2(ΔCurve)(PVG )

Option Styles
Convexity - American: May be exercised at any time
(PV? ) + (PVB) − [2 × (PVG)] DERIVATIVES - European: May only be exercised at expiration
ApproxCon =
(ΔYield)6 (PVG)
European Option Values
1 DERIVATIVE MARKETS AND INSTRUMENTS
%ΔPV P,JJ = −D1)& × ΔYTM + (Conv)(ΔYTM)6 c2 = max[0, S2 − X]
2 Types of Derivatives
(PV? ) + (PVB ) − 2(PVG ) p2 = max[0, X − S2]
EffConv = Forward commitments: Obligation to trade on a
(ΔCurve)6(PVG ) cG ≥ max[0, SG − X⁄(1 + r)2 ]
specified date at a previously agreed price
pG ≥ max[0, X⁄(1 + r)2 − SG ]
Contingent claims: Trade may or may not occur
depending on market conditions American Option Values
- The value of an American call/put must be at
Forward least equal to the value of an equivalent European
Contingent Claims
Commitments call/put.
Options - American calls on dividend-paying stock or
Forward contract
Credit derivatives American puts may be exercised early.
Futures contracts
Asset-backed - American calls on nondividend-paying stock
Swaps
securities should never be exercised early.
Forwards vs. Futures Factors Impacting Option Values
Forward Contracts Futures Contracts Increase in Call Put

Duration Gap Fully customizable Standardized Value of underlying ↑ ↓
Duration gap = D1$( − Investment horizon Largely Heavily regulated Exercise price ↓ ↑
- If positive: Price risk > Reinvestment risk unregulated Time to expiration ↑ ↑*
- If negative: Reinvestment risk > Price risk Over-the-counter Exchange-traded Risk-free rate ↑ ↓
(OTC)
Volatility of underlying ↑ ↑
FUNDAMENTALS OF CREDIT ANALYSIS Counterparty credit Guaranteed by
Payments on underlying ↓ ↑
risk exposure clearinghouse
Credit Risk Cost of carry ↑ ↓
No cash flows until Margin deposit
- Default risk: Probability of default *Except for some deep-in-the-money put options
maturity and daily mark-
- Loss severity: Loss given default

to-market Put-Call Parity

E[Loss] = Pr(Default) × Loss severity
cG + X⁄(1 + r)2 = sG + pG
Loss severity = 1 − Recovery rate
BASICS OF DERIVATIVE PRICING AND Fiduciary call = Protective put
Spread Risk VALUATION

Put-Call-Forward Parity
- Credit migration risk: Possibility of downgrade The Principle of Arbitrage: Replication
cG + X⁄(1 + r)2 = FG(T)⁄(1 + r)2 + pG
- Market liquidity risk: Need to sell at a discount Strategies
Fiduciary call = Protective put w. forward contract
Seniority Ranking Asset − Derivatives = Risk-free asset

Binomial Valuation of Options
- First Lien Loan – Senior Secured Forward Contract: Price
πc4B + (1 − π)c4?
- Second Lien Loan – Secured FG (T) = SG (1 + r)2 − FV2 (benefit) + FV2 (cost) cG =
1+r
- Senior Unsecured
Forward Contract: Value 1+r−d
- Senior Subordinated π=
u−d
- Subordinated Initiation VG (T) = 0 B ?
c4 − c4
- Junior Subordinated Expiration V2(T) = S2 − FG (T) h= B
S4 − S4?
Pari passu: All creditors in the same ranking, V# (T) = S# − PV#(benefit)
Time t
regardless of maturity, have the same priority + PV# (cost) − FG (T)⁄(1 + r)2?#
ALTERNATIVE INVESTMENTS Commodities PORTFOLIO RISK AND RETURN: PART I
Roll yield: Spot price (𝑆) − Futures price Money-Weighted Return (MWR)
Qualities of Alternatives vs. Traditional Assets Collateral yield: Risk-free return on deposit - IRR derived from all cash inflows and returns
- Lower liquidity Futures price: - Can be skewed by timing/value of cash flows
- Narrow manager specialization SG (1 + r) + Storage costs – Convenience yield - Appropriate if manager controls timing of CFs
- Low correlation with traditional investments
Contango Backwardation Time-Weighted Return (TWR)
- Less regulation and lower transparency
- Limited historical risk and return data Price curve - Geometric mean of sub-period returns
Upward Downward
- Unique legal and tax considerations slope - Compound growth for an initial $1 investment
Convenience - Unaffected by timing/value of cash flows
Hedge Fund Strategies Low High
yield
- Equity hedge: Long and short positions in equity Risk Aversion
Roll yield Negative Positive Combination of ability and willingness to take risk
and equity derivative securities; Bottom-up
- Event-driven: Seek to profit from Infrastructure Investments Risk averse: Requires a premium to take more risk
short-term events (e.g., Mergers); Bottom-up - New (greenfield) or existing (brownfield) assets Risk neutral: Only concerned with expected return,
- Relative value: Seek to profit from pricing - Economic (roads) or social (healthcare facilities) indifferent to level of risk
discrepancies between related securities - Direct ownership or indirect (via LP or ETF) Risk seeking: Will pay a premium to take more risk
- Macro: Emphasize top-down approach to - Private vehicles or public securities (uncommon) Utility Function
identifying global economic trends 1
U = E(r) − Aσ6
Hedge Fund Fees 2
- “2 and 20”: 2% mgt fee, 20% incentive fee PORTFOLIO MANAGEMENT A is the degree of risk aversion, it is >0 for risk-
- Hard hurdle rate: Incentive fee applies only to averse, 0 for risk-neutral, and <0 for risk-seeking
returns above the hurdle rate PORTFOLIO MANAGEMENT: AN OVERVIEW

Indifference Curves
- Soft hurdle rate: Incentive fee applies to entire
Portfolio Management Process
return if hurdle rate is cleared
Planning: List objectives and constraints in IPS
- High water mark: Incentive fee only applies to
Execution: Asset allocation, security analysis,
profits after previous losses have been recovered
portfolio construction
Private Equity: Leveraged Buyouts Feedback: Monitoring and rebalancing,
- Management buyouts: Current management team performance measurement and reporting
is involved in the acquisition

- Management buy-ins: Current management team Institutional Investor Clients

is being replaced by the acquiring team - DB pension plans: Younger beneficiaries increase
time horizon and risk tolerance
Private Equity: Venture capital
- Endowments/Foundations: Generally longer time
- Formative-stage financing: Angel investing,
horizon, low liquidity needs, high risk tolerance
seed-stage financing, early-stage financing Minimum-Variance Portfolios
- Banks: Short time horizon, high liquidity need,
- Later-stage financing: After commercial
very low risk tolerance
production and sales have begun but before IPO
- Insurers: Short time horizon (longer for Life than
- Mezzanine-stage financing: Prepare to go public
P&C), high liquidity needs, low risk tolerance
Exit strategies: Trade sale (best price), IPO,
- Investment companies: Time horizon and risk
recapitalization, secondary sale, liquidation
tolerance vary by mandate, liquidity needs are

Forms of Real Estate Investing usually high due to potential redemptions
Debt Equity - Sovereign Wealth Funds: Vary by mandate
Mortgages, Direct ownership
Robo-Advisors
Private Construction (e.g., JVs, LPs,
- Cater to underserviced segments, “mass affluent”
lending commingled funds)
- Lower fees compared to traditional managers
Shares in RE corps., Capital Allocation Line (CAL)
Public MBS, CMOs - Relatively low barriers to entry
REITs Line representing possible combinations of risk-
Mutual Funds free assets and optimal risky asset portfolio
Real Estate Valuation Approaches
- Open-end: Accept new investors after launch E[R + ] − R N
- Comparable sales: Prices for similar properties E£R . ¤ = R N + € • σ.
- Closed-end: No new shares created after launch, σ+
- Income: Discounted NOI
may trade at a premium/discount to NAV
- Cost: Replacement value
- No-Load: No investing/redemption fees, funds
charge a percentage of NAV

Exchange Traded Funds (ETFs)

- Mutual funds only trade at the end of each day,
ETFs can be traded at any time during the day
- Investors can sell ETFs short or buy on margin
- ETFs do not trade at discount/premium to NAV
- ETFs distribute dividends to investors, mutual
funds reinvest dividends
- ETFs have lower minimum investment levels
Investor’s Optimal Portfolio Security Market Line (SML) Risk measures: Standard deviation, beta, duration,
Graphical representation of CAPM: delta, gamma, VaR, CVaR, etc.
Risk modification: By prevention and avoidance,
transfer (insurance), or shifting (derivatives)

TECHNICAL ANALYSIS
Technical Analysis: Assumptions
- Supply and demand determine prices
- Prices respond to changes in supply and demand
- Prices can be projected with technical tools

- Markets can be inefficient due to investors’ biases

Technical Analysis: Charts
PORTFOLIO RISK AND RETURN: PART II
Bar chart Candlestick Chart
Capital Market Line (CML) Identifying Mispriced Stocks
CAL with risky portfolio being market portfolio Stocks that plot above the SML are underpriced;
E[R ' ] − R N stocks that plot below the SML are overpriced
E£R . ¤ = R N + € • σ.
σ' Ratios
Borrowing vs. Lending Sharpe R. − RN

Total risk

ratio σ.
M- σ'
dR . − R N e + RN
squared σ. White body: close > open; Dark body: close < open
Treynor R. − RN Point and Figure Chart
Systematic

ratio β.
risk

Jensen’s
R . − £R N + β. (R ' − R N )¤
alpha

BASICS OF PORTFOLIO PLANNING AND

Beta CONSTRUCTION
Cov(R + , R ' ) ρ+,' σ+ Investment Policy Statements (IPS)
β+ = =
σ6' σ' Investment objectives: Risk/return objectives
Systematic risk = Non-diversifiable (market) risk Constraints: Liquidity, time horizon, tax concerns,
Nonsystematic risk = Diversifiable risk legal and regulatory factors, unique circumstances Line chart: A plot of price data, typically closing
Total risk = Systematic risk + Nonsystematic risk prices, with a line connecting the points
Asset Allocation

Capital Asset Pricing Model (CAPM) Strategic asset allocation: Set of exposures to IPS- Trends
Assumptions: permissible asset classes in weights that are Uptrend: Price reaches higher highs/lows
- Investors are risk-averse, utility-maximizing, consistent with the client’s long-term objectives Downtrend: Price reaches lower highs/lows
rational individuals Tactical asset allocation: Deliberate deviations Support: Buying is sufficient to stop further decline
- Markets are frictionless from policy weights based on forecasts of asset Resistance: Selling pressure stops further increase
- All investors plan for same single holding period class returns over the near term
- Investors have homogeneous expectations
- Investments are infinitely divisible AN INTRODUCTION TO RISK MANAGEMENT
- Investors are price takers Risk Management
E£R . ¤ = R N + β+ [E[R ' ] − R N ] Risk management framework:
- Risk governance
Limitations:
- Risk identification and measurement
- Single-factor: Only accounts for systematic risk
- Risk infrastructure
- Single-period: Does not consider multiple periods
- Defined policies and processes
- Inclusion of assets that are not investable, such as
- Risk monitoring, mitigation, and management
human capital and assets in closed economies
- Communications
- Strategic analysis or integration
Risk tolerance: Which risks are acceptable and how
much risk should be taken
Risk budgeting: How the risks should be taken
Financial risks: Arise from financial market
activities (e.g., market, credit, liquidity risk)
Non-financial risks: Arise from within entity or
from external (e.g., operational, legal, regulatory,
political, model, tail risk)
Reversal Patterns Price-Based Indicators Intermarket Analysis
Head and shoulders (H&S): Indicate an upcoming Moving average (MA): Average closing price over a The combined analysis of major categories of
downtrend following a preceding uptrend specified number of periods (e.g., 7-day, 60-day) securities (equities, bonds, etc.) to identify
Inverse H&S: Indicate an upcoming uptrend Golden cross: Short-term MA crosses long-term MA patterns and inflection points
following a preceding downtrend from below; bullish indicator

Dead cross: Short-term MA crosses long-term MA
FINTECH IN INVESTMENT MANAGEMENT
from above; bearish indicator
Bollinger bands: Lines representing MA +/ − X Machine Learning
standard deviations; Bullish if MA reaches lower Supervised learning: Algorithm finds relationships
bound, bearish if MA reaches upper bound among labeled training data
Unsupervised learning: Algorithm works with
unlabeled data to create clusters/groupings

Data Processing Methods

Data capture: Collecting data, transforming into
usable format
Data curation: Cleaning data to ensure high quality
Data storage: Recording, archiving, accessing data
Search: Finding specific information in datasets
Transfer: Moving data from source or storage
Price target = Neckline − (Head − Neckline) location to the analytical tool

Double tops: When an uptrend reverses twice at Momentum Oscillators Uses of Fintech in Investment Management
Rate of Change (ROC) Oscillator:
about the same high Text Analytics: Analysis of unstructured data
M = (V − Vx) × 100
Price target = Valley − (Top − Valley) Natural Language Processing: Interpreting human
V = last closing price
language (e.g., speech recognition)
Vx = closing price x days ago, typically 10
Double bottoms: When a downtrend reverses twice ROC oscillator crossing 0 in the same direction as Distributed Ledger Technology (DTL)
at about the same low the trend direction is buy/sell signal Ownership of assets is created and exchanged on a
Price target = Top + (Top − Valley) Relative Strength Index: peer-to-peer network
Triple Tops/Bottoms: More significant indicators 100 Σ(Up changes) Smart contracts: Programmed to execute if
RSI = 100 − , RS =
than double tops/bottoms 1 + RS Σ(|Down changes|) specified conditions are met
Stochastic Oscillator: Blockchain: Digital ledger for blocks of linked
Continuation Patterns Last closing price − Low in past 14 transactions validated through user consensus
Triangles (Ascending and Descending) %K = 100 q r
High in past 14 − Low in past 14 Permissionless networks: No centralized authority
%D = average of last 3 daily %K values needed to validate transactions
MA convergence/divergence (MACD) oscillator: Permissioned networks: Members are restricted
Consists of MACD line and signal line: MACD line is from participating in certain activities
the difference between two exponentially
Uses of DTL in Investment Management
smoothed moving averages (12 and 26 days);
Cryptocurrencies: Allow transactions without
Signal line is the exponentially smoothed average
Triangle (Symmetrical) intermediaries, such as banks
of MACD line (9 days)
Narrowing = bullish; Widening = bearish Tokenization: Represents ownership of physical
Sentiment Indicators assets on a blockchain or distributed ledger
Put/call ratio: Volume of put options traded Clearing/Settlement: DTL allows near real-time
divided by volume of call options traded trade verification and reconciliation
CBOE Volatility Index (VIX): Measures near-term Compliance: Allows regulators to conduct near
market volatility calculated by the CBOE real-time review of all transactions
Short interest ratio: Number of shares sold short

divided by the average daily trading volume

Flow-of-Funds Indicators
Arms index (or TRIN): A ratio >1 shows greater
Rectangles (Bullish and Bearish) flow into declining stocks. Managers typically hold
cash if they are bearish.

Cycles
Kondratieff wave: 54-year long economic cycles

Elliott Wave Theory

Flag: Parallel trend lines over short period Market moves in regular, repeated waves that
Pennant: Converging trend lines over short period follow ratios of numbers in a Fibonacci sequence
Wave sizes: grand supercycle, supercycle, cycle,
primary, intermediate, minor, minute, minuette,
and subminuette
BA II PLUS CALCULATOR TIPS

Basic Operations
2ND : Access secondary functions (in yellow)
ENTER : Send value to a variable
2ND + ENTER : Toggle between options
↑ ↓ : Navigate between variables/options
STO + 0 - 9 : Store current value into memory
RCL + 0 - 9 : Recall value from memory

Time Value of Money (TVM)

For annuity, loan, and bond calculations
N : Number of periods
I/Y : Effective interest rate per period (in %)
PV : Present value
PMT : Payment/coupon amount
FV : Future value/redemption value
CPT + one of the above : Solve for unknown
2ND + BGN : Toggle between ordinary annuity
and annuity due
2ND + CLR TVM : Clear TVM worksheet
Note:
- Always clear the TVM worksheet before
starting a new calculation
- For bonds, PMT and FV should have the same
sign, and opposite signs to PV
Cash Flow Worksheet ( CF , NPV , IRR )
For non-level payments
Input ( CF )
CF0: Initial cash flow
C01: 1st distinct cash flow after initial cash flow
F01: Frequency of CO1
C0n: nth distinct cash flow
F0n: Frequency of C0n
Note:
- Always clear the CF worksheet before starting
a new calculation
- The use of F0n is optional. You can leave them as
1 and input repeating cash flows multiple times. If
you do so, C01 will be the cash flow at time 1, C02
will be the cash flow at time 2, and so on.
Output ( NPV , IRR )
I: Effective interest rate per period (in %)
NPV + CPT : Solve for net present value
IRR + CPT : Solve for internal rate of return