Professional Documents
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(CFA) (2015) (L2) 20141129 - 前导ppt道德财务企业理财衍生其他部分 (兼容模式)
(CFA) (2015) (L2) 20141129 - 前导ppt道德财务企业理财衍生其他部分 (兼容模式)
(CFA) (2015) (L2) 20141129 - 前导ppt道德财务企业理财衍生其他部分 (兼容模式)
前导课程
洪波 CFA
金程教育资深培训师
地点: ■ 上海 □北京 □深圳
Topic Weightings in CFA Level II
Session NO. Content Weightings
Study Session 1-2 Ethics & Professional Standards 10-15
Study Session 3 Quantitative Methods 5-10
Study Session 4 Economic Analysis 5-10
Study Session 5-7 Financial Statement Analysis 15-20
Study Session 8-9 Corporate Finance 5-15
Study Session 10-12 Equity Analysis 15-25
Study Session 13 Alternative Investments 5-10
Study Session 14-15 Fixed Income Analysis 10-20
Study Session 16-17 Derivative Investments 5-15
Study Session 18 Portfolio Management and Wealth Planning 5-10
Total: 100
2-98
Ethics &Professional Standards
3-99
Framework of Ethics
Code of Ethics and Standards of Practice
Soft Dollar Standards
Research Objectivity Standards
Case study
Case 1: The Glenarm Company
Case 2: Preston Partners
Case 3: Super Selection
Trade Allocation: Fair Dealing And Disclosure
Case 4: Changing Investment Objectives
Prudence in Perspective
4-99
Guidance for Standards I~VII
Knowledge of the law;
Independence and objectivity;
Professionalism
Misrepresentation;
Misconduct
Material nonpublic information;
Integrity of capital markets
Market manipulation
Loyalty, prudence and care;
Fair dealing;
Duty To Clients Suitability;
Performance presentation
Standards Preservation of confidentiality
Loyalty;
Duty To employers Additional compensation arrangements;
Responsibility of supervisors
Diligence and reasonable basis;
Investment Communication with clients;
Record retention
Disclosure of conflicts;
Conflicts of interest Priority of transaction;
Referral fees
Conduct as members and candidates;
Responsibility as members
Reference to CFA institute, designation
5-99
Framework of ROS
Company policies and practices related to research objectivity
1.0 Research objectivity policy
2.0 Public Appearance
3.0 Reasonable and Adequate Basis
4.0 Investment Banking
5.0 Research Analyst Compensation
6.0 Relationship With Subject Companies
7.0 Personal Investments and Trading
8.0 Timeliness of Research Reports and Recommendations
9.0 Compliance and Enforcement
10.0 Disclosure
11.0 Rating System
6-99
Financial Statement Analysis
7-99
Framework
SS 5
Reading 15 Inventories
Reading 16 Long-lived assets
SS 6
Reading 17 Intercorporate Investments *
Reading 18 Employee Compensation: Postretirement and
Share-based *
Reading 19 Multinational Operations *
SS 7
Reading 20 Evaluating Financial Reporting Quality
Reading 21 Integration of FSA Techniques *
8-99
Inter-Co Investment
Key Points:
The financial reporting to each type of investments in
accordance with degree of influence;
Passive investment:
Held to maturity;
Trading security;
Available for sales;
Active investment:
Significant influence: equity method;
Control: consolidate the FS of subsidiaries.
Issues of equity method
Share results;
How to treat the investment cost in excess of book value.
9-99
Inter-Co Investment
Key Points:
Issue of controlling investment:
Pooling of interests method vs. purchase method;
Consolidation of FS;
Goodwill
Impairment;
Negative goodwill;
Active investment:
Significant influence: equity method;
Control: consolidate the FS of subsidiaries;
Difference between IFRS and US GAAP for the above topics.
10-99
Pension and share-based comp.
Key Points:
2 types of pension plan
DC and;
DB.
Financial reporting of DB (key area!!!)
Pension obligation (B/S);
Factors affects the obligation and relationship with I/S;
DB assumptions;
How to adjust the FS when conducting analysis.
Difference between IFRS and US GAAP;
Share-based compensation (simplified this year);
Accounting issues.
11-99
Multinational operation
Key Points:
Hyper-inflation
12-99
Integration of FSA techniques
Key Points:
How to do analysis?
13-99
Business combination – Acquisition method LOS 19.c
14-99
Business combination – Acquisition method LOS 19.c
Balance sheet
Acquisition
A Acquisition
T Combined method
method
historical FV adj. Adjusted Post-acq Adj.
15-99
Business combination – Acquisition method LOS 19.c
Example – 4
Goodwill = consideration (acquisition cost) + fair value of minority interests – fair
value of net asset of the Target;
Under the this example, the controlling interest results from the acquisition, T
becomes the subsidiary of A.
T prepares the FS of itself in a consistent way post acquisition as that prior to
the acquisition.
When prepares consolidated FS, the assets and liabilities of T are adjusted
by fair value at the acquisition date (only for the assets and liabilities exist
prior to the acquisition);
During the period subsequent to the acquisition, adjustments are made both
on B/S and I/S to amortize the fair value appreciation/depreciation, except for
goodwill;
If the target is merged to acquirer, no subsidiary and parent relationship, the
assets and liabilities are combined to acquirer’s FS at fair value at the acquisition
date.
16-99
Business combination – Acquisition method LOS 19.c
Example – 4
Inventory increased fair
The I/S in FY07 is as follows, assuming: value of 30.
All inventories of T at beginning FY07 was sold in FY07;
FA increased fair value of
Remaining useful lives of FA of T are 10 years; 50. 50/10=5
Useful lives of IA are 10 years. IA increased fair value of
No transaction incurred in FY07 between A and T. 100. 100/10=10
Income statement
FY07 FY06
Acquisition Acquisition
A T FV adj. A T
method method
17-99
Business combination – Acquisition method LOS 19.c
Example – 4
Key points for I/S post acquisition:
I/S of the target is included in consolidated I/S from the date of acquisition;
Some items might be adjusted due to the fair value adjustment:
COGS is adjusted to reflect the fair value of inventory of the target prior to
acquisition;
Depreciation is adjusted to reflect the fair value of FA of the target prior to
acquisition;
Amortization of I/A is also adjusted as similar with that in FA.
Please be noted, similar to B/S, under this example, T prepares its I/S in
a way consistent with that prior to acquisition. Only when prepares the
consolidated FS, the fair value adjustments are made.
In case a merger, with the combining of assets and liabilities of target at
fair value into acquirer’s FS, the impact on I/S post to the acquisition is
also reflected.
Goodwill is not amortized.
18-99
Business combination – Acquisition method LOS 19.c
Goodwill
Goodwill is excess acquisition cost over fair value of identifiable assets and
liabilities of the target.
Goodwill is not amortized;
Goodwill is subject to an impairment test at least annually;
Goodwill is impaired if the carrying value greater than the fair value;
An impairment provision is made to extent that carry value in excess of fair
value;
Full goodwill under US GAAP; IFRS allows partial goodwill or Full
goodwill
Negative Goodwill is,
Recognized as a gain after the re-assessment under IFRS;
Similar with IFRS from fiscal year after Dec 15, 2008.
19-99
Business combination–non–controlling interests LOS 19.c
20-99
Examples: Full and Partial Goodwill
Assume GF paid $450 million for 75% of the stock of company D. Calculate the
amount of goodwill GF should report using the full goodwill method and the
partial goodwill method.
Full goodwill: GF balance sheet goodwill is the excess of the fair value of
the subsidiary ($450 million / 0. 75 = $600 million) over the fair value of
identifiable net assets acquired, just as in the example above. Acquisition
goodwill = $40 million.
Partial goodwill: GF balance sheet goodwill is the excess of the acquisition
price over Wood's proportionate share of the fair value of Pine's identifiable
net assets:
Purchase price $450 million
Less: 75% of fair value of net
0.75 x $560 = $420 million
assets Acquisition goodwill $30 million
21-99
Business combination – Pooling of interests method LOS 19.c
Pooling method
Combines the ownership interests of two companies and views the
participants as equals-neither firm acquires the other;
Pooling of interests method is only allowed in a certain special
circumstances with strict criteria under US GAAP. Under IFRS, it’s not
allowed.
Asset and liabilities of the two firms are combined (and any inter-
company accounts are eliminated).
Major attributes of the pooling method are:
The two companies are combined using accounting book values.
Operating results for prior periods are restated as though the two
firms were always combined.
Ownership interests continue, and former accounting bases are
maintained.
22-99
Business combination – Comparison of 2 methods LOS 19.c
23-99
Post-retirement plan overview LOS 20.a
DC plan 缴费确定型
Employer make periodical contributions to specific accounts;
The contribution made by employer is fixed or pre-determinable;
The obligation of employers is make contribution on time;
The amount received by employees after retirement depends on the
fair value of the specific accounts accumulated;
The accounting for DC plan is quite simple, expensed as incur.
DB plan 收益确定型
Employers promise to payment a certain amount to employees after
their retirement;
The obligation of employer is pay a pre-determined amount to
employees after their retirement; the amount received by employee
is pre-determined;
Firms usually set up several funds to meet the future liabilities;
The accounting for DB plan is complicated.
24-99
Post-retirement plan overview LOS 20.a
DC DB OPB
Not determined;
Amount of
Depends on future Depends on
benefit Pre-determined
value of plan specifications of plan
assets
Investment risk Born by
Born by employer Depends
employee
25-99
Illustration of DB LOS 20.b
Date of Payment of
Current Servicing retirement
period pension
B/S date
……
discounting
PBO PV of Pension
payment
26-99
Translation of foreign currency FS LOS 21.c
Adoption of 2 methods
Re-measurement Translation
Local Functional Reporting
Currency Temporal Currency Current rate Currency
Method Method
27-99
Translation of foreign currency FS LOS 21.c
29-99
Corporate Finance
30-99
Review of Level I basics & Links with Level II
Corporate Finance
31-99
Review of Level I basics & Links with Level II
The main objective of an entity is shareholders wealth
maximization
Shareholders wealth includes two elements:
Capital gain = P1 – P0
Dividend income = D1
P1 - P0 + D1
Holding period yield (HPY) =
P0
32-99
Framework of Corporate Finance
SS 8
R22: Capital Budgeting
R23: Capital Structure
R24: Dividends and Share Repurchases
SS 9
R25: Corporate Performance, Governance, and Business
Ethics (Newly Added)
R26: Corporate Governance
R27: Mergers and Acquisitions *
33-99
Introduction to Capital Budgeting
Capital Budgeting
Capital budgeting project evaluation
Inflation effects on capital budgeting
Mutually exclusive projects with different lives
Project risk analysis
Using the CAPM in capital budgeting
Evaluating projects with real options
Common capital budgeting pitfalls
Alternative measures of income and valuation models
Other valuation models
34-99
Introduction to Capital Structure
35-99
Introduction to Dividends and Share Repurchase
36-99
Introduction to Corporate Governance
Corporate Governance
What Is The Corporate Governance?
Three Major Business Forms;
An agency Relationship: Agent, Principal, and Conflict;
Responsibilities of The Board of Directors;
Corporate Governance Best Practices;
Corporate Governance Policies: Investors And Analysts
Should Assess;
The Strength And Effectiveness of A Corporate Governance
System
37-99
Introduction to Mergers and Acquisitions
Mergers and Acquisitions
1. Categorize Merger And Acquisition Activities
2. Bootstrapping *
3. The Industry Life Cycle And Merger Motivations
4. Key Differences Between Forms of Acquisition
5. Method of Payment And US Antitrust Legislation
6. Takeover Defense Mechanisms: Pre-offer And Post-offer
7. The Herfindahl-Hirschman Index (HHI)
8. Valuing A Target Company:Three Basic Methods
9. Evaluating A Merger Bid
10.Downsizing Operations Through Corporate Restructuring
38-99
Cash flow projection
Expansion project
Terminating
stage
Operating
stage
Initial
stage
WC
FA
Operating CF
CAPEX
TNOCF = NWCInv+SalT
W.C. investment
–T(SalT–BT)
CF = (S–C–D)(1–T)+D
=(S–C)(1–T)+DT
Initial outlay = In operating stage, the CF is
based on incremental, i.e.,
–FCInv–NWCInv
Incremental sales;
Incremental cost;
Incremental depreciation.
39-99
Cash flow projection
Replacement project
Terminating
stage
Operating
stage
Initial CF from
stage disposal
Operating CF WC
CAPEX FA
W.C. investment TNOCF = NWCInv+SalT
Cash collected ΔCF = (ΔS–ΔC)(1–T) –T(SalT–BT)
+Δ DT
Initial outlay = In operating stage, the CF is
based on incremental, i.e.,
–FCInv–NWCInv
Incremental sales;
+[Sal0–T(Sal0–B0)]
Incremental cost;
Incremental depreciation.
40-99
Capital Structure Theory
MM proposition 1 without taxes: capital structure irrelevance
the market value of a company is not affected by the capital structure.
Assumptions:
Investors agree on the expected cash flow from a given investment;
Bonds and shares of stock are traded in a perfect capital market;
investors can borrow/lend at the risk-free rate
no agency costs
Financing decision and investment decision are independent
40% 40%
V L = VU
stocks bonds
60% 60%
bonds stocks
41-99
Capital Structure Theory
MM proposition 2 without taxes: higher leverage raises the cost of equity.
the cost of equity is a linear function of D/E.
Assumption: financial distress has no cost, and debtholders have prior claim
to assets and income. rd < re
re rises with higher D/E to offset the increased use of cheaper debt to
maintain constant WACC
D
Cost of re = r0 + (r0 - rd )( ) The r0 is not determined by
equity E
capital structure, but by
business risk of the company.
WACC
r0 EBIT
Cost of debt V=
rd r0
D/E
D E D
b a = ( )b d + ( )be Þ be = b a + (b a - b d )
V V E
42-99
Capital Structure Theory
MM proposition 1 (with taxes):
the tax deductibility of interest payment creates a tax shield that adds value to the
firm, and the optimal capital structure is 100% debt.
V L = VU + t ´ d
MM proposition 2 (with taxes):
WACC is minimized at 100% debt.
We do not consider the costs
Cost of here:
capital D Cost of financial distress;
re = r0 + (r0 - rd )( )(1 - t )
E Cost of bankruptcy.
WACC
E B I T (1 - t )
After-tax cost of VL =
debt r0
D/E
43-99
Static Trade-Off Theory
44-99
Implications for managerial decision making
MM’s proposition
No tax: irrelevant
With tax: tax shield makes borrowing valuable, WACC is minimized at
100% debt
Without taxes With taxes
Proposition 1 VL=VU VL=VU+t*D
Proposition 2 re= r0+(r0-rd)*D/E re= r0+(r0-rd)(1-t)*D/E
Static trade-off theory: Increasing the use of debt also increases the costs
of financial distress. At some point, the costs of financial distress will exceed
the tax benefits of debt.
optimal proportion of debt
Pecking order theory: 最优资本结构的反例,融资方式由disclosure的程
度决定
45-99
Tax consideration – Taxation methods
Tax consideration: Effective tax rate depends on the tax system
Double-taxation
Earnings are taxed at the corporate level regardless of whether
they are distributed as dividends, and dividends are taxed again at
the shareholder level.
Effective tax rate = 1 x corporate tax rate
+ (1-corporate tax rate) x (individual tax rate)
Split-tax rate system
Corporate earnings as dividends are taxed at a lower rate at the
corporate level than retained earnings.
At the individual level, dividends are taxed as ordinary income.
Earnings as dividends are still taxed twice, but with relatively low
corporate tax rate. The effect is to offset the higher (double) tax
rate applied to dividends at the individual level.
46-98
Tax consideration – Taxation methods
47-99
Tax consideration – Shareholder Preference
Tax consideration: Shareholder Preference for Current Income vs. Capital Gains
All else equal, the lower an investor's TD relative to TCG, the stronger
preference for dividends.
Other issues also impinge on this preference
The investor may buy high-payout shares for a tax-exempt retirement
account. Even if TD < TCG, it is not clear that shareholders will
necessarily prefer higher dividends.
TCG not have to be paid until being sold, whereas TD must be paid in the
year received, even if reinvested.
In some countries, shares held at the time of death benefit from a step-up
valuation as of the death date.
Tax-exempt institutions (e.g. pension funds and endowment funds) are
major shareholders in most industrial countries and are exempt from both
TD and TCG. (indifferent)
48-99
Payout policies
49-99
PHILOSOPHIES UNDERLYING BUSINESS ETHICS
Friedman Doctrine
The only social responsibility is to increase profits "within the rules of the
game," meaning through "open and fair competition without deception or
fraud.” His assertion is flawed, ethics requires more than profits.
Utilitarianism
Utilitarianism argues business must weigh the consequences to society of
each of their actions and seek to produce the highest good for the largest
number of people.
Modern cost-benefit analysis is an application of this principal.
Many costs and benefits of actions are difficult to measure. utilitarianism
fails to consider that justice as the greatest good for the many could come at
the expense of exploiting a smaller subgroup.
50-99
PHILOSOPHIES UNDERLYING BUSINESS ETHICS
Kantian ethics
Kantian ethics argue that people are different from other factors of
production.
Rights theories
Rights theories argue that all individuals have fundamental rights and
privileges. The greatest good of utilitarianism cannot come in violation of the
rights of others.
Justice theories
Justice theories focus on a just distribution of economic output.
They agree to rules and that whatever the personal results to themselves, the
results are fair.
They recognize unequal divisions of wealth and income may be acceptable
under the differencing principal, which holds the unequal division must
benefit the least-advantaged members of society.
51-99
Categorize merger and acquisition activities
Types of mergers
1) In a horizontal merger, the two businesses operate in the same or similar
industries, usually as competitors. Two reasons:
Pursuit of economies of scale, which are savings achieved through
consolidation of operations and elimination of duplicate resources.
To increase market power
2) In a vertical merger, the acquirer buys another company in the same
production chain. Including forward integration to ultimate consumers and
backward integration to suppliers
3) In a conglomerate merger, the acquirer buys another company unrelated to
its core business. There are few synergies from combining the two
companies.
By investing in companies from a variety of industries, companies hoped
to reduce the volatility of the conglomerate’s total cash flows.
Company level diversification is not necessarily in the shareholders’ best
interests.
52-99
Categorize merger and acquisition activities
Forms of integration
1) In a statutory merger, the acquiring company acquires all of
target’s assets and liabilities.
A+B=A
2) In a subsidiary merger, the target company becomes a
subsidiary of the purchaser.
A+B=A+B
3) With a consolidation, both companies cease to exist in their
prior form, and they come together to form a completely new
company.
A+B=C
53-99
Categorize merger and acquisition activities
Merger motivations
1. Synergies,
1 + 1 > 2,
cost saving due to economies of scale,
sales synergies due to cross-selling, expanded market share, or higher prices
from reduced competition.
2. Achieving more rapid growth,
Making investments internally (organic growth) or buying the necessary
resources externally (external growth).
Faster to grow externally. Growth through M&A is common for a company in
a mature industry.
External growth can mitigate risk, less risky than to enter an unfamiliar
market and establish resources internally.
3. Increasing market power,
both vertical and horizon integration increase market power.
4. Gaining access to unique capabilities and resources,
5. Diversification,
Not in the best interest of the conglomerate’s shareholders.
54-99
Categorize merger and acquisition activities
Merger motivations
6. Bootstrapping earnings (refer to next page)
Possible to create the illusion of synergies or growth
7. Personal benefits for managers.
Manger’s compensation highly related to company size;
Corporate executives may be motivated by self-aggrandizement.
8. Tax benefits
A target with tax losses has the tax shield, but not legally approved if the
primary reason for merger is tax avoidance.
9. Unlocking hidden value.
10. Achieving international business goals
Taking advantage of market inefficiencies;
Working against disadvantageous government policies;
Technology transfer to new market;
Product differentiation;
Provide support to existing multinational clients
55-99
Who benefits from merger?
Distribution of merger benefits: empirical evidence related to the
distribution of benefits in a merger.
Short-term performance studies show:
target shareholders reap 30% premiums over the stock's pre-
announcement market price, and the acquirer's stock price falls between
1 and 3%;
on average, both the acquirer and target tend to see higher stock returns
surrounding cash offers than around share offers.
The high average premiums paid to target shareholders may be
attributed to the winner's curse.
Hubris of acquirers’ mgt by overestimating synergies. Even if no
synergies from a merger, managerial hubris would still lead to higher-
than-market bids and a transfer of wealth from the acquirer's
shareholders to the target's shareholders
Longer term performance studies show
that acquirers tend to underperform their peers
a general post-merger operational failure to capture synergies;
56-99
Who benefits from merger?
When distinguishing value-creating deals, analysts must examine the
operational strengths possessed by the acquirer and the target to discern
the likelihood that post-merger synergies will be achieved.
The following are characteristics of M&A deals that create value:
Strong buyer: Acquirers that have exhibited strong performance (in
terms of earnings and stock price growth) in the prior three years.
Low premium: The acquirer pays a low takeover premium.
Few bidders: The lower the number of bidders, the greater the
acquirer's future returns.
Favorable market reaction: Positive market price reaction to the
acquisition announcement is a favorable indicator for the acquirer.
57-99
Derivatives
58-99
Introduction—Framework
Level Ⅰ 概念
Derivatives Level Ⅱ 定价
Level Ⅲ 应用
59-99
Framework Summary
SS 16 - Forwards and Futures
R48 Forward Markets and Contracts
R49 Futures Markets and Contracts
60-99
Forward Markets and Contracts - Framework
1. Forward Contracts
2. Price and Value
3. Generic Pricing
4. Forwards Arbitrage
5. Forward contract value
6. Equity Forward Contracts
7. Forward Contracts on Coupon Bonds
8. Forward Rate Agreements (FRAs)
9. FRA Pricing
10. Currency Forward Contracts
11. Credit risk in forward contracts
61-99
Futures Markets and Contracts - Framework
1. Futures Contracts & forward contracts
2. Futures/Spot Price Convergence
3. Futures Price vs. Forward Price
4. Futures Arbitrage
5. Costs and Benefits
6. Futures Contract Value
7. T-bill Futures Contracts
8. Eurodollar Futures Contracts
9. Eurodollar futures vs. T-bill futures contracts
10. T-bond Futures Contracts
11. Equity Futures Contracts
12. Currency Futures Contracts
62-99
Option Markets and Contracts– framework
1. Put-call parity for European options
2. Create synthetic instruments
3. Exploit violations of put-call parity
4. One-period binomial model
5. Risk-neutral valuation of a call with a one-period binomial tree
6. The two-period binomial model (call option)
7. The binomial interest rate tree
8. Valuation of a call on a coupon bond with a binomial interest rate tree
9. Valuing an interest rate cap and floor with a binomial interest rate tree
10. Continuous-time option pricing model
11. The Value of European option using the BSM
12. Option Greeks
13. The option delta
14. Dynamic hedging
15. The option gamma
16. The effect of the underlying asset’s cash flow
17. The BSM model with cash flows
18. The critical role of volatility
19. Put –call parity for options on forwards and futures
20. Compare American with European options on forward and futures
63-99
Swap Markets and Contracts – Framework
1. Swap contracts
2. Equivalence of swaps to combinations of other instruments
3. Pricing a plain vanilla swap
4. Valuing a plain vanilla swap
5. Pricing a currency swap
6. Valuing a currency swap
7. Pricing an equity swap
8. Valuing an equity swap
9. Swaption contracts
10. Why swaption exist
11.Valuing a plain vanilla swaption at expiration
12.Credit Risk in Swaps
64-99
Interest Rate Derivative Instruments– framework
65-99
Credit Derivatives: An Overview
1. Structure and features of credit default swaps
2. Obligations and risks faced by the protection buyer and seller
3. Relationship with other credit derivatives
4. Uses of CDS
5. Relation among CDS spread, expected spread payments and
expected default losses
6. Riske management roles and activities of credit derivative
dealers.
66-99
Generic Pricing: No-Arbitrage Principle
Pricing a forward contract is the process of determining the no-arbitrage
price that will make the value of the contract be zero to both sides at the
initiation of the contract
Forward Price = price that would not permit profitable riskless arbitrage
in frictionless markets
FP = S 0 × (1 + R f )T
67-99
Forward contract value
Forward value of long position at initiation, during the
contract life, and at expiration
Time Forward Contract Valuation
t=t FP FP
Vlong = St − Vshort = −Vlong = T −t
− St
(1 + R f )T −t (1 + R f )
t=T St-FP
68-99
Futures Contracts & forward contracts
Differences
Futures Forwards
Exchange traded Over-the-counter
Standardized Customized
69-99
Futures/Spot Price Convergence
The spot (cash) price of a commodity or financial asset is the price for
immediate delivery. The futures price is the price today for delivery at some
future point in time (the maturity date).
Basis = spot price − futures price = S0 − FP
As the maturity date nears, the basis converges to zero, At the maturity date, the
futures price must be the same as the spot price. Otherwise, there will exists
arbitrage opportunity.
Futures
price Spot price
70-99
Futures Price vs. Forward Price
Prices of Futures vs. Forward Contracts
If the correlation
between the
Investors will…
underlying asset value
and interest rate is…
71-99
T-bond Futures Contracts
Underlying: $100,000 par value T-bonds with any coupon but with a maturity of at least
15 years.
The quotes are in points and 32nds: A price quote of 95-18 is equal to 95.5625 and a
dollar quote of $95,562.50
The short has a delivery option to choose which bond to deliver. Each bond is given a
conversion factor (CF), which means a specific bond is equivalent to CF standard bond
underlying in futures contract. The short designates which bond he will deliver
(cheapest-to-deliver bond).
[ T
FP = bond price × (1 + R f ) − FVC ×
1
CF
]
72-99
Equity Futures Contracts
Futures on an individual stock:
FP = S0 × (1 + R f )T - FVD = ( S0 - PVD) × (1 + R f )T
Equity Index Futures: for an index contract, rather than take the present value
of each dividend on hundreds of stocks, we can make the calculation as if the dividends
are paid continuously (rather than at discrete times) at the continuous time equivalent
of the dividend yield rate on the index.
( R cf −δ c )×T
FP = S 0 × e
where :
R cf = continuously compounded risk-free rate
δ c = continuously compounded dividend yield
73-99
Currency Futures Contracts
Discrete interest rates
(1 + RDC )T
FT (currency futures contract) = S0 ×
(1 + RFC )T
Where:
DC= domestic currency
FC= foreign currency
74-99
Put-call parity for European options
Notice that the payoff to a fiduciary call is the same as the payoff protective
put. Arbitrage ensures that the two should have the same cost, which leads us
to Put-call parity for European options:
X
Ct + T-t
=Pt +St
(1+R f )
X ct
Vt =St − = Ct -Pt
(1+R f )T-t
Call
St-X/(1+Rf )T-t
Forward (-pt)
St
Put
Stock X/(1+Rf)T-t
Bond
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Create synthetic instruments
There are four synthetic instruments:
A synthetic European call option: X
C0 = P0 + S 0 −
synthetic call = put + stock − bond
(1 + R f )T
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Option Greeks 2
Sensitivity Factor Input Calls Puts
(Greek)
Delta Underlying price Positively related Negatively related
(S) (Delta>0) (Delta<0)
Vega Volatility (σ) Positively related Positively related
(Vega>0) (Vega>0)
Rho Risk-free rate (r) Positively related Negatively related
(Rho>0) (Rho<0)
Theta Time to Value $0 Value usually $0
expiration (T) As call maturity, as put maturity,
Theta<0 Theta < 0*
Strike price (X) Negatively related Positively related
* There is an exception to the general rule that European put option thetas are negative.
The put value may increases as the option approaches maturity if the option is deep in-the-
money and close to maturity.
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The Option Delta
Value of a Call
stock price
Out-of-the-money in-the-money
Exercise price
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The Option Delta
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Pricing a plain vanilla swap
1 = C×B1 + C×B2 + C×B3 + …… + C×Bn +1×Bn
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Valuing a plain vanilla swap
The market value of a swap to the pay-fixed side is the difference
between the value of a floating-rate bond and the value of a fixed-
rate bond at any time during the life of the swap.
Paying fixed rate
Company X Company Y
Paying floating rate
Notes: the value of a floating rate bond will be equal to the notional amount at any of its
periodic settlement dates when the next payment is set to the market rate (floating).
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Swaption contracts
A swaption is an option to enter into a swap. We will focus on the plain vanilla interest
rate swaption. The notation for swaptions is similar to FRAs. For example, a swaption
that matures in 2 years and gives the holder the right to enter into a 3-year swap at the end
of the second year is a 2×5 swaption.
A payer swaption is an option to enter into a swap as the fixed-rate payer.
If interest rate increases, the payer swaption value will go up. So a payer swaption is equivalent
to a put option on a coupon bond. Another view?
It’s also equivalent to a call option on floating rate.
A receiver swaption is an option to enter into a swap as the fixed-rate receiver (the
floating-rate payer). If interest rate increases, the receiver swaption value will go down.
So a receiver swaption is equivalent to a call option on a coupon bond.
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Why swaption exist
There are three primary uses of swaption:
Lock in fixed rate. If an investor anticipates a floating rate exposure at some
future date (e.g.,he will be issuing bonds or getting a loan), a payer swaption
would “lock in” a fixed rate and provide floating-rate payments for the loan.
It would be exercised if the yield curve shifted up to give the investor
(effectively) a loan at the fixed rate on the swaption.
Interest rate speculation. Swaption can be used to speculate on changes on
interest rates. The investor would buy a payer swaption if he expects rate to
rise, or buy a receiver swaption if he expects rates to fall.
Swap termination. Swaption can be used to terminate a swap. A fixed rate
payer on 5-years swap could buy a 3-year receiver swaption (at the same
fixed rate as the swap) expiring in two years. This swaption would give the
investor the right to enter into an offsetting swap at the end of two years,
effectively terminating the 5-year swap at the end of the second year.
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Interest rate cap and interest rate floor
An interest rate cap is an agreement in which one party agrees to
pay the other at regular intervals over a certain period of time when
the benchmark interest rate(e.g.,LIBOR) exceeds the strike rate
specified in the contract. This strike rate is called the cap rate.
A long cap is equivalent to a portfolio of long put options on fixed-income
security prices.
An interest rate floor is an agreement in which one party agrees to
pay the other at regular intervals over a certain period of time when
the benchmark interest rate(e.g.,LIBOR) falls below the strike rate
specified in the contract. This strike rate is called the floor rate.
A long floor is equivalent to a portfolio of long call options on fixed-income
security prices.
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Interest rate cap and interest rate floor
Figure 1: Profit to a Long Cap
Profit to a
Cap buyer
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Interest rate collar
An interest rate collar is a simultaneous position in a floor and a cap on
the same benchmark rate over the same period with the same settlement
dates. There are tow types of collars:
If the cap and floor rates are set so that the premium paid for the long
position is equal to the premium received for the short position, it is
called a zero-cost collar.
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Structure and features of credit default swaps
Credit default swaps (CDS) is essentially an insurance contract for the reference,
the reference obligation is the fixed income security on which the swap is
written-usually a bond but potentially also a loan.
Protection buyer receives a payment from the protection seller if default
occurs on the reference entity.
The protection buyer pays the seller a premium that is either paid upfront or
over a period of time. The default swap premium is also referred to as the
CDS spread.
Default Payment
Protection Dealer Reference
Buyer (Protection Seller) entity
Default swap premium / CDS spread
The protection buyer:
Create a short position in the reference obligation
Increase the payoff as the credit quality and market price of the reference
obligation declines.
Not protect against market wide interest rate risk, only credit risk
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Alternative investments
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Framework of alternative investments
Introduction Income Approach
Investment
PE Funds Characters
Private Equity Terms, fees and valuation
Valuation Buyout Funds
NPV method
Venture Capital
IRR method
Investing In Hedge Fund Universe
Hedge Funds: Hedge Fund Indices
A Survey Performance Evaluation Valuation
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Exam Focuses on Private Real estate investment
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Framework of Private Equity Valuation
Calculate NOI
Stabilized NOI
Income
Directed Capitalization Method All risks yield (ARY)
Approach
Gross income
Cost Approach
Multiples
Technique
Sales
Comparison Term and Reversion
Approach Approach
DCF Method
Layer Method
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Exam Focuses on Publicly Traded Real Estate Securities
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FFO and AFFO in REIT Valuation
FFO
Accounting net earnings
+ Depreciation expense
+ Deferred tax expenses (i.e., deferred tax expenses)
- Gains from sales of property and debt restructuring
+ Losses from sales of property and debt restructuring
= Funds from operations
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FFO and AFFO in REIT Valuation
AFFO, also known as cash available for distribution (CAD) or funds available for
distribution (FAD).
Non-cash (straight-line) rent adjustment: refers not to the cash rent paid during the
lease but rather to the average contractual rent over a lease period.
Recurring maintenance-type capital expenditures and leasing commissions: represent
costs that must be expended in order to maintain the value of the properties.
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Framework of Private Equity Valuation
Three Sources of Value Creation
Divers of returns
Venture Capital
NPV and IRR methods
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Exam Focuses on hedge funds
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Hedge Funds vs Mutual Funds
Hedge Funds Mutual Funds
Regulation •less regulated •more regulated
Investors •only to qualified investors •unrestricted
• extensively use derivatives, leverage, • subject to legal restrictions and
Strategies
short-selling, and multiple asset classes articles of association
• filing of prospectuses and reporting
Disclosure •No disclosure requirements NAV daily and fund holdings
semiannually
Liquidity •illiquid •more liquid
• Management Fee (1% of Asset Base) + • fee structures is symmetric: if fees are
Fee structure Incentive Fee (20% of Profits) levied on gains, fund managers have
• high water mark, hurdle rate to share in losses as well
Lockups can be hard or soft: in a hard lockup, withdrawals are not permitted, while in the
case of a soft lockup, withdrawals are penalized with a redemption fee of 1-3%.
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Funds of Funds (FOF)
Benefits Drawbacks
• Due diligence
• Fee
• Diversification
• Difficult to generate positive
• Lower minimum investment
alpha after fees.
• Better liquidity
• Lower mortality
A Two-Edged Sword
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It’s not an end but just the beginning.
The most important thing in life is to have a great aim, and the
determination to attain it.
人的一生中最重要的事情就是确定一个伟大的目标,并下定
决心实现它。(德国诗人、戏剧家 歌德 . J . M .)
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