CFA二级培训项目

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:

 2 Methods and applications:

Re-measurement (all-current method) and;

 Functional currency → representation currency

 How to determine the functional currency

Translation (temporal method).

 Local currency → Functional currency

 Hyper-inflation

12-99
Integration of FSA techniques

 Key Points:

 How to do analysis?

 Evaluate the quality of a company’s financial data

 How to improve quality and comparability?

 Analyze effects of balance sheet modifications, earnings

normalization and cash-flow-statement-related modifications.

13-99
Business combination – Acquisition method LOS 19.c

Balance sheet as at 1 Jan 2007

Example – 4 Historical FV
 A acquired 100% of interests A A T T
Pre-acq Post-acq
in T on 1 Jan 2007
(acquisition, T becomes the Cash 600 100 30 30
subsidiary of A post the Inventory 150 150 50 80
AR 150 150 50 50
acquisition); 900 400 130 160
 The total consideration is 500;
F/A 400 400 250 300
 The B/S of A and T are: I/A - - - 100
 The consolidated B/S as at 1 Invest. - 500 - -
400 900 250 400
Jan 2007 post acquisition? 1,300 1,300 380 560

AP 400 400 180 180

Capital 550 550 150 380
R/E 350 350 50
1,300 1,300 380 560

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.

Cash 30 - 30 100 130 130

Inventory 50 30 80 150 230 230
AR 50 - 50 150 200 200
130 30 160 400 560 - 560
F/A 250 50 300 400 700 700
I/A - 100 100 - 100 100
Invest. - - - 500 500 (500) -
GW - 120 120 - 120 120
250 270 520 900 1,420 (500) 920
GW=500-(560-180)=120
380 300 680 1,300 1,980 (500) 1,480
AP 180 - 180 400 580 580
Capital 150 - 150 550 700 (150) 550
R/E 50 - 50 350 400 (50) 350
FV adj. - 300 300 - 300 (300) -
380 300 680 1,300 1,980 (500) 1,480

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

Sales 2,000 1,000 - 3,000 2,000 1,000 2,000

COGS (1,000) (600) (30) (1,630) (1,000) (600) (1,000)
Depre. of F/A (40) (30) (5) (75) (40) (30) (40)
Amort. of I/A - - (10) (10) - - -
S&G Exp. (300) (200) - (500) (300) (200) (300)
Taxation (200) (50) - (250) (200) (50) (200)
Net income 460 120 (45) 535 460 120 460

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

 Goodwill & MI process are different

 Full goodwill
Allowed in both US GAAP and IFRS
= consideration / % of interests acquired – fair value of net assets;
MI is stated (% of MI shareholders own) * (consideration / % of
interests acquired);
 Partial goodwill
Only allowed under IFRS;
= consideration – fair value of net assets X % of interests acquired.
MI is stated (% of MI shareholders own) * FV of net assets;

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

 Acquisition vs. Pooling

Differences Purchase Pooling

Combination Accounted for at fair value Accounted for at book value

Pre-acquisition Not recognized Acquire pre-acquisition earnings
earnings are recognized by acquirer

Post-acquisition Includes additional depreciation and Dose not include additional

earnings amortization based on fair value depreciation and amortization
because book value are retained

Profit margin Lower (because of greater Higher (no increase in expenses)

depreciation, etc)
ROA Lower (lower earnings and higher Higher
recorded asset base
ROE Lower (lower earnings and higher Higher
recorded equity base)

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

Employer’s  make periodic  Make pre-determined  Similar to DB

obligation contributions payment to retiree  Usually unfunded

 The key to identify DC or DB:

 Who bear the investment risk
 How about the employer’s future obligation.
 OPB could be regarded as an extension of DB;

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

 The payment of pension after the retirement is committed by the firm.

Therefore, these cost should be recognized during the servicing period of
the employees. The present value of the cost as at the end of current
year is called PBO
 The firm (sponsor) usually set up a fund to meet the liability.

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

Scenario Treatment required Applicable Method

Local currency is the Translation only Current rate method

functional currency
Functional Currency is the
Reporting currency
Neither of above
Re-measurement only Temporal method
Both translation and re- Temporal method first,
measurement then current rate
method

27-99
Translation of foreign currency FS LOS 21.c

Comparison of 2 methods – applicable FX rate (1)

Rate under Rate under

B/S items
Temporal Method Current Rate Method

Monetary Current Current

Assets/Liabilities
Non-monetary assets/ Historical Current
Liabilities (inventories,
FA, unearned revenue)
Capital Historical Historical
R/E Balancing Balancing
Equity (as a whole) Mixed (because the Current
change in retained
earnings is mixed)
Note: Liability is usually regarded as monetary.
28-99
Translation of foreign currency FS LOS 21.c

Comparison of 2 methods – applicable FX rate (2)

Rate under Rate under

I/S items
Temporal Method Current Rate Method
Sales and other Average Average
expenses
COGS Historical Average

Depreciation Historical Average

Revenue and other Average Average
expenses
Translation G/L Recognized on I/S Recognized in equity (B/S,
(Affecting retained not through I/S) resulting in
earnings, no CTA) CTA (cumulative translation
adjustment)

29-99
 Corporate Finance

30-99
Review of Level I basics & Links with Level II

Corporate Finance

How to create Investment Invest in project – Capital budgeting (R25)

wealth? decision Invest in company – M&A (R29)

How to fund the Financing Debt or equity finance – Capital structure

investment? decision (R26)

How to distribute Dividend Distribute or retain – Dividend and share

the wealth? decision repurchase (R27)

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

 Capital Structure and Leverage

 Capital Structure Objective
 Capital Structure Theory
 Costs and their Potential Effect on the Capital Structure
 Static Trade-Off Theory
 Implications for Managerial Decision Making
 Target Capital Structure
 Role of Debt Rating
 Capital Structure Policy and Valuation
 International Differences in Leverage

35-99
Introduction to Dividends and Share Repurchase

 Dividends and Share Repurchase

 Dividends policy and company value theory
 Factors affecting dividend policy
 Payout policies
 Analysis of dividend safety

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

 Value is not created by just change the leverage of a firm;

 With the increase in leverage, the increase in equity returns is offset by increases
in the risk and the associated increase in the required rate of return on equity.
 For simplification, assume 2 firms have the same cash flow (FCFF) and uncertainty.
The firm value is the same as the discount rate is the same.

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

 The static trade-off theory seeks to balance the costs of financial

distress with the tax shield benefits from using debt and state that
there is an optimal capital structure that has an optimal proportion
debt. V L = VU + ( t ´ d ) - PV (C osts of Financial D istress)
Firm value Cost of capital
Costs Of Financial
Max distress
firm Cost of equity
value Value of
levered firm
PV
tax of
shield
Value of WACC
unlevered firm
After-tax cost
of debt with
financial
distress
D/E
Optimal capital Optimal capital D/E
structure structure

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

 Tax consideration: Effective tax rate depends on the tax system

 Tax-imputation system
taxes are paid at corporate level but are attributed to the
shareholder, all taxes are effectively paid at the shareholder
rate.
Effective tax rate = shareholder’s marginal tax rate.

If shareholder’s marginal tax rate > company’s, shareholder

pays the difference between the two rates.

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

 Residual dividend model

Dividends are based on earnings less funds the firm retains
to finance the equity portion of its capital budget.
 The model based on the firm’s:
 investment opportunity schedule;
 target capital structure;
 access to and cost of external capital.

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.
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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

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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.

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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
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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;

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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.

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 Derivatives

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Introduction—Framework

Level Ⅰ 概念

Derivatives Level Ⅱ 定价

Level Ⅲ 应用

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Framework Summary
 SS 16 - Forwards and Futures
 R48 Forward Markets and Contracts
 R49 Futures Markets and Contracts

 SS 17 - Options, Swaps, and Interest Rate and Credit Derivatives

 R50 Option Markets and Contracts
 R51 Swap Markets and Contracts
 R52 Interest Rate Derivative Instruments
 R53 Credit Derivatives: An Overview

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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

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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
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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
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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
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Interest Rate Derivative Instruments– framework

1. Interest rate cap and interest rate floor

2. Compute the payoff for a cap and a floor

3. Interest rate collar

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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.

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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=S0＋Carrying Costs－Carrying Benefits

 T-bill (zero-coupon bond) forwards

 buy a T-bill today at the spot price (S0) and short a T-month T-bill
forward contract at the forward price (FP)

FP = S 0 × (1 + R f )T

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Forward contract value
 Forward value of long position at initiation, during the
contract life, and at expiration
Time Forward Contract Valuation

t=0 Zero, because the contract is priced to prevent arbitrage

t=t FP FP
Vlong = St − Vshort = −Vlong = T −t
− St
(1 + R f )T −t (1 + R f )

t=T St-FP

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Futures Contracts & forward contracts
 Differences

Futures Forwards
Exchange traded Over-the-counter

Standardized Customized

Marked to market Not marked to market

Clearinghouse as counterparty Originating counterparty

regulated usually not regulated

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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

Spot price Futures

Time price Time
(a) basis=spot price-futures price (b)

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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…

Prefer to go long in a futures contract, and the futures price

Positive will be greater than the price of an otherwise comparable
forward contract.

Zero Have no preference

Prefer to go long in a forward contract, and the forward price

Negative will be greater than the price of an otherwise comparable
futures contract.

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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).

FP = bond price × (1 + R f )T − FVC

[ T
FP = bond price × (1 + R f ) − FVC ×
1
CF
]

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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

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Currency Futures Contracts
 Discrete interest rates

(1 + RDC )T
FT (currency futures contract) = S0 ×
(1 + RFC )T
Where:
DC= domestic currency
FC= foreign currency

 Continuous interest rates

c c
( RDC − RFC )×T
FT (currency futures contract) = S 0 × e

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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

 A synthetic European put option: X

P0 = C0 + T
− S0
synthetic put = call + bond − stock (1 + R f )

 A synthetic pure-discount risk-less bond: X

T
= P0 + S 0 − C0
synthetic bond = put + stock − call (1 + R f )
 A synthetic stock position:
X
S 0 = C0 + T
− P0
synthetic stock = call + bond − put (1 + R f )

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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

Call payoff curve Call payoff

prior to expiration diagram at
expiration

Delta=the slope of the

prior-to-expiration curve

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

 And then we can get the C as:

1 − Bn
C=
B1 + B2 +  + Bn

 Recall that Bn is the discount factor, which is the present value of

$1 in n periods. It’s important to note that the answer C is a
periodic rate, and you must annualize it to get the annual swap rate.

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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

Vswap (X) = Bflt -Bfix

Vswap (Y) = Bfix -Bflt

 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

Per period premium Market

(amortized cost) Interest Rate
Cap strike

Profit to a Figure 2: Profit to a Long Floor

floor buyer

Per period premium Market

(amortized cost) Interest Rate
floor strike

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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:

 The first type of collar is to purchase a cap and sell a floor.

 The second type of collar is to purchase a floor and sell a cap.

 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

Private Real Valuation Cost Approach

Estate
Sales comparison Approach
Investment Analysis and Evaluation
Types
Why Public Traded
Public Traded Advantages & Disadvantages
Real Estate Characters & Risks
Alternative
Securities
Investments
REITs Subtypes

NAVPS, P/FFO, P/AFFO, DCF

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

Investment characteristics and risks

Three valuation approaches used for appraisal purposes
Income approach
Direct capitalization method and the Discounted cash flow method
Relationship between the capitalization rate and the discount rate

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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

 Different types of publicly traded real estate securities;

 Advantages and disadvantages of publicly traded real estate securities;
 Types of REITs, economic value, characteristic, principle risks, due
diligence considerations;
 Various approaches to REIT valuation
 Calculate the value of a REIT share

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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).

FFO (funds from operations)

- Non-cash (straight-line) rent adjustment
- Recurring maintenance-type capital expenditures and leasing commissions
= AFFO (adjusted funds from operations)

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

PE Funds Characters Risks, Costs, Structure, Terms

Management fee, Carry interest

NAV, PIC, DPI, RVPI, TVPI
Private Equity
Valuation Divers of returns
Buyout Funds
Valuation

Divers of returns
Venture Capital
NPV and IRR methods

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Exam Focuses on hedge funds

Different hedge fund strategies and their risks

Biases in reported hedge fund performance
concepts behind factor models and the motivations for replication strategies
causes and impacts of non-normality in hedge fund returns on risk measurement
and performance appraisal

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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

Lockup periods •1-3 years •none

• 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)

 Funds of Funds (FOF)

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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