Flash Card Notes

Corporate Finance:
- Degree of operating leverage: the percent change in EBIT that will result from a 1%
change in sales

- Degree of total leverage: the percentage change in EPS resulting from a change in sales
of 1%
o Total leverage is operating * financial leverage

- An increase in the tax rate will decrease the firms after-tax cost of debt (Kd*(1-tax)) and
consequently decrease the firms WAAC

- Increases in inventory increase CA and WC needs, not capital investments

- Stretching payables by waiting until their due would increase the firms average days of
payables and shorter the firms cash conversion cycle (days of receivables + days of
inventory days of payables) but would not affect its operating cycle.

- Executive directors are board members who are also senior managers of the company.
In a two-tier board structure, the management board includes executive directors and
the supervisory board includes only external (non-executive) directors.

- Debt-to-equity ratio is most likely to increase as a result of an extra dividend.

o Extra dividend is a cash payment to shareholders that will decrease assets and
shareholders equity (retained earnings) but will not affect liabilities.
o Splits, reverses, and stock dividends change the number of shares outstanding
but not the value of equity or require any use of the firms assets.

Economics:
- Capital account
- Current account
- Financial account
- Economic union: members establish common economic policies and institution
- Monetary union: common currency
- Regional trading agreements remove barriers to imports and exports among their
members
- Elasticities approach on the effect of exchange rates on the trade balance
o The more elastic both import demand and export demand are, the more likely
currency depreciation is to narrow a trade deficit
o Net exports = private and government savings investment
- Real business cycle theory
o Holds that economic cycles are driven by utility-maximizing individuals and firs
responds to changes or shocks in real economic factors
 - Keynesian cycle theory
o Business cycle changes due to change in business confidence
- Monetarist theory
o Attributes the business cycle to inappropriate changes in the rate of money
supply growth
- Changes in the US fed funds rate and changes in long-term interest rates are unlikely to
be proportionate
o If a decrease in the target fed funds rate causes economic agents to increase
their inflation expectations, the change in long-term rates will be less than the
change in the federal funds rate
- Increase in aggregate demand will cause short-run equilibrium to move along the short-
run supply curve
o This will tend to increase both real GDP and the price level in the short run
- An increase in the money wage rate would not increase long-run aggregate supply
(potential real GDP), but instead would decrease the short-run aggregate supply curve

Financial Reporting:
- IASM fundamental qualitative characteristics of financial statements
o Relevance and faithful representation
- Cash conversion cycle = collection period + inventory period payables period
o An increase in inventory turnover will decrease the inventory period and shorten
the cash conversion cycle
- Sustainable growth rate = retention rate * ROE
o Retention rate = (1-dividend payout ratio)
- If amortized and not expense, the cost would be classified as an CFI rather than CFO
o The asset created by capitalizing the cost would increase assets so the debt-to-
assets ratio would decrease
- If it becomes probably that a portion of a deferred tax asset will not be realized, a
valuation allowance should established
o The difference between tax payable and income tax expense will not reverse in
future periods
- Under IFRS and GAAP, long-lived assets that are reclassified as HFS cease to be
depreciated
o If to be abandoned or exchanged, classified as held for use until disposal and
continue to be depreciated
- Finance lease only the interest portion of the lease payment is classified as CFO
o Principal portion is classified as a CFF outflow
o Only depreciation expense will hit the income statement with a finance lease
o Operating lease, the entire lease payment will be an operating expense
- Impairment charges
o Reduce operating income and NI in the period of the charge
o Taxes are not affected b/c any loss in asset value will reduce taxes only when the
asset is disposed of and the loss is actually realized
o D/E ratio increases in the period of the charge b/c equity is reduced
 - GAAP: firms are required to capitalized any asset with a useful economic life of more
than one year
o R&D costs are expensed under GAAP
- By capitalizing a purchase instead of recognizing it as an expense in the current period, a
firm increases operating cash flow by classifying the cash outflow as CFI rather than CFO
- IFRS a firm may value investment property using either the cost model or the fair value
model
o GAAP does not distinguish investment property from other types of long-lived
assets
- Defined contribution pension plan: only pension expense for the company are the
predetermined contributions required to be made
- Gain or loss on redemption = book value reacquision price unamortized issue costs
o GAAP, unamortized issue costs are reported on the BS as an asset and are not
included in the book value of the bond liability. Thus, the remainder of the issue
costs must be written off when the bond is called
- LIFO is not permitted under IFRS

Portfolio Management:
- Execution step of the portfolio management process typically begins with a top-down
analysis of economic variables
o Asset class rebalancing is part of the feedback step
o Investment policy is completed during the planning step
- Treynor measure is stated in terms of systematic risk (Beta) while Sharpe and M-
squared measure are defined in terms of total risk (standard deviation)
- According to CAPM, all investors who hold risky assets will hold the same portfolio of
risky assets (the market portfolio)
- Beta: is its covariance with the returns of the market portfolio divided by the variance of
the market portfolio
- Insurance is an example of transferring risk while shifting a risk is changing the
distribution of possible outcomes
- Investment policy statement should most appropriately establish a target asset
allocation strategy

Derivatives and Alternative Investments:

- Holding an asset and a short position in a forward contract on the asset replicates
investing at the risk-free rate b/c the future payoff is certain
- Costs of holding the underlying asset that are greater than the benefits increase the no-
arbitrage price of a forward contract
- A decrease in the risk-free rate of interest will decrease call values
o An increase in asset price volatility will tend to increase the value of a call option
- An interest rate swap may be replicated by a series of off-market FRA if their PVs sum to
zero at initiation
o An interest rate swap may have a nonzero value at initiation, while FRAs must
have a value of zero at initiation
 - Forward contracts typically do not require a margin deposit
o They may require settlement in cash or delivery of the underlying asset, and they
have counterparty risk
- Survivorship bias in a hedge fund index returns will most likely result in index risk that is
biased downward and returns that are biased upward b/c only including the funds that
succeeded
- HF incentive fee is usually 20% of the excess gross return over the hurdle rate
- VaR and the Sortino ratio based on downside deviations from the mean are measures of
downside risk
- Repeat sales index most likely exhibits sample selection bias. Includes prices of
properties that have recently sold but these may not be representative of overall
property values
o Appraisal index or a REIT index is generally constructed for a sample of
representative properties or REIT property pools

101 Must Knows

- Misrepresentation states that "... citing specific quotations supposedly attributable to 'leading
analysts' and 'investment experts' without specific reference.." is a form of plagiarism and, as such,
is a violation of the Standards.

- Initial GIPS compliant presentation must include compliant performance history for 5 years or since
inception of firm. After must add a year of GIPS-compliant presentation each year until the total is
10.
o These standards are voluntary and adopted by firms on a firm wide basis and must be
applied firm wide if adopted
o No such thing as a partial GIPS compliance
o Cant claim GIPS compliance for a particular calculation methodology (no partial claims)
o Verification of firms GIPS compliance is voluntary
If you elect to show verification must be by a third party
- GIPS composites: each composite must include all discretionary, fee-paying portfolios managed to
the mandate, index, or strategy of the composite.
o All fee-paying discretionary accounts to be included in at least one composite
o Total firm assets include all accounts, including accounts managed by sub-advisors

- Fair dealing addresses oversubscribed IPOs

o Distribute to all clients for whom investment is appropriate
o If the issue is oversubscribed, members and candidates should forego any sales to
themselves or their immediate families in order to free up additional shares for clients
Family members who are clients should be treated as any other client
o Also addresses hot issues (expected to initially trade at a premium)
Prohibited from withholding such securities for their own benefit and must not use
such securities as a reward or incentive to gain benefit

- Knowledge of the law

 o Must comply with the most strict of: code and standards or laws and regulations where
member candidate resides or does business

- Yield measures for money-market securities

o Bank discount yield = discount/face value * 360/days
o To determine rate of return earned by investor, convert to EAY annualized to 365-day with
compounding
Calculate HPY: percent gain or loss on amount invested
Annualized with compounding: EAY = (1+HPY) ^(365/days) -1
HPY = discount/price
o Short term securities are quoted with a money market yield or BEY
Money market yield = HPY * (360/days)
BEY = HPY * (365/days)
- Question 57
o An increase in tax rate will increase both the DTA and DTL if the DTA is larger, the net
effect will be to decrease income tax expense
-

- Question 58
o Capital projects analysis
o Independent project, accept if NVP>0
NPV is the sum of discounted future cash flows initial outlay
o Mutually exclusive projects, accept project with highest NPV
o IRR is the discount rate at which NPV = 0
o Should accept if IRR>cost of capital
When deciding between multiple project, use NVP
Project with unconventional cash flows may have multiple or no IRR at all
o Profitability index is the ratio of discounted cash flows to initial outlay
For independent project, accept if >1 (means NPV>0)
PI of 1.1 means PV of cash flows is 110% of initial outlay so we can interpret this to
mean the NVP is 10% of initial outlay
o E.g. $2mm initial outlay * (1.20 PI 1) = $400,000 NPV
- Question 59
o Breakeven quantity of sales = (fixed operating and financing costs) / (price per unit
variable cost per unit)
o An increase in fixed financing costs would increase the breakeven quantity, but a decrease
in variable cost per unit would decrease the breakeven quantity
The net effect on the breakeven quantity will depend on the relative strengths of
these opposing effects
- Question 60
o When calculating WACC, use the market value when figuring out the weights
o For cost of preferreds, use the dividend / market price
o Use YTM for the cost of debt * (1-tax rate)
- Question 61
o Marginal cost of capital schedule breakpoints
Breakpoint is an amount of capital at which marginal cost of capital increases
 o Breakpoint amount of total capital = breakpoint in components cost / components weight
in firms capital structure
- Question 62
o A share repurchase will increase EPS when the earnings yield is greater than the after-tax
cost of funds
Earnings yield is EPS / current px
- Question 64
o The greater the proportion of fixed costs to total costs in a firms cost structure, the greater
its operating leverage (operating risk)
o Operating leverage = TFC/TVC
- Question 65
o Investor constraints
Liquidity, legal factors, time horizon, tax situation, and unique circumstances
o Investor objectives
Risk and return requirements
o Two objectives and five constraints RRLLTTU
- Question 66
o Use of derivatives to reduce risk by changing the distribution of possible outcomes is
referred to as risk shifting
- Question 67
o Portfolios along the capital market line are combinations of the market portfolio and the
risk-free asset
o Portfolios along the CML have only market risk and are efficient
o Slope of the CML is E(Rmarket- Rf) / Portfolio standard deviation
- Question 68
o Security market line includes only systematic risk (beta) as there are no additional returns in
equilibrium for unsystematic risk in the CAPM
o All assets and portfolios plot on the SML in equilibrium
o Slope of the SML is the market risk premium and beta is represented on the x-axis
- Question 70
o All investors are risk averse but differ in their degree of risk aversion, so a risk averse
investor may or may not hold risky assets, a relatively low risk portfolio, or a high risk
portfolio
- Question 71
o Life insurance company has a low risk tolerance, long investment horizon, and high liquidity
requirements
Banks will have a short time horizon
- Question 72
o Preferred stock holder cannot vote
o Will get paid dividends first but is not a contractual obligation of the company
- Question 73
o Over-the-counter markets are not order-driven markets
Orders are executed using trading rules in order-driven markets
In OTC, markets traders transact with dealers
o OTS markets are also referred to as price-driven, quote-driven, and dealer markets
- Question 74
o Margin call price = P0 * (1-initial margin / 1-maintenance margin)
o Initial margin requirement is the percentage of cash required to buy on margin
o Margin calls are different between stocks and futures contracts
With stocks, must restore to maintenance margin to keep position open
 With futures, must restore to initial market to keep position open
- Question 75
o Market cap weighted index
Does not need to be adjusted when a stock splits or pays a dividend because the
weight of an index stock is based on its market capitalization
o Price-weighted index
Arithmetic average of the prices of the securities included in the index
Matched by a portfolio with an equal number of shares of each constituent stock so
shares must be reduced after a stock split
- Question 75
o Weak
Stock prices fully reflect available security market info
Volume, information/past price do not relate to future direction of security prices
Investor cannot achieve excess returns using technical analysis
o Semi-strong
Security prices instantly adjust to new public information
Investor cannot achieve excess returns using fundamental analysis
o Strong
Stock prices fully reflect all information from public and private sources
Assumes perfect markets in which all information is cost free and available to
everyone at the same time
Even with inside info, investor cannot achieve excess returns
- Question 77
o High industry fragmentation increases rivalry among existing competitors so pricing power
is low
o High industry capacity may simple be the result of high demand for the product; high
excess capacity suggests intense price competition
- Question 78
o Justified P0/E1= (D1/E1) / (k-g)
D1/E1 is simple the dividend payout
ratio
- Question 79
o

- Question 81
o Beta = Covariance / Variance
Use the variance of the index and covariance of the stock with the index
o Margin requirement in the example of 60% is how much cash you are required to put up so
you end up borrowing 40% and get charged an interest rate of 1.4% and need to subtract
that out from your returns. Because you borrowed money, your returns will be amplified.
- Question 82
o Duration
For a change of 50bps youd put
0.005 as the change YTM

- Question 83
o Can calculate the 2-year spot rate given the 1-year spot rate and the 1 year
forward rate one year from now
[(1.02)(1.023)]^1/2 -1 = 2.15%
o uses the formula (1+S2)^2 = (1+S1)(1+1y1y)
we know the 1-year spot rate and the 1 year forward rate 1 year from
now and square root and subtract 1 to get the 2-year spot rate
- Question 84
o If the OAS is less than the Z-spread, the embedded option is unfavorable for the
bondholder (call option)
If volatility increases, the value of the call option increases and thus
decreases the value of a callable bond (more likely it will get called)
- Question 85
o Macaulay duration
Horizon at which market price risk and reinvestment risk just offset
This is the weighted average of times until a bonds cash flows are
scheduled to be paid
o Modified duration
Approximate change in a bonds price given a 1% change in its YTM
o When Macaulay duration is greater than the investment horizon, the investor
faces greater market price risk (from an increase in interest rates) than
reinvestment risk (from a decrease in interest rates)
- Question 86
o Flat price of bonds
is their full price at
settlement
accrued interest

- Question 87
o Duration of a bond is higher when its coupon rate is lower (more risk from
market with lower coupon)
o Shorter maturity and higher YTM decrease duration
- Question 88
o Repo margin is the difference between the market value of the subject security
and the amount it is purchased for (loan amount)
o The margin is higher when the credit quality of the subject security is lower, and
lower when the credit quality of the borrower is higher or the subject security is
in high demand/short supply
- Question 89
o Corporate family rating is the rating of a company senior unsecured debt
(Debentures)
- Question 91
o Agency RMBS are pass-through securities and have only one class or tranche
- Question 92
o Cash flows on the asset during the put options life reduce the value of the asset
at expiration and increase the value of a put option
 o Other things equal,
an increase in the
risk-free rate will
decrease the value
of a put option
o An increase in the tie
to expiration can
decrease the value
of a European put
option under some
circumstances
- Question 93
o A risk-free bond that pays the exercise price at maturity can be replicated by
buying the stock, buying the put option (right to sell), and writing the call option
- Question 94
o Breakeven stock price for a covered call position is the stock price the premium
received for the call option
o Losses for a short call are unlimited while gains are limited to the premium
received
- Question 95
o The value of a forward contract with no costs or benefits of holding the asset
during its life is equal to the spot price of the asset minus the present value of
the forward contract price (discounted at the risk-free rate).
- Question 96
o A simple interest rate swap can be replicated by borrowing at a fixed rate and
lending at a floating rate with the interest payments on the same dates as the
swap settlement dates. A swap can be replicated with a series of forward rate
agreements each settling on one of the swap settlement dates but these will
most likely be off-market and not have zero values.
- Question 97
o The gross ending value of the fund is 100 0.92 = 92 million. The fund will charge
a management fee in 20X1 of 2% 100 million = 2.0 million. The fund will not
charge an incentive fee in 20X1 because the value of fund assets has declined, so
the net value of the fund at the beginning of 20X2 is 92 - 2 = 90 million.
o The gross ending value for 20X2 is 90 1.20 = 108 million, which is above the
high water mark of 100 million by 8%. Because 8% exceeds the 5% hard hurdle
rate by 3%, incentive fees for 20X2 are 20% 3% 100 million = 600,000.
- Question 98
o Contango: futures price > spot price
o Collateral yield is the interest income from short-term securities that a futures
investor deposits to meet margin requirements. Roll yield is negative for a
futures market in contango and positive for a futures market in backwardation.
- Question 99
 o The correlation of commodity returns with returns on equities has been low, on
the order of 0.20. Nominal returns have been less than those of global stocks
and bonds on average. Given the high correlation of commodity returns and
inflation, real returns tend to be low.
- Question 100
o A hedge fund is most likely to report a trading NAV that differs from its
accounting NAV
o Trading NAV is adjusted downward for the illiquidity of investment positions and
applies to hedge funds as they may hold infrequently traded assets or positions
that are large relative to the normal trading volume of the asset.

Notes:
- Continuous compounding rate of return
o Ln(1+r)
- Kurtosis is a measure of the degree to which a distribution is more or less peaked than
a normal distribution
- Bayes formula
o Updated probability = (probability of
new information for a given event /
unconditional probability of new
information) * prior probability of
event
- Correlation tells the strength of the linear
relationship between two of the variables.
- The Chi-squared distribution is not symmetrical
- This is the variance formula you can square root the whole thing to get standard
deviation.
o The p1,2 is the correlation
coefficient

- mean<median = negatively skewed

- An increase in real interest rates can be expected to decrease business investment and decrease
consumption.
- In order for effective price discrimination to occur, the seller must have a downward sloping demand
curve.
- Expansionary fiscal policy tends to expand the public sector. Contractionary monetary policy tends
to contract the private sector.
o Fiscal policy deals with budgets, deficits and surpluses
Expansionary when the deficit is increasing
 o Monetary policy is expansionary when the policy rate is less than the neutral
interest rate
- If the price elasticity of demand is -2.0, this indicates that the percentage change in quantity
demanded is twice the percentage change in price. Thus, a decrease in price will be more than offset
by the increase in quantity, and total revenue will increase. We are not at the point of maximum
total revenue which is where elasticity is -1.0-the point of unit elastic demand.
- The money supply schedule is vertical because it is not affected by changes in the interest rate but is
determined by the monetary authorities such as the Federal Reserve System (Fed) in the United
States.
- International Monetary Fund
o Promotes international monetary cooperation
o Facilitating the expansion and balanced growth of international trade
o Promoting exchange stability
o Assisting in the establishment of a multilateral system of payments
- World Bank
o Source of financial and technical assistance to developing countries around the
world
o Mission is to fight poverty with passion and professionalism
- World Trade Organization
o Only international organization dealing with the goal rules of trade between
nations
o Main function is to ensure that trade flows as smoothly. Predictably, and freely
as possible
- Action lag
o The time it takes for fiscal policy actions to be proposed, approved, and implemented
- The lessee's cash flows from financing will be higher for an operating lease because the payments
made for an operating lease are operating cash outflows, not financing cash outflows. The
payments made under a finance lease are split between interest paid and principal. The latter is
charged to cash flow from financing.
- Direct financing lease
o Implicit rate is such that the present value of the minimum lease payments equals the cost
of the leased asset.
o Thus, at lease inception the total assets do not change and no gain is recognized.
- General journal
o A listing of all the journal entries in order of their dates
o Records every transaction showing which accounts are changed and by what
amounts
- General ledger
o Sorts the entries in the general journal by account
- Dividends paid to stockholders are considered CFF outlays under US GAAP
- Common size balance sheets
o Vertical common-size statements enable the analyst to make better comparisons of two
firms of different sizes that operate in the same industry.
o Horizontal common-size financial statements express each line as a percentage of the base
year figure; thus, horizontal common-size statements can be used to identify structural
changes in a firm's operating results and financial condition over time.
- Deferred tax liabilities
o If expected to reverse in the future, then they should be classified as liabilities.
o If, however, they are not expected to reverse in the future, then they should be classified as
equity.
- The most appropriate analyst adjustment for an operating lease is to add the present value of lease
payments to the firm's assets and long-term debt (leaving equity unchanged). This will result in a
higher debt-to-equity ratio
- The completed contract method is used under U.S. GAAP when cost estimates are unreliable.
o Percent-of-completion is used where contracts and cost estimates are reliable.
- The cash conversion cycle is its operating cycle minus its average days payables outstanding.
- If the after-tax cost of borrowing is greater than the earnings yield (E/P) of the shares,
the share repurchase reduces EPS
- Breakpoint
o Calculated as the amount of capital where component cost changes / weight of
component in the WACC
- Qbreakeven = Fixed Cost / (Price Variable Cost)
- High operating leverage
o When a high percentage of a firms total costs are fixed
o Means that a relatively small change in sales will result in a large change in
operating income
o Operating leverage can be defined as the trade off between variable and fixed
costs
- Profitability index
o The PV of the future cash flows / initial outlay for the project
If the initial outlay is the same for 2 projects, the one with the higher
profitability index has both higher PV of future cash flows and the higher
NPV
o Ranking projects on their payback periods or their IRRs can lead to incorrect
ranking
- Order of dividend dates
o Declaration date
o Ex-dividend date
Two business days prior to the holder-of-record date, giving the firm time
to identify the rightful owner of the dividends
o Holder-of-record date
o Payment date
- Secondary sources of liquidity
o Liquidating short-term or long-lived assets
o Negotiating debt agreements
o Filing for bankruptcy and reorganizing the company
- Primary sources of liquidity
o Sources of cash a company uses in its normal operations
- Pulls and drags on liquidity
o Factors that weaken a companys liquidity position
- Leverage ratio of 2.3x means assets/equity = 2.3x
 o If you assign a value of 1 to equity, then debt-to-equity ratio must be 2.3-1=1.3
o So the capital structure weight for debt is 1.3/2.3 = 57% and equity is 1/2.3= 44%
- Beta unlevered = levered beta / (1+ ((1-tax)(debt/equity))
- Beta levered = beta unlevered * (1+ ((1-tax)(debt/equity))
- If the NPV is negative, the discount rate used by the company must be greater than the
IRR (discount rate for which the NPV equals 0)
- If the NPV for two mutually exclusive projects is negative, both should be rejected
- WACC
o When acquiring a company un-lever their beta and re-lever it to your capital
structure
o If D/E ratio is 2.5 your weights will be 1/3.5 and 2.5/3.5 because 2.5/1 is your D/E
so your total is 2.5+1 for the denominator
- Beta of stock A = covariance between stock and the market / variance of the market
o Variance is the standard deviation squared
- CAPM can be thought of as the required return and you can compare that number vs.
the expected or forecasted return and if the forecasted is lower, youll sell because
overvalued
- All portfolios on the Capital Market Line (CML) are perfectly positively correlated
o Introduction of a risk-free asset changes the Markowitz efficient frontier into a
straight line
This straight efficient frontier line is called the CML
o Since the line is straight, the returns on any two portfolios on tis line will be
perfectly, positively correlated
o The risky assets for each portfolio on the CML are the same
- Treynor measure
o Excess return relative to beta (systematic risk)
- Sharpe Ratio
o Measures excess return relative to standard deviation
- Jensens alpha
o Measures a portfolios excess return relative to return of a portfolio on the SML
that has the same beta
- Equal weighted price indicator series
o Assumes than an equal dollar investment is made in each stock in the index
All stocks carry equal weight regardless of their price or market value
- Growth rate = (ROE)*(1 Dividend Payout Ratio)
o Can be used to find the implied growth rate in dividends
- Sustainable Growth Rate = (ROE)*(RR)
o RR = retention rate
Retention rate = 1- payout ratio
Payout ratio = 1 (dividends/net income)
- P0/E1 = (D1/E1) / (k g)
o = payout ratio / (k g)
- The value of the stock will be the dividend paid next year / (the required rate of return
the growth rate)
o Constant growth model: Value of Stock = D1 / (k-g)
- If youre given next years earnings of $4.25, the dividend at
period 1 would be the earnings * (1-RR) because that is the
amount not retained or paid out as a dividend
- Key rate duration
o The price sensitivity of a bond or portfolio to a
change in the interest rate of one specific maturity
on the yield curve
- Issuers credit rating (corporate family rating) is based on
its senior unsecured debt
- Key rate duration, also known as partial duration, is used to measure the sensitivity of a
bond price to a change in yield at a specific maturity
- Inventory valuation
o IFRS, inventory is measured at the lower of cost or net realizable value
Inventory that has been written down can later be revalued upward if its
net realizable value recovers but only to the extent that reverses the
write down
o GAAP, inventory that has been written down may not be revalued upward
- LIFO COGS to FIFO COGS
o FIFO COGS = LIFO COGS change in LIFO reserve
- Average age of depreciable assets is useful for estimating financing required for major
capex in the near term to replace depreciated assets
- Dividends paid to stockholders is a financing activity CFF
o GAAP required interest paid to bondholders to be considered an operating CFO
- DTLs are a result of pretax income that is greater than taxable income due to temporary
differences
- Complex capital structure
o One that has potentially dilutive elements
- Commercial paper should be classified as current if it will be converted to cash in less
than a year
o A liability that is held for trading purposes should also be classified as current
- GAAP DTLs and DTAs are classified as current or noncurrent based on the underlying
asset or liability
o IFRS, deferred tax items are classified as noncurrent
- Capitalizing interest costs related to a companys construction of assets for its own use
is required by IFRS and GAAP
- FIFO Inventory = LIFO inventory + LIFO reserve
- Impairments cannot be restored under GAAP
o During the year of a write-down, retained earnings and deferred taxes will
decrease
o The write-downs are reported as a component of income from continuing
operations
- Inventories are valued on the balance sheet at the lower of cost or net realizable value.
- The completed contract method is used under U.S. GAAP when cost estimates are unreliable
- The Central Limit Theorem states that if the sample size is sufficiently large (i.e. greater than 30) the
sampling distribution of the sample means will be approximately normal.
- Joint probability
o Two events that both must occur
- Sampling error
o The difference between any sample statistic and its corresponding population
parameter
- EAY takes the HPY and annualizes it based on a 365-day year accounting for
compounding
o (1 + HPY) ^ (365/t) 1
- Assumption of technical analysis
o The market is driven by rational and irrational behavior
- Discrete uniform distribution
o Characterized by an equal probability for each outcome
o A single die roll is an often-used example
- The time-weighted method of returns
o Not affected by the timing of cash flows
o If the investment is greater than one year, an analyst must use the geometric
mean to calculate the annual time-weighted return
o The money-weighted return applies the concept of internal rate of return to
investment portfolios
- Binomial distribution
o Random variable X is discrete
o The trials are independent
o The expected value does not have to be a whole number
- Covariance example
o Cov(A,B) = sum of P(A-mean A)(B- mean B) +
- Chebyshevs inequality
o The minimum percentage of observations that lie within k standard deviation of
the distribution mean
o = 1 (1 / k^2)
- statistical estimator is unbiased if
o the expected value of the estimator is equal to the population parameter
o desirable properties of an estimator are unbiasedness, efficiency, and
consistency
o estimator is consistent if an increase in sample size decreases the standard error
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