CFA Level 1 – 101 All Must Knows. 100% Coverage & Mastery. Rated A+

CFA Level 1 – 101 All Must Knows. 100% Coverage & Mastery. Rated A+ Addition Rule of Probability - ☑☑ADDITION: P(A or B) = P(A) + P(B) - P(AB) Roy's Safety First Criterion - ☑☑Safety First Ratio = (E(R) - Rₜ) / σ ...

CFA Level 1 – 101 All Must Knows. 100% Coverage & Mastery. Rated A+ Addition Rule of Probability - ☑☑ADDITION: P(A or B) = P(A) + P(B) - P(AB) Roy's Safety First Criterion - ☑☑Safety First Ratio = (E(R) - Rₜ) / σ Larger ratio is better If (Rₜ) is risk free rate, then it becomes Sharpe Ratio Sharpe Ratio - ☑☑Sharpe Ratio = (E(R) - RFR) / σ Larger ratio is better If (Rt) is higher than RFR, then it becomes Safety First Ratio Central Limit Theorem - ☑☑If we take samples of a population, with a large enough sample size, the distribution of all sample means is normal with: - A mean equal to the population mean - A variance equal to the population variance divided by sample size (σ² / n) Standard Error of Sample Mean - ☑☑σ / n^½ Binomial Probability - ☑☑One of two possible outcomes (i.e. success/failure) Possible outcomes can be demonstrated in binomial tree Use "nCr" on calculator to solve: nCr = P(success)^x * P(failure)^(n-x) P - Value - ☑☑Based on a calculated test statistic, rather than a significance level (which is chosen) p-value = smallest significance level at which an analyst can reject the null hypothesis one-tailed test - "less than or equal to" two-tailed test - "equal to" Cumulative Distribution Function - ☑☑Gives the probability that a random variable will have an outcome less than or equal to a specific value (represented by F(x)) F(x) = probability of an outcome less than or equal to x Standard normal table (z) shows cumulative probabilities Effective Annual Yield - ☑☑EAY = (1 + (i/n))^n - 1 Stated Rate = (EAY^(1/n) - 1) * n Continuous Compounding - ☑☑ln(EAY) = continuously compounded stated rate e^(continuously compounded stated rate) = EAY Type I Error - ☑☑Incorrectly rejecting a true null hypothesis (convicting an innocent person is Type I) Type II Error - ☑☑Failure to reject a false null hypothesis (failure to convict a guilty person is Type II) Significance Level / Power of a Test - ☑☑Significance Level = Probability of Type I Power of a Test = (1 - Probability of Type I) Covariance (Probability Model) - ☑☑Covariance of random variables A and B from probability model On the calculator: 1) Enter returns for set A and joint probabilities for AB; find mean A 2) Enter returns for set B and joint probabilities for AB; find mean B 3) Multiply each joint probability AB by each set's returns minus means (ex: P(AB1)(A1 - Mean A)(B1 - Mean B) + P(AB2)(A2 - Mean A)(B2 - Mean B) + ... + P(ABn)(An - Mean A)(Bn - Mean B)) 4) The summed total is your covariance Covariance (Sample) - ☑☑Covariance of random variables A and B from sample with historical data with n observations Correlation Coefficient - ☑☑COVab / σaσb Bank Discount Yield (Discount basis) - ☑☑(Discount / Face Value) * (360 / Days) Money Market Yield - ☑☑(HPY) * (360 / Days) Bond Equivalent Yield - ☑☑(HPY) * (365 / Days) Most appropriate for comparing yields! Technical Analysis Indicators - ☑☑Continuation: TRIANGLE (or pennant) = Suggests a pause in the stock price movement that will be followed by a continuation of the previous trend Reversal: HEAD AND SHOULDERS = Suggests a future decline in the stock price regardless of prior trend DOUBLE BOTTOM = Increasing stock price in the future (reversal of a downtrend) Trendlines: SUPPORT / RESISTANCE = Range that stock price trades in based on supply/demand. Stock is "supported" from going below a certain low price, and "resists" going above a certain high price Price Elasticity - ☑☑%ΔQuantity / %ΔPrice = (ΔQ / ΔP) * (P₀ / Q₀) Demand is elastic if less than -1 Demand is inelastic if 0 to -1 Income Elasticity - ☑☑%ΔQuantity / %ΔIncome Positive for normal good Negative for inferior good Cross-Price Elasticity - ☑☑%ΔQuantity / %ΔPriceʳᵉˡᵃᵗᵉᵈ ᵍᵒᵒᵈ Positive for substitutes Negative for complements Sources of Economic Growth - ☑☑Increases in: - Labor - Physical Capital - Technology - Natural Resources - Human Capital (LPT:HN) "Life Pro Tip: No Hangovers" Production Function Approach (GDP) - ☑☑Potential GDP = A * f(L,K) L = Labor K = Capital A = "total factor productivity" aka increased growth not explained by growth of labor and capital This is a proxy for growth of technology Solow (neoclassical) model (GDP) - ☑☑Growth in Potential GDP = growth in technology + Wₗ(growth in labor) + Wₖ(growth in capital) Growth in a country's per capita GDP = growth in technology + Wₖ(growth in K/L ratio) No Arbitrage Forward Rate - ☑☑(1 + price currency int. rate) / (1 + base currency int. rate) = forward exchange rate / spot exchange rate ((1 + price currency int. rate) / (1 + base currency int. rate)) * spot rate = no arbitrage forward rate Exchange Rate Quotes - ☑☑Price Currency / Base Currency Read as "units of price currency for each unit of base currency" Business Cycle - Leading Indicators - ☑☑Precede: Weekly Hours Manufacturing Manufacturing New Orders; Non-defense Consumer Goods ISM New Orders Index Stock Prices Yield Curve New Unemployment Ins. Claims Building Permits Capital Goods ex. Aircraft Leading Credit Index Consumer Expectations Business Cycle - Coincident Indicators - ☑☑Coincide: Nonfarm payrolls Personal Income - Transfer Payments Manufacturing and Trade Sales Business Cycle - Lagging Indicators - ☑☑Follow: *Unemployment Rate Duration of Unemployment Inventory / Sales Ratio Manufacturing and Trade Commercial and Individual Loans Prime Rate Manufacturing Labor Cost per Unit of Input Commercial / Personal Credit Income Ratio CPI The Fundamental Relationship (GDP) - ☑☑Expenditures: GDP = C + I + G + (X - M) Income: GDP = (C + S) + T Fundamental Macro Relationship - ☑☑(S-I) = (G-T) + (X-M) S = Personal Savings I = Personal Investment G = Government Spending T = Tax Revenue X = Exports M = Imports If G > T, government deficit If X > M, trade surplus Inflationary Gap - ☑☑Real output above full employment (LRAS) Upward pressure on wages will decrease SRAS, reducing output and increasing prices (SRAS moves up) Recessionary Gap - ☑☑Real output below full employment (LRAS) Downward pressure on wages should increase SRAS, increasing output to full employment, but recessionary gap may persist if "downward sticky." Kenesyian theory suggests government spends to step in and increase AD up to equilibrium (stimulus or expansionary monetary policy) Effects of Trade Restrictions - ☑☑Trade restrictions typically increase the welfare of domestic producers, but decrease welfare of domestic consumers and foreign producers. Overall welfare is decreased by trade restrictions (deadweight loss) Types of Trade Restrictions - ☑☑Tariffs (Oldest) - Taxes on imported goods; benefits government who collects tariff revenue Quotas - Limits quantity of imports in a time period; benefits government if selling licenses; benefits foreign producers through quota rents Voluntary Export Restraints - Foreign countries limits on quantity of exports to domestic nation. Effects are similar to quota, but government gets no revenue. Consumer Price Indexes - ☑☑Designed to measure change in cost of basket of goods/services Weights in CPI reflect purchases of typical urban household Annual inflation rate is year over year % change in CPI Laspeyres Index (US CPI) - ☑☑(Base year basket at current prices / Base year basket at base prices) * 100 Doesn't account for introduction of new goods, substitutions, or quality improvements (tends to overstate inflation). Paasche Index - ☑☑(Current year basket at current prices / Current year basket at base prices) * 100 Does allow for substitution Fischer Index - ☑☑Chain weighted: Geometric mean of Paasche & Laspeyres Indexes Market Stuctures - ☑☑Perfect Competition Monopolistic Competition Oligopoly Monopoly Perfect Competition - ☑☑Many Firms "Commodity" Products No pricing power (price taker) Compete only on price Monopolistic Competition - ☑☑Many Firms Differentiated Products Slight pricing power Compete on price, features, advertising Oligopoly - ☑☑Few Firms May be differentiated May be significant pricing power Compete on price, features, advertising Monopoly - ☑☑One Firm No Good Substitutes Significant pricing power No need to compete; only advertise Expansionary Fiscal Policy - ☑☑Fiscal policy is expansionary if deficit increases or surplus decreases (G > T) policy rate < neutral interest rate Contractionary Fiscal Policy - ☑☑Fiscal policy is contractionary if deficit decreases or surplus increases (G < T) policy rate > neutral interest rate Neutral Interest Rate - ☑☑Long Term Trend of GDP Growth + Target Inflation Rate Cash Flow from Operations (CFO) - ☑☑Transactions that affect Net Income CFO = Net income + noncash - WC investments Typically, cash flows are operating if they affect current assets/liabilities IFRS: Interest or dividends received CFO or CFI Interest or dividends paid CFO or CFF US GAAP: Interest or dividends received CFO Cash Flow from Investing (CFI) - ☑☑Purchases and sales of assets, some financial investments Typically, cash flows are investing if they affect long-lived assets IFRS: Interest or dividends received CFO or CFI Cash Flow from Financing (CFF) - ☑☑Transactions that affect firm's capital structure (equity; long-term debt) Typically, cash flows are financing if they affect long-lived liabilities and equity IFRS: Interest or dividends paid CFO or CFF US GAAP: Dividends paid are CFF Non-Cash Transactions - ☑☑Disclosed in footnotes of cash flow statement Operating Cycle - ☑☑Days inventory on hand + Days Sales Outstanding (DSO) Cash Conversion Cycle (Net Operating Cycle) - ☑☑Days inventory on hand + Days Sales Outstanding (DSO) - Days payables Days Inventory on Hand - ☑☑365 / Inventory Turnover Days Sales Outstanding (DSO) - ☑☑365 / Receivables Turnover Days of Payables - ☑☑365 / Payables Turnover Net Profit Margin - ☑☑Net Income / Revenue Asset Turnover - ☑☑Revenue / Assets Leverage Ratio - ☑☑Avg. Total Assets / Avg. Total Equity DuPont Decomposition of ROE (1-3 Stage) - ☑☑ROE (1 Stage) = (Net Income / Equity) ROE (2 Stage) = (Net Income / Revenue) * (Revenue / Equity) = Net Profit Margin * Equity Turnover ROE (3 Stage) = (Net Income / Revenue) * (Revenue / Assets) * (Assets / Equity) = Net Profit Margin * Asset Turnover * Financial Leverage (or Equity Multiplier) DuPont Decomposition of ROE (5 Stage) - ☑☑ROE = (Net Income / EBT) * (EBT / EBIT) * (EBIT / Revenue) * (Revenue / Assets) * (Assets / Equity) = tax burden * interest burden * EBIT margin * asset turnover * Financial Leverage (or Equity Multiplier) Free Cash Flow to Firm (FCFF) - ☑☑Cash flow available to debt and equity holders FCFF = Net income + noncash charges + after-tax interest - FC (fixed) investment - WC (working) investment FCFF = CFO + after-tax interest - FC investment Free Cash Flow to Equity (FCFE) - ☑☑Cash flow available to equity holders after meeting obligations of debt holders Can sometimes be used in lieu of dividends to evaluate value of firm FCFE = CFO - FC Investment + net borrowing Impairment of Long-Lived Assets - ☑☑Asset is impaired if market value falls below B/S carrying value IFRS: check for impairment annually US GAAP: Assess when circumstances dictate; apply recoverability test Recoverable Amount - ☑☑Greater of fair value less selling costs (what you can net for it if you sell it) or value in use (PV of future cash flows) Recoverability Test - ☑☑Asset is impaired if sum of undiscounted cash flows is less than carrying value Recovery of Impairment - ☑☑May be recognized under IFRS; not allowed under US GAAP Financial Statement effect of Impairment - ☑☑- Long-lived asset decreases by impairment amount - Income decreases by impairment amount when recognized - Taxes due not affected because tax deductions are not recognized until asset is sold/disposed (unrealized loss) - If DTL for asset exists, reduces DTL to narrow gap between carrying and tax base - cash flows not affected (non-cash) - Depreciation expense in future periods will decrease (reduces depreciable value) Revaluation of Long-Lived Assets - ☑☑US GAAP: prohibited IFRS: allowed if fair market value can be determined reliably Revaluation Up - ☑☑Revaluation up to fair value Goes directly to S/E as revaluation surplus unless they reverse a previous loss on I/S Revaluation Down - ☑☑Revaluation down to fair value Reduces any previous reevaluation surplus first; if no previous surplus exists, go to I/S and recognize as loss Fair Value Model for Investment Property - ☑☑IFRS only; long-lived assets held for rental income or price appreciation FVM is similar to trading securities Carry asset at fair value; recognize gains/losses on I/S Revaluation vs. Fair Value Models - ☑☑If no losses have been recognized, Fair Value model will value asset higher because any gains will be sent to S/E as revaluation surplus under revaluation model Types of Leases - ☑☑Operating Lease Finance Lease (IFRS) / Capital Lease (US GAAP) Finance Leases - ☑☑Treat as if borrowing to purchase asset Treat liability as if amortizing loan IFRS: Finance Lease if rights/risks of ownership transferred to lessee US GAAP: Finance Lease if any of these are met: - Title Transfers at end of lease - Bargain purchase option at end of lease - Lease period is 75% or more of useful life - PV of lease payments if 90% or more of value Operating Leases - ☑☑Treat as if renting the asset Payments are rental expense on I/S Payments are CFO outflows on C/F Finance Lease (B/S) - ☑☑Recognize long-lived asset equal to lower of fair value or PV of lease payments, and recognize a liability equal in value to the long-lived asset Long-term liability has a current portion, same as LT debt Finance Lease (I/S) - ☑☑Depreciation expense on asset and interest expense on liability - greater than lease payments in early years of lease; less than payments in later years Finance Lease (C/F) - ☑☑Payments are part interest (CFO outflow) and part principal (CFF outflow) Interest portion can be classified as CFF under IFRS Cash Flow from Operations (CFO) - ☑☑Transactions from firm's regular business activities CFO (Direct Method) - ☑☑Direct Method: Start with cash from customers; add all other CFO receipts; subtract all CFO payments CFO (Indirect Method) - ☑☑Indirect Method: Start with net income and undo anything that isn't CFO Requires adjusting accruals to a cash basis Sources of Cash - ☑☑Increase in a liability; decrease in an asset Uses of Cash - ☑☑Decrease in a liability; increase in an asset Expensing Asset - ☑☑Cost is an expense on I/S Classified as operating cash outflow Capitalizing Asset - ☑☑Cost is recorded as asset on B/S Classified as an investing cash outflow Expense (depreciation or amortization) on I/S, cost spread over asset's life Effects of Capitalizing vs. Expensing - ☑☑Capitalization: - smooths earnings - Higher NI in current period, lower in later periods - Higher assets and S/E - Increase CFO, decrease CFI Total Debt Ratio - ☑☑Debt / Assets Fixed Asset Turnover Ratio - ☑☑Sales / Fixed Assets Deferred Taxes - ☑☑Result from different accounting rules for financial reporting and tax reporting Income tax expense (fin. reporting) might not always equal taxes payable (tax reporting) If differences are temporary, B/S will reflect DTA or DTL Deferred Tax Examples - ☑☑Accelerated depreciation warranty expense Warranty Expense - ☑☑Recognized over warranty period for fin. reporting, but not actually paid for tax reporting Tax Loss Carryforward - ☑☑Taxable losses from earlier period can be carried forward. Losses can be used to reduce taxable income in subsequent periods. Reduction in future taxes payable is DTA Valuation Allowance - ☑☑DTA reduced for probability that it won't be realized; contra account under US GAAP (DTAs are directly reduced under IFRS; no such thing as valuation allowance) Revenue Recognition LT Projects (Reliable) - ☑☑Firms may recognize revenue and profit for LT projects if outcome can be reliably estimated. Loss (if any), must all be recognized in current period Percentage of Completion (Method) - ☑☑Revenue each period = Total project revenue * percentage of completion - revenue recognized to date Revenue Recognition LT Projects (unreliable) - ☑☑IFRS: Expense costs when incurred, recognize revenue up to costs, no profit until completion US GAAP: Completed contract method; all revenue, expense, and profit at completion Percentage of Completion (Formula) - ☑☑Costs incurred to date / total estimated costs Ending Inventory - ☑☑Beg. Inventory + Purchases - COGS LIFO - ☑☑Last In First Out Is not allowed under IFRS! Choosing an Inventory Costing Method - ☑☑Choose the one that matches flow of physical goods most appropriately LIFO Layer - ☑☑Layer of goods at certain LIFO price FIFO Inventory (calculation) - ☑☑LIFO Inventory + LIFO reserve FIFO Retained Earnings - ☑☑LIFO Retained Earnings + LIFO reserve * (1 - tax rate) FIFO COGS - ☑☑LIFO COGS + Change in LIFO reserve Inventory Preferences for Analysis - ☑☑FIFO values for Inventory LIFO values for COGS These valuations are closer to true replacement cost Accounting for Investment in Securities - ☑☑Trading Securities: - Intended to sell in short term; marked to market each period; unrealized gains/losses reported on I/S Available for Sale: - May sell prior to maturity; marked to market each period; unrealized gains/losses reported on S/E (OCI) Held to Maturity: - Not to be sold; B/S value is amortized cost (unless impaired, then market value) Change in Security Value (Accounting) - ☑☑Realized Gains/Losses, Interest, dividend income always to I/S Accounting for fixed-coupon bond liabilities - ☑☑IFRS: Proceeds - Issuance Costs US GAAP: Proceeds (issuance costs amortized on B/S as asset) YTM when issued will determine interest expense for each period Effective Interest Method - ☑☑Discount or Premium amortized over life of bond, so that at maturity B/S liability will equal face value Follows Constant Yield Price Trajectory Straight Line Method (EIM) - ☑☑Total discount (premium) / #periods Permitted under US GAAP Fair Value Alternative (EIM) - ☑☑IFRS and US GAAP allow reporting liability at fair value; cannot change to another method once selecting (changes I/S value) Effects of Leasing vs. buying Long-Lived Asset - ☑☑Purchase Long Lived Asset: Recognize asset on B/S at original cost Recognize depreciation each period on I/S Cash paid for asset is CFI in purchase period Lease long lived asset (finance lease): Recognize asset & liability on B/S Lower of: PV of payments, fair value Each period: recognize expenses on I/S Depreciation expense on asset; Int. exp on liability Cash paid for lease payments is part CFF (principal repaid) and CFO (interest paid) Finance Lease Liability - ☑☑Treated as an amortizing loan (lease liability and loan liability are the same) Temporary and Permanent Tax Differences - ☑☑Difference between income tax expense and taxes payable DTAs and DTLs are temporary differences and will eventually be reversed Tax-exempt interest income is permanent and will not be reversed Permanent Tax Difference Formula - ☑☑Tax Rate = Income Tax Expense / Pre-Tax Income Aggressive Accounting Decisions - ☑☑Increase current income or improve reported financial position Conservative Accounting Decisions - ☑☑Decrease current income or worsen reported financial position Basic EPS Calculation - ☑☑(Net Income - Preferred Dividends) / Weighted avg. common shares Weighted avg. common shares includes share issuance, share repurchases, stock splits / dividends Diluted EPS Calculation - ☑☑Company must report diluted EPS if they have them Potentially Dilutive Securities - ☑☑Stock Options or Warrants Convertible Bonds Convertible Preferreds Stocks & Warrants (Dilutive EPS) - ☑☑Exercise does not affect earnings to common, but does increase common shares Use Treasury Stock Method: Assume company purchases shares w/ proceeds of options / warrants, and issues new share for the rest, all at average price for the year Convertible Preferred Shares (Dilutive EPS) - ☑☑Conversion affects earnings to common, and increases common shares Test for dilution: Convertible Preferred Dividends / #New Shares if converted Convertible Bonds (Dilutive EPS) - ☑☑Conversion affects earnings to common, and increases common shares Test for Dilution: (Convertible Bond Interest) * (1-tax rate) / #New shares if converted Current Ratio - ☑☑Current Assets / Current Liabilities Net Profit Margin - ☑☑Net Income / Sales Debt to Equity Ratio - ☑☑Total Debt / Shareholder's Equity Effect of Changes in Tax Rate on DTA / DTL - ☑☑Values of DTA / DTL based on tax rate expected when temporary diff. reverses If tax rate decreases, deferring tax good; prepaying bad - DTAs & DTLs both decrease If tax rate increases, deferring