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WEEK ENDING

WK END 1 14-Feb Quantitative Methods

WK END 2 21-Feb

WK END 3 28-Feb

WK END 4 7-Mar Corporate Finance

WK END 5 14-Mar

Financial Reporting & Analysis

STUDY Review QM, FRA, Corp Fin ` Sample test on topic 40% weightage topics done

REVIEW Sample test on topic Sample test on topic

SELF TESTS

MILESTONES References: Topics Weightages How to Forum Analyst notes analyst forum

Topic Areas Ethics/ Professional Standards Quantitative Methods Economics http://www.analystnotes.com/ Financial Statements Analysis http://www.analystforum.com/ Corporate Finance Equity Analysis Investopedia Exam http://www.investopedia.com/professionals/cfa/default.asp?viewed=1 Fixed Income Derivatives Diff. 2009, 2010 http://www.finquiz.com/tips/level1 Alternative Investments Portfolio Management 2 Mid Term Tests 2 Full Length Tests Total

http://www.cfainstitute.org/cfaprog/courseofstudy/topic.html http://finguru.in/web/level1.php http://www.ehow.com/how_4702731_pass-cfa-level-exam.html

WK END 6 21-Mar Equity Investments

WK END 7 28-Mar Fixed Income

WK END 8 4-Apr Economics

WK END 9 11-Apr

WK END 10 18-Apr Derivatives Ethical & Professional Standards

WK END 11 25-Apr Portofolio Managem ent & Alternative Wealth Investmen Planning ts

Review EQ Inv, FI, Economics

Sample test on topic

Sample test on topic

Sample test on topic 72% weightage topics done

Sample test on topic

Sample test on topic

% weightage pics done Level I

pic Areas cs/ Professional Standards antitative Methods nomics ancial Statements Analysis porate Finance uity Analysis ed Income ivatives rnative Investments tfolio Management id Term Tests ull Length Tests al

Exam Weights Approx. Hours 15% 8 12% 24 10% 24 20% 45 8% 10 10% 16 12% 21 5% 18 3% 6 5% 6 50% Each 8 100% Each 12 100% 198

Done? 100% 60% 100% 100%

OVERALL ST PREPARATION STAR TARGET DATE TO F WEEKS REMAINING TO F DAYS REMAINING TO F DAYS GON % EXPECTED % ACTUAL

100%

51%

WK END 12 2-May

WK END 13 9-May

WK END 14 16-May

WK END 15 23-May

WK END 16 30-May

WK END 17 6-Jun

Review QM, FRA, Corp Fin,

Review EQ Inv, FI, AI, Derivatives

Review Economics, Ethics, PM

Review heavy weights and weak areas

Sample test on topic 100% topics done

CFA inst. Sample test

CFA inst. Sample test

CFA inst. Sample test

CFA inst. Sample test

D DAY

OVERALL STATUS PREPARATION START DAY TARGET DATE TO FINISH WEEKS REMAINING TO FINISH DAYS REMAINING TO FINISH DAYS GONE BY % EXPECTED DONE % ACTUAL DONE

AMBER 9-Feb 2-May 0 0 1214 100.00% 88.51%

Remaining readings per day

#DIV/0!

SUMMARY Suggested Study Session Topic time 1 30.0

245 Hours' Dist

TOPICS Ethical and Professional Standards (15%) 1 Code of Ethics and Standards of Professional Conduct 2 Guidance for Standards IVII 3 Introduction to the Global Investment Performance Standards 4 Global Investment Performance Standards (GIPS) Portfolio Management and Wealth Planning (5%) 72 asset allocation decision 73 introduction to portfolio management 74 asset pricing models Equity Investments (10%) 49 organisation and functioning of securities markets 50 security market indexes

Session 1 2 12.0

7.5 7.5 7.5 7.5

Session 12

2.0 2.0 2.0 20.0 3.0 3.0

51 efficient capital markets 52 market efficiency and anomalies* 53 54 55 56


introduction to security valuation* industry analysis* company analysis and stock valuation* introduction to price multiples*

Session 13

3.0 3.0 3.0 3.0 3.0 3.0 12.0 2.0 2.0 2.0 2.0 2.0 30.0

Session 14

Corporate Finance (8%) 44 capital budgeting 45 cost of capital 46 working capital management 47 financial statement analysis 48 corporate governance of listed companies Fixed Income (12%)

Session 11

57 features of debt securities 58 59 60 61 62 63


risks associated with investing in bonds overview of bond sectors and instruments understanding yield spreads introduction to valuation of debt securities yield measures, spot rates and forward rates measurement of interest rate risk

5.0 5.0 5.0 5.0 5.0 5.0 5.0 10.0 3.0


Session 18

Session 15

Session 16

Alternative Investments (5%) 70 Types of Alternative Investments and their Characteristics

71 Commodities Financial Reporting and Analysis (20%) 7

Session 18

3.0 60.0

29 financial statement analysis 30 financial reporting mechanics 31 financial reporting standards 32 understanding income statement 33 understanding balance sheet 34 35 36 37 38 39 40 41 42 43
understanding cashflow statement inventories long-lived assets income taxes long-term liabilities and leases financial analysis techniques financial reporting quality: red flags and accounting warning signs accounting shenanigans on the cashflow statement financial statement analysis: applications international standards convergence

Session 7

4.0 4.0 4.0 4.0 4.0

Session 8

Session 9

Session 10

4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 30.0 4.0 4.0 4.0 4.0

Quantitative Methods (12%) 5 Time Value of Money 6 Discounted Cash Flow Applications 7 Statistical Concepts and Market Returns 8 Probability Concepts

Session 2

9 Probability Distributions 10 Sampling and Estimation

4.0 4.0

11 Hypothesis Testing 12 Technical Analysis Derivatives (5%) 64 Derivative markets and Instruments 65 Forward Markets and Instruments 9

Session 3

4.0 4.0 18.0 3.0 3.0

Session 17

66 67 68 69

Futures Markets and Instruments Options Markets and Instruments Swaps Markets and Instruments Risk amangement applications of option strategies

Session 17

3.0 3.0 3.0 3.0 50.0 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5

Economics (10%) 13 elasticity 14 efficiency and equity 15 markets in action 16 organising production 17 output and costs 18 Perfect Competition 19 Monopoly 20 Monopolistic competition and oligopoly 21 Markets for factors of production 22 Monitoring jobs and price level 23 aggregate supply and aggregate demand 24 money, price level and inflation 25 us inflation, unemployment and business cycles 26 fiscal policy 27 monetary policy 28 overview of central banks

10

Session 4

Session 5

Session 6

88.51%

64.5 Revision Effort 4.0

7.58%

0.00%

% DONE

Consolidati on Revision 10-may%

Hit rate

100.00% 100.00% 100.00% 100.00% 4.0 100.00% 100.00% 100.00% 8.0 100.00% 100.00% 11-may% 10-may%

82.00% 82.00% 82.00% 75.00%

100.00% 100.00% 100.00% 100.00% 100.00% 80.00% 4.0 100.00% 100.00% 100.00% 100.00% 100.00% 6.0 13-may% 12-may%

100.00% 100.00% 100.00% 100.00% 100.00%

2.0 100.00%

14-may%

100.00% 15.0 9-may%

100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 90.00% 90.00% 90.00% 100.00% 100.00% 100.00% 100.00%

0.5 0.5 0.5

100.00% 88.00% 75.00% 75.00% 70.00% 90.00%

70.00%

100.00% 100.00% 100.00% 100.00%

100.00% 100.00% 100.00% 100.00%

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100.00% 100.00% 5.0 100.00% 100.00%

8-may% 15-may%

100.00% 100.00% 100.00% 100.00% 15.0 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 16-17may

Key things to remember

book/market value ratio? Ways to reduce transaction costs: trading turnover, liquidity costs

impact of Retention on stock price, EPS and dividend P1

repeat after reviewing FSA CF ratios

treasury bonds have semi-annual coupons zero-coupon bond is also valued using semi-annual discounting remember to double the IRR calculated to get YTM (or BEY) of a semi-annual paid bond

- difference between qualified, unqualified and adverse opinion - diff between footnotes, MDA, proxy statements spg:39 double-declining balance, EPS calcs: options, weightedshares SPG124:Q23 how is unrealized gain included in net income? Q3

redo once

annuity begin/end timelines

- remember to do 1-p wherever appropriateoptions will always have a 'p' - don't apply std. dev. Approximations, instead use Z-table - difference between confidence interval for a population and for a sample - shortfall risk interpretation of confidence interval: spg282 std. deviation v/s variance - alpha/2 only when two-tailed test i.e. equal to test - usage of sample v/s hypothesized statistic - type 1, 2 error, p value, power of test - chi-squared, f-test, paired comparison and diff. of means tests

Revision Guide SPG75: 7, 15, 18, 19, 21, 32, 40, 44, 49. 50 BPG125: 2, 8, 10, 13, 14, 16, 21, 27, 29, 32, 33

spg75: 3, 7, 10, 11, 18 spg96:3,4,5, 13 25 all questions all questions all questions all questions all questions all questions all questions all questions

SPG142: time-weighted RoR SPG147: BEY Calculation, SPG150| 2, 3, 9 spg169: quartile calc; spg180; spg188:2,4,

spg268: q28, q3A; spg 292:q22; q3

spg331:q18; spg333:q1,2,3 spg347: all

12-May 13-May 14-May 15-May 16-May 17-May 18-May 19-May 20-May 21-May 22-May wed thu fri sat sun mon tue wed thu fri sat revision 1 FSA Quant. FSA portfolio mgmt Ethics PM equities corp fin. alternative inv. fixed income economics TEST 1

revision 2

tue 9 12 3 6 10 12 3 6 10 2

wed thu fsa qf cf, pm, equities ethics fi, der econ que que ai + que sch1 cfa2

fri

sat

sch2

23-May 24-May 25-May 26-May 27-May 28-May 29-May 30-May 31-May 1-Jun 2-Jun sun mon tue wed thu fri sat sun mon tue wed revision 2 revision 3

revision 4

EQUITIES CORP FIN Alternative Fixed Inc Econ. TEST2 weights 15.00% 11.67% 10.00% 20.00% 8.33% 10.00% 5.00% 10.00% 5.00% 5.00% ### test1 55.56% 64.29% 41.67% 66.67% 60.00% 75.00% 66.67% 66.67% 33.33% ### 62.98% TEST3

ethics qf econ fsa cf equities deriv fi ai pm

55->70

3-Jun thu

4-Jun 5-Jun 6-Jun fri sat sun revision 4

FEATURES OF DEBT SECURITIES (1 Bond indenture: contract, rights, obligations Covenants: prohibitions (negative) and promises (affirmative) Negative covenants examples: restriction on sale of collateral same collateral backing multiple bonds additional borrowings Affirmative Covenants examples: maintenance of certain financial ratios

Zero-coupan bonds sold at discount to par value Step-up notes coupan rates increase over time at a specified rate Deferred coupan bonds initial coupans are deferred for specified period Coupans accrue, paid as lumpsum at period end

Almost all treasury bonds and US corporate bonds pay two semiannual coupan installments Debentures are unsecured whereas bonds have some collateral that's kept asside Options granted to bondholder (lender) Sinking fund provisions favours buyer, lower coupan therefore provide for principal repayment through are valued higher => lower yield as compared to a series of payments over issue life other non-option bonds (other things same) e.g. $1M starting 6th year for a $15M loan Conversion option: right to convert bonds into for 20 years fixed number of shares Put provisions: right to sell the bond to issuer at Example: Q10,11 pg 21 a specified price prior to maturity Floor: minimum coupan rate for a floating-rate bond

RISKS ASSOCIATED WITH INVESTING IN BONDS (24 -

Interest risk: when interest rates increase, bond prices decrease interest rate risk, sensitivity and duration are used interchangeably Yield curve risk: pertains to a non-parallel shift of yeild curve induced by the fact that maturity differences may also contribute to Yield differences Call risk: when interest rates are volatile, bonds have more risk in terms of them being called and hence the risk Prepayment risk: Reinvestment risk: as market rates fall, coupans will have to be re-invested at a lower %. Call/prepayment can also induce re-investment risk as principal received will have to be invested at lesser % Zero-coupan bond doestn' have re-investment risk Volatility risk: for bonds having options Changes in interest rates will cause yield curve indicating Interest Rate risk Inflation risk: reduction in purchasing power of coupans/principal Event (natual disaster), credit, liquidity, exchange rate risks are other risks Non-parallel shift happens because long-term in Soverign risk: ability and willingness of governments to repay debt higher yield because of changing policies As coupan rate of a floating rate secur Relationship between price of a callable bond, price is less sensitive to interest rate ch price of an option-free bond, price of an embedded call option compared to fixed-coupan bond. callable bond value = option-free bond value -- call option value Price will be back to par at every reset.

putable bond value = option-free bond value + put option value

However, greater the reset period, high rate risk. Presence of a cap increases Interest Ra as price would start fluctuating beyo

price-yield curve is positively convex towards origin => + price less, than -ve yield will increase price. This is g another interpretation is that as yield increases, prices d similarly, as yields decrease prices increase at a fas

In case of a callable bond, beyond certain point, as yield at a lesser rate (because of negative convexity)th to the call price, higher is the call probability. Another way to look at this is, as price of a callable bond more like a noncallable bond Only at lower yields, curve shows -ve convexity

OVERVIEW OF BOND SECTOR AND INSTRUMENTS (PG 45 Four methods to issue sovereign debt; Treasury bond, note prices are quoted as: 1 regular cycle auction - single price 102-5 of face value => (102+5/32)% of FV highest price at which entire auction can be sold T-bills are zero coupan bonds (short-term) 2 regular cycle auction - mult. price Treasury Inflation Protected Securities (TIPS) winning bidders get it at the price they bid Coupon = inflation adjusted par value X coupan rate / 2 3 ad hoc auction system continous change of par, updated par used to calc. next coupon auction when conditions are in favour of govt. at maturity inflation adjusted face value is given back On-the-run issues: most recently auctioned treasury issues 4 tap system based on previous issuances of bonds Off-the-run issues: that have been replaced with recently auctioned treasury issues Agency bonds: issued by US Govt. agencies. Those owned by Govt. are free from Credit Risk Govt. sponsored enterprises are privately owned (SallieMae, FreddieMac, FannieMae) and have some credit risk Corporate bond issues: are sold at once are sold on firm-commitment basis i.e. underwriter guarantees entire issue sale have a single coupon rate and maturity Medium term Notes (MTN) differ from corporate bonds on all three can be sold over a period of time with each issue being a minimum amount have maturity ranges, can have different coupan rates offering is done on a best-effort basis Structured notes: bond combined with a derivative step-up notes inverse floaters deleveraged floaters dual-indexed floaters range notes index amortizing notes CDs:

1 2 3 4 5 6

Negotiable CDs;

Banker's acceptan

Commercial paper: short term (<270) unsecured debt, free from SEC registration issued as a pure discount security by corp. having strong credit r no active secondary market and are hold till maturity

UNDERSTANDING YIELD SPREADS (PG 67 Theories of term structure of interest rates: Pure Expectations theory: yield of a particular maturity is an average of short-term rates expected in future If short-term rates are expected to rise in future, interest rate

FED manages short-term rates by: 1 tweaking discount rates at which banks borrow 2 buying/selling Treasury securities in market 3 tweaking reserve rates at which banks must par

yields on longer maturity will be higher as compared to short-term therefore, the yield curve will be upward sloping Liquidity preference theory: investors require risk premium for holding longer term bonds measured with Liquidity premium Market segmentation theory: supply (willingness to borrow) and demand (willingness to lend) determines equilibrium yields for various long/short term maturities Preferred habitat theory: follows market segmentation thoery with an addition that investors can be moved from their preferred maturity/yield range if yield is sufficiently higher VALUATION OF DEBT SECURITIES (PG 84 Steps to valuation: estimate cashflows determine appropriate spot discount rates calculate PV of all CFs Problems in estimating cashflows: unpredictable principal repayment streams coupon payments are not certain for FRNs, default risk bond is convertible, has an option yield on a risky bond = yeild on default-free bond + risk premium

4 persuading banks to alter their lending policies

Spot rates, YTM: YTM = IRR for a bond incase of semi-annual bond, YTM = 2 X IRR as spot rate = appropriate discount rate to calculate individual future payment a number of spot-rates (one for each coupan an are used therefore to compute PV/price of the b From YTM, you can calculate bond's current pric Q. 8, pg- 80

if YTM = coupon rate, bond is selling at par zero coupon bonds are always valued using semi-annual discount rates and semi-annual discounting spot rates are always annual i.e. a 6-month spot rate of 7% would mean that a zero coupon bond after 6-month will yeild 7/2 = 3.5% Bonds in general are paid semi-annually so semi-annual rates = YTM/2 should be used

BEY, EAY Description Bond-equivalent Yield assumes 6-monthly coupons. So it can be seen as semi-annual YTM However, if bond is paid annually, (1+BEY/2) = SQRT(1+ annual YTM) EAY - effective annual yield of an annually paid bond = annual YTM for semi-annually paid bond, (1+EAY) = SQUARE(1+BEY/2) YIELD MEASURES, SPOT RATES, AND FORWARD RATES Current yield: looks only at annual interest income ALL RATES NEED TO BE ANNUALIZED AFTER = annual coupon payment / current bond price COMPUTATION. = [par value* stated coupon rate ] / current bond price SIMILARLY, ALL RATES NEED TO BE REDUCED, since current yield is based on annual interest income IN CASE OF SEMI-ANNUAL PAYMENTS current yield is same for semi-annual/annual bond EXCEPT FOR SEMI-ANNUAL DISCOUNT RATE YTC, YTP are calculated with call/put price as FV and first opportunity to call as maturity date YTC < YTM, when bond is selling at a premium to call price, hence it is used as true yeild YTP > YTM when bond is selling at a discount to put price, hence used as true yield Yield to Refunding is used in situation where bond is in Reinvestment income: callable price range however, and refunding isn't = compounded return - (capital gain + coupon) allowed till a future date YTR uses call price and first callable date when refunding Bootstrapping process protection ends Limitations of YTM, YTC, YTP assumes coupon re-investment at YTM doesn't account for re-investment risk

MEASUREMENT OF INTEREST RATE RISKS

price sensitivity of an embedded op is lesser than that of an option-

Effective Duration =

effective duration will be positive. If change in price = -- effective du an increase in yield will cau

Floating rate securities coupan rate varies as reference rate changes reference rate(LIBOR) + margin Inverse floater coupan rate = X - Reference rate(LIBOR) Inflation-indexed bonds coupan = X + CPI Floating rate securities with cap, floor, collar

Full (dirty) Price includes accrued interest Full Price = Clean Price + Accrued interest Cum coupan -> with right to next coupan Ex coupan -> without right to next coupan If issuer is in default, bond will trade without accrued interest

red for specified period s lumpsum at period end

Options to issuer (borrower) favours issuer, higher coupan therefore are valued lower => higher yield as compared to other non-option bonds (other things same) Prepayment options: just like loans no fixed payment schedule though Call option: right to buy issue at a specified price prior to maturity Accelerated sinking fund provisions Caps: maximum on coupan rate for floating rate bond

Cap is equivalent to a series of interest rate call options Floor is equivalent to a series of interest rate put options

Margin buying from a broker/bank with Is regulated by SEC in term

Repurchase agreement arrangement when an instit it back at a specified (h (buying price - selling price repo rate = annualized % d Most of the bond financin repo rate < bank rate in lesser risk to lender be not regulated by Fed

rates will cause yield curve to shift parallely

ppens because long-term investments may require

rate of a floating rate security changes sensitive to interest rate changes as ed to fixed-coupan bond. back to par at every reset.

Disadvantages of callable or prepayable security 1 uncertainty about cashflow timings as it could be called 2 calling, prepayment is more probable with declining interest rates 3 more principal is returned when there are lesser exciting reinvestment opps.

reater the reset period, higher the interest

4 because of lesser sensitivity to interest rates, prices appreciate less

Liquidity risk: 1 investor wants higher yield in case of lesser liquidity 2 lesser liquidity also increases bid-ask spread 3 because securities are used as collateral, MTM y convex towards origin => +ve yield change will reduce becomes a challenge in case of lesser liquidity will increase price. This is good for bond holders 4 lower valuation can lead to higher cost of capital as yield increases, prices decrease at a lesser rate ease prices increase at a faster rate Yield Volatility risk: Higher yield volatility eyond certain point, as yield decreases, price increase 1 => more call probability => lesser price lender will be willign to pay for a callable b e of negative convexity)this is because closer it gets 2 => more put probability =>higher price lender will be willing to pay for a putable b s the call probability. More re-investment risk when: s, as price of a callable bond is very less, it behaves coupon is higher it has call feature ve shows -ve convexity it is an amortizing security contains prepayment option

f a cap increases Interest Rate risk would start fluctuating beyond cap

Since US Govt. doesn't issue 0-coupon notes/bonds CMO (Collateralized Mortgage Obligatiosn) Investment bankers create strips derived from mortgage passthru certs. Coupan Strips: strips created from coupan Tranche I: receives interest and all principal Principal Strips: strips created from prinicipal payments until it is completely paid off ue X coupan rate / 2 payment stripped from original security Tranche II: receives interest till TrancheI is ar used to calc. next coupon Strips sold as zero-coupon bonds completely paid off, beyond that all princ. ue is given back payments till it is completely paid ned treasury issues FredieMac,FanieMae issue 3 types of MBS: Tranche III: only interest till Tranche II is ced with recently mortgage passthrough paid. Beyond that all princ. CMO AND stripped MBS payments till it is completely paid Mortgage passthrough security: Tranche 1 has lesser expected maturity ve some credit risk all payments are passed through to investors Tranche 3 has lesser prepayment risk interest, prepayment, closures CDs: Asset backed securities issued in specific denom. SPV - separate legal entity to which corporate legally for a specified period sells financial assets for an ABS issue insured by FDIC upto 100,000 ABS therefore don't have Bankruptcy risk Negotiable CDs; Motivation of ABS is to reduce borrowing costs can be sold in secondary market External credit enhancements: Banker's acceptances: Corporate guarantee guarantee by a bank that a loan will be paid Bank letter typically used in cross-border trades Bond insurance

y corp. having strong credit ratings hold till maturity Absolute yield spread = yield on higher yeild bond - yield on lower yield bond Relative yield spread = absolute yield spread / yield on benchmark bond

rm rates by: ates at which banks borrow from FED ury securities in market tes at which banks must park their funds with FED

Impact of embedded o All else same, inve

o alter their lending policies

Yield ratio = subject bond yield / yield on benchmark bond Credit spread: is yield spread between two bonds that are equal in all al bond, YTM = 2 X IRR as such needs to be annualized respect except credit ratings ate discount rate to calculate PV of After Tax Yield = (1 - tax rate) * taxable yield tes (one for each coupan and payback) o compute PV/price of the bond lculate bond's current price and vice-versa

All else same, borr

Liquidity impact:

ould mean that th will yeild 7/2 = 3.5%

Valuation approaches: Traditional approach get YTM of a bond sim use this YTM as a disc Arbitrage-free valuation a discount each CF using these discount rates ar zero-coupon bonds It says all else equal, v all parts. If this is n

3 sources of returns if bo coupon interest payme recovery of principal, a re-investment income

Regardless of required yield, bond price will converge to par value as Maturity approaches Nominal spread = YTMbon UALIZED AFTER If its selling at discount, bond price will increase as maturity approaches to par value zero volatility spread: (Z-s TO BE REDUCED, yearly spot rates on treasur because we are not tak DISCOUNT RATE spread on top of local s

Steeper spot rate curve

tal gain + coupon)

The earlier bond princip A callable bond has hig and therefore, a hig Option-adjusted Sprea if it were option-fre t=0 t=.5 t=1 t=1.5 t=2 t=2.5 t=3 t=3.5

First Call value = 102

refunding protection ends

YTC would use N=4 (2*2); FV = 102. YTC to be calculated only when bond is trading at permium YTR (yeild to refunding) calculated when bond is currently callable but can't be refunded because of p assuming price is beyond 102, in that case, FV = call price, N = time left for refunding protection

nsitivity of an embedded option bond (w.r.t. interest rates) esser than that of an option-free bond

e Duration =

e duration will be positive. If you want to compute change in prices, it would be as follows: nge in price = -- effective duration * (change in yield) an increase in yield will cause decrease in price

Call provisions give issuer a right to call the bond call protection i..e period before which bond can't be called After the call period, bond is currently callable Bond with call option have higher coupan Non refundable bonds can't be called

ccrued interest

next coupan o next coupan

Margin buying involves borrowing funds for buying securities from a broker/bank with securities as collateral Is regulated by SEC in terms of % of bond values. Repurchase agreement: arrangement when an institution sells a security with a commitment to buy it back at a specified (higher) price (buying price - selling price) accounts for the interest (repo rate) charged by the lender (buyer) repo rate = annualized % difference between buying and selling price Most of the bond financing is done via repurchase agreements as: repo rate < bank rate in case of margin loan lesser risk to lender because he owns security as against having a claim on collateral not regulated by Fed

Interest rate risk, duration, sensitivity All rest equal, a bond having longer maturity will have higher % change in value for a given change in interest rates This is because of the intrinsic value i.e. PVcoupon+PVprincipal at the market rate of interest Siimilarly, bond having higher coupan will have lesser % change in price with a given change in interest rates this is because of the "size of change w.r.t. Bond's interest rate"

nterest rates Only Maturity increases Duration (ie. Interest rate risk) ing reinvestment opps. value of option bonds is less sensitive as they have a price limit

appreciate less

Duration = -- (% change in bond price) (% change in yield) this isn't % of percent Duration of a zero coupan bond is approximately equal to its years to maturity Duration of a floater is equal to fraction of an year till the next reset date Duration of a portfolio is Market-Weighted average of individual bond's duration

willign to pay for a callable bond willing to pay for a putable bond

that all princ.

Stripped MBS either principal-only (PO) or interest-only strip (IO) PO strips gain with prepayment as face value is received before maturity IO strips lose with prepayment as lesser interest is paid because of lesser principal outstanding Municipal bonds: GO (general obligation) bonds: backed by taxing power of issuer Revenue bonds: backed by revenue generated by project Prefunded bonds: bonds for which treasury securities have been bought and parked in escrow account. Amount sufficient to pay for bonds CFs secured debt, unsecured debt, senior debt, subordinated debt CDO (collateralized debt obligation): collateral is an underlying pool of other debt instruments Tranches are created based on claim seniority of CFs from these instruments

Impact of embedded options on yield spreads All else same, investors would require higher yield on a callable bond this is because of the calling option available to borrower should bond price go above strike price thereby benefitting the borrower

All else same, borrowers would be give lower yield on a putable bond this is because of the put option available to investor should bond price go down below strike price thereby benefitting the investor Liquidity impact: less liquid the bond is, higher the yield required would be

Valuation approaches: Traditional approach get YTM of a bond similar in terms of risks, maturity characteristics use this YTM as a discount rate to discount coupon, principal CFs Arbitrage-free valuation approach discount each CF using a Discount Rate specific to maturity of that CF these discount rates are called Spot Rates and are actually YTM rates of zero-coupon bonds having same maturity as the CF under valuation It says all else equal, value of T-bond based on spot rates must be equal to the PV of all parts. If this is not the case, there is an arbitrage opportunity 3 sources of returns if bond is held yntill maturity: coupon interest payments recovery of principal, alongwith any capital gain re-investment income

Nominal spread = YTMbond - YTMtreasurybond zero volatility spread: (Z-spread) yearly spot rates on treasury are not the right rates to measure value of a risky bond because we are not taking into account the risk premium. Z-spread is that constant spread on top of local spot rates, for which PV = sum of discounted cashflows Steeper spot rate curve is, higher the difference between nominal spread and z-spread The earlier bond principal is paid, higher the spreads. A callable bond has higher yield as compared to an option-free bond and therefore, a higher nominal or z-spread Option-adjusted Spread (OAS) is spread w.r.t. Treasury bond that the bond will have if it were option-free

rotection ends

d is trading at permium n't be refunded because of protection eft for refunding protection

ORGANISING AND FUNCTIONING OF SECURITIES MARKETS (PG 153) Characteristics of well functioning securities markes: Primary/Secondary markets Call and continuous markets timely and accurate information IB provide competitive bids, best efforts, negotiations Call markets: stock traded only at specifc times liquidity 3rd markets: OTC markets Continuous markets: trades occur anytime market is open internal efficiency - low transaction costs prices are set either by auction process or dealer bid/ask quotes 4th markets(ECNs): serve retail brokers and institutional traders informational efficiency - prices adjust rapidly to new info. these n/ws match large buy and sell orders Short-sell rules: Uptick rule short seller must pay all dividends due to lender of security short seller must deposit collateral to guarantee eventual repurchases of security

Initial Margin: % money investor should initially have in the account Maintenance margin: % money investor should have in the account post purchase trigger price = Po (1 - initial margin)/ (1 - maintenance margin) Broker starts with "1-initial margin" contribution and doesn't want to go beyond "1-maintenance margin"

Exchange membership specialist: controls the limit order books, posts bid/ask prices, trades for his own account commission broker: executes customer trades for a brokerage firm floor broker: act as freelancer brokers for other commission brokers registered trader: trade for their own accounts

Types of orders Market orders: buy/sell at best avl. Price immediately Limit orders: buy at a price lesser than current; sell at a price above current timeframe associated with order Short sale orders: sell now and buy later Stop loss orders: order to sell if price hits a lower val. order to buy if price hits a higher val. stoploss buy in general results from short-sell

SECURITY MARKET INDEXES Price-weighted index Market Value-weighted index Average of current stock prices Sum of (total outstanding value of stocks) In case of stock-split, denominator is divided by a similar sum calculated at base period adjusted while keeping index value same Multiplied by index's base value (100) firm having higher price has higher impact firm having greater market cap has greater impact on the mkt. All index returns exclude dividends = (Current index value / base value)*100 it is not average of current index value Total return index assumes re-investment of dividend PRICE->VALUE->RETURN EFFICIENT CAPITAL MARKETS (PG 178 ) Efficient market => current prices reflect all info. Avl. Including risk stock prices adjust quickly+completely to new info. Efficient market assumptions large no. of people analysing, valuing securities independenly new info. comes randomly and independently investors adjust prices rapidly in response to information expected returns implicitly incldues Risk involved No assumption around correctness of adjustment

Unweighted index or equal weighted index Based on % returns, working on % price changes Change in value of index can be calculated as: Arithmetic mean: Xi / n where Xi = return Geometric mean:

Source and Direction of Bias Price-weighted bias: larger high-growth firms have an advantage over small low growth firms as they can split their stocks. As a result, low growth firms will lose weight Value-weighted bias: firms having larger market cap have greater impact on the index Unweighted/equal weighted index: usage of Geometric Mean will cause a downward bias as compared to Arithmetic Mean

where Xi = (1 + HPR) = Pricet+1 / Pricet Bond Indexes: more difficult as 1. bond universe is much broader, changes constantly due to wide variety of new issues New index price = Old index price + change in index value bond maturities, calls and sinking funds, 3.. Lack of continuous data

Forms of Efficient market hypothesis (EMH): Weak-form: prices fully reflect all currently available security market information .=> No excess returns by technical analysis Semi-strong form: prices fully reflect all publicly avaliable security market information .=> No excess returns by Fundamenta/technical analysis Strong-form: prices fully reflect all public/private avaliable security market information .=> no group has availability of monopolistic information and therefore, no-one can have abnormal excess returns

Weak-form test of EMH: statistical tests for independence over time returns are not significantly correlated over time stock price changes are independent over time Trading rule tests: mechanical rules based on price data don't earn abnormal results taking transaction costs into accnt. doesn't out-perform buy-and-hold on a risk-adjusted basis

Market anamolies refuting EMH Earning surprises to predict returns: markets haven't adjusted stock prices to reflect earnings surprises as fast as would have been expected by semi-strong EMH Calendar studies: Due to tax-induced trading at year-end, an investor can benefit by buying stocks at year-end and selling them in first week Weekend-effect shows that av. Returns for weekdays is +ve but -ve return is associated with Friday close to Monday open P/E ratios: low P/E ratio stocks experience higher returns relative to market while higher P/E have inferior returns

Small-firm effect: small firms consistently earn larger risk-adjusted returns than larger firms Neglected firm effect: firms that have only small no. of analysts following them have abnormally high returns Book value/Market value ratios: greater the ratio of book/market value, lower the return

Overall Conclusion on EMH After incorporating transaction costs, simple trading rules can't generate abnormal returns Hence, results support weak-form EMH Mixed results for semi-strong form: event studies strongly support SS EMH time-series, cross sectional tests give evidence that markets are not always efficient Apart for Insiders and Specialists results support Strong-form EMH

Semi-strong form test of EMH Strong-form test of EMH: emphasis on finding if abnormal results possible No group of investors have access to 1 unadjusted -> Ractual - Rmkt private information that would allow 2 risk adjusted -> Ractual - [RFR + (Rmkt - RFR)] group to consistently earn abnormal returns Time-series tests: is it possible to predict It assumes that all info is free and is avl. To all at the same time abnormal long-term returns over time Tests indicate that Insider Traders Event studies is it possible to derive abnormal have made abnormal profits returns done after announcement of signification public information As exchange specialists have access to Cross-sectional tests is it possible to predict limit orders, they have managed to earn abnormal returns based on analysing crossabove-average returns sectional data like P/E, dividend yield etc. Security analysts have managed to asume that markets are efficient and security's influence markets returns lie around SML Professional money managers "have not" managed to match performance of simple Conclusions; buy-and-hold policy Performance should be measured against a buy-and-hold strategy of stocks within same riskclass As it may be possible to make above-average retuns by selecting small cap firms, high book/market value so selecting appropriate fund manager can help Invest in Index funds

Behavioral Finance Overconfidence bias: Expected utility theory: decisions are made only on the basis of possible outcomes and risk involved analysts have been found to be over-confident Prospect theory: individuals rank risky outcomes based on where the outcome lies w.r.t. some w.r.t. growth compaines reference point (.e.g. initial wealth) they over-emphasize good news Motivation for prospect theory is a finding that individuals are: downplay bad news risk averse when it comes to gains prefer risk when faced with uncertain losses MARKET EFFICIENCY AND ANAMOLIES (PG 193 ) 3 limitations to efficient markets: processing information takes time and cost if prices adjust within hours, market is efficient otherwise not smarter, efficient analysts are compensated as they evaluate information and fundamentals fast enough inefficient prices may persist because of transaction costs because of higher short-sell transaction costs, stocks can remain more overvalued as compared to undervalued stocks as creation of long position has low transaction costs arbitrage may not necessarily bring efficient prices think about a short-company who is taken over at a higher price

Confirmation bias: People seek out information after making a decision and avoid/ignore new info. That questions that decision This can extend to prior beliefs

Escalation bias tendency of investors to commit more funds to a position that has gone down - called "Averaging" To agree that original analysis was flawed is generally downplayed in favour of more-compelling buy And this makes them average too often, escalating their positions

Four problems that prevent arbitrageurs correct prices there isn't any guarantee around when (if at all) mispricings will be corrected No two securities have exact same risk They have limited funds. This means only more significant pricing differences are exploited while others are allowed to persist Capital providers may place limits on arbitrage trades Reasons why a price misfit

Reasons for Justified anamolies a. small firms are persistently under-priced OR firm's may not include some risk associated with firm's size this would lead to CAPM projecting lesser risk and return b. Strategy risk: if strategy is based on 20 yr returns, abnormal results may be possible in only a few of them

Bias in abnormal returns estimation data mining bias: statistical errors can impact return estimations Survivorship bias Sample selection bias Small sample bias non synchronous trading

Introduction to security valuation and industry analysis (PG 203 ) valuation techniques preferred yield is lesser than highest grade bonds yields based on PV of future cashflows based on some multiple of firm's expected perf. e.g. EPS, Sales per share

General Calculator guidelines always read all the options especially in subjective questions use exclusion in subjective questions exclude carefully.revisit exclusion in case of confusion convert to positive statementsleast likely -> most likely. E.g least likely incorrect => most likely correct give such questions more time to reflect carefully! in case of most-likely, least likely.use categorization if not too clear on the right option

Quant whenever multiple interest rates, confusing (end/begin) timelines, draw timeline be careful about the payment durations - in case of monthly, quarterly, semi-annual payments adjust N and I/Y accordingly. Si be careful around when cashflows happen - begin or end of a time Annuity Due is greater than normal annuity Calculating compounded annual growth rate: should consider only the final and initial revenue PV/FV calculations follow additivity principle i.e. PV of cashflows = sum of PV of individual cashflows degree of confidence, significance leve, degree of freedom hypothesis testing: sample statistic, hypothesized value

FSA

movement from one asset account to another doesn't impact total asset size diff. between trading and avl. For sale securities is how they handle unrealized gains/loss. AFS->other comprehens

SEEK APPROXIMATION IN DATA INTENSIVE QUESTIONS especially around covariance and all - TRY SOLVING W/O CAL BE CAREFUL ABOUT STRAIGHT CHOICESMOSTLY THOSE WILL BE INCORRECT DON'T AVOID CHOICES THAT HAS WORDS WHICH YOU DON'T RELATE TOTHOSE COULD BE OTHER WAY OF PUT

Fixed income while computing IRR of a semi-annual bond: YTM = 2 x IRR

ETHICS keep underlining controversial statements, keywords, anything that sounds fishy in first reading Goodness check: good for profession, good for markets, good for clients, good for empnoyers Hurt check: who does it hurt: profession, markets, clients, employers, beneficiaries Look for outside favours, conflicts, trade of one thing against other catch words like BUT, HOWEVER, MANIPULATED

Calculator guidelines Everytime you set calc to BEGIN, set it back to END after calc. Regularly clear the worksheets I/Y is period interest in percentage. be careful about the payment durations - in case of monthly, quarterly, semi-annual payments adjust N and I/Y accordingly. Si redo calculations in case the computed value differs significantly with any of the choiceschances are that the data hasn't bee above is true for questions that has too many data points entering 8% instead of .08 for cashflow/interests in TVM

adjust N and I/Y accordingly. Similarly, adjust those if computed based on the payments made Mistake types: most/least likely concepts/knowledge trick calculation completeness carelessness fatigue language issue

1 2 3 4 5 6 7

ns/loss. AFS->other comprehensive income TS -> income

Whernever there are 3 continuous corrects, re Mark questions with doubtful responses in 1st

nd all - TRY SOLVING W/O CALCULATOR

OULD BE OTHER WAY OF PUTTING IT

first reading

N and I/Y accordingly. Similarly, adjust those if computed based on the payments made re that the data hasn't been inputted correctly

2 6 2 1 1

3 continuous corrects, review it again objectively doubtful responses in 1st go

PROFESSIONALISM Knowledge of law (differentiate law with best practice, play safe)

E.G. BPG 18 ex1,2 Independence and objectivity

BPG 26: 1, 2,4,7, Misrepresentation: "knowingly" means knows and should have known

Misconduct

BPG 36: Ex4 INTEGRITY OF CAPITAL MARKETS material non-public information:

market manipulation: DUTIES TO THE CLIENTS loyalty, prudence, and care

fair dealings

suitability

performance presentation: present information current, clear, complete, accurate, no misrepresentations, easy to underst preservation of confidentiality

DUTIES TO THE EMPLOYER loyalty:

additional compensation arrangements responsibilities of supervisors

INVESTMENT ANALYSIS, RECOMMENDATIONS AND ACTIONS diligence and reasonable basis: diligence, independence and thoroughness supported with appropriate R&D and investig

communication with cleints and prospective clients

record retention

CONFLICT OF INTEREST disclosure of conflicts

priority of transactions

referral fees

RESPONSIBILITIES OF A CFA INSTITUTE MEMBER OR CFA CANDIDATE

PROFESSIONALISM Knowledge of law (differentiate law with best practice, play safe)

know law...not necessarily be an expert though must comply with laws and regulations that directly govern their work follow more stricter law or code/standards if law is weaker of the two responsible for voilation if they participate and/or assist "KNOWINGLY" or participate "UNKNOWINGLY" when they should hav the regulation

If a member has reasonable ground to believe illegal activity, they MUST disassociate or separate from the activity after attem (reporting to supervisor, confronting the person) doesn't work. Reporting to regulatory bodies ISN'T NECESSARY unless man the law CFA institute "ENCOURAGES" DOESN"T REQUIRE reporting to CFA Institute of potential voilations Encourage employers to develop and/or adpot Code of Ethics, make available applicable laws and regulations, and establish procedures for voilations reporting

E.G. BPG 18 ex1,2 Independence and objectivity avoid situations that could cause or be perceived as loss of independence and objectivity in recommeding/taking investment a

external sources may try to influence by offfering benefits. Reject any offer of gifts that could be expected to threaten independence/objectivity. Benefits could include gifts, invitation to lavish functions, tickets, favors, job referrals etc.

MAY ACCEPT BONUSES/ modest GIFTS as long as such are appreciations and not perceived detrimental to other cleints OR favours seeking to influence the member. MUST BE disclosed to employers and must not be perceivable as causing loss of objectivity/independence. Some client relationships are more precarious that others...discretion should be maintained on the b how gifts can be perceived DO NOT USE subtle/ambiguous language in reports to circumvent pressures from supervisors recommendations must convey member's true opinions, free of bias from internal/external pressures and be stated in clear an unambiguous terms

In IB, analysts and Ibankers can work together only if conflict of interest is carefully and EFFECTIVELY MANAGED AND DISC AND reporting structure must be separate. And Research analyst's compensation shouldn't be linked to IB assignments

Issuer paid research: potential for conflict of interests. Report must state these potential conficts, including nature of compensa due diligence means gathering information from a wide variety of sources analysts must also distinguish between fact and opinions BPG 26: 1, 2,4,7, 8 Misrepresentation: "knowingly" means knows and should have known

MUST NOT make any misrepresentations relating to investment analysis, recommendations, actions or other professional acti misrepresentations: omission of any fact, untrue or miseading statement, guarantee of returns unless it is built into product stru for which institution has agreed to cover any losses; false impression in oral representations. No plagiarism: copying or using other's material without permission/acknowledgementgive credit where it is due. This holds plain language description of general concepts like price/earning ratio, std dev etc. Actual "SPECIFIC" source of the information must be cited even though info, is picked up from an intermediate source Misconduct Must not engage in any professional conduct involving dishonesty, fraud, deceit or any act that reflects adversely on professio reputation, integrity, or competence Doesn't cover legal transgressions resulting from acts of civil disobedience in support of personal beliefs e.g. nonviolent protes

abusing CFA institute professional conduct program to settle personal, political or other disputes unrelated to professional ethi BPG 36: Ex4

INTEGRITY OF CAPITAL MARKETS material non-public information: no investment activity by self/other relatives on material non-public information. Info. Isn't mater voilation won't occur if conclusion is made on the basis of non-material public/non-public information. ensure material information is disseminated in an equitable manner in any situation, first determine if the information is public as long as story/recommendation is built on "mosaic theory", its fine and isn't in violation its common for analysts to analyse insider information like new products, capital projects, competitive env., merry that up with the information to make a recommendation a well-known analyst's research report doesn't fall under this even if his recommendation changes can cause price fluctuations isn't supposed to make this public as the research is paid for by his clients not all situations where material non-public information is avl. would warrant ceasing trading activity as that itself could be seen release of material information e.g. withdrawal of market-making

however in case of risk-arbitrage trading, it is best to suspend trading activity. This is because potential for illegal profits is grea market manipulation: not engage in practices that distort prices or artificially inflate trading volumes with an intent to mislead mark doesn't prohibit transactions done for tax purposes e.g. selling and immediate buying DUTIES TO THE CLIENTS loyalty, prudence, and care

cleint before employer and self, determine and comply with fiduciary duty as imposed by law/regulation, exercise same level o prudence, judgement and care that would be applied for own interests under similar circumstances recognize higher trust that client shows

fair dealings

ensuring same level of service to all clients based on what they are paying for prioritization in terms of communication of info. Can be done based on relevance to the customer (e.g. only long position holde be interested in downgrade recommendation investments - in line with block-allocation policies. Such policies should be disclosed to the cleints too

suitability recommendations in line with objectives, constraints. Judge suitabilitity in context of cleint's complete portfolio KYC before making investment recommendations and regular updates. performance presentation: present information current, clear, complete, accurate, no misrepresentations, easy to understand for maintain recommendations, perf. Calculation data. preservation of confidentiality info. of current, former and prospective clients confidential unless illegal activities, disclosure required by law, or allowed by cli DUTIES TO THE EMPLOYER loyalty: must not deprive employer of the advantage of skills/abilities , divulge confidential information or otherwise cause harm to comply with policies and procedures established by employers that govern the relationship as long as these don't conflict with code/standards

don't need to subordinate important personal/family obligations to work. Should enter into a dialouge about WBL when person interfere with work on a regular/significant basis employers must also adhere to their duties towards employess independent practice: provide notification, description of services and compensation received and start activities only after rec consent leaving employer: must continue to act in employer's best interestsensuring no conflicts of interest/services post-leaving, members can use skills/experience gained. Clients can also be reached out to using public information unless th specific agreement with the employer whistle-blowing: when integrity of capital markets and/or clients is compromised by the firm nature of employment: understand terms and abide by those additional compensation arrangements must not accept gifts that might reasonably be expected to create a conflict of interest with employer's interest responsibilities of supervisors must make reasonable effort to detect/prevent violations mere reporting up the chain of command or warning employee isn't enough. Supervisors should take steps to ensure the voila not repeated such as placing limits, or increasing monitoring of employee's activities if procedures aren't good enough, member should decline to accept supervisory responsibilities untill firm adopts these establish procedures for record-keeping and checks on personal trades INVESTMENT ANALYSIS, RECOMMENDATIONS AND ACTIONS diligence and reasonable basis: diligence, independence and thoroughness supported with appropriate R&D and investigation in m

communication with cleints and prospective clients

record retention

CONFLICT OF INTEREST disclosure of conflicts

priority of transactions

referral fees

RESPONSIBILITIES OF A CFA INSTITUTE MEMBER OR CFA CANDIDATE

In case member/candidate notices voilation: 1 report to supervisor 2 confront person 3 report to regulator ONLY if required by the law

Compliance procedure: Members and candidates should encourage em

4 OR disassociate by reassignment

Compliance procedure:

Compliance procedures:

not meant to cover legal transgressions resulting from acts of civil disobedience in support of personal beliefs as these don't re

professional reputation, integrity or competence

rial if source of infomration can't be reliable. Info. More ambiguous the effect on the price, less material the information is

cross-firewall communication is fine as long it is very well guarded and monitored. E.g. between analyst and investment bankin inter-firewall comm. Should be managed by the compliance officer compliance procedures:

determine if info. is material/non-public determine if info. is work of a paid analyst no trading should happen on material/non-public information unless the info. Is prepared in-line with mosaic theory

Compliance procedures

ethics and compliance should be segregated to ensure better understanding

making investments, recommendations

Compliance procedure: Members and candidates should encourage employers to: establish procedures so that employees are regularly informed review procedures maintain current files

establish protocols to handle reporting of voilations

Compliance procedure: members, firsm must protect integrity of opinions restricted list: if firm is unwilling to permit dessemination of adverse opinions about a corp. client, members shuld encourage removal of the firm from research universe by putting it in restricted list. This MUST BE done in ANTICIPATION NOT REACTIVELY

restric special cost arrangements: issuer should not always be hosting meetings between limit gifts to token items. restrict investments

review procedures

Compliance procedures: written list of firm's available services. Contains ways of describing firm's services, qualiications, and compensation.

bedience in support of personal beliefs as these don't reflect badly on

price, less material the information is

monitored. E.g. between analyst and investment banking divisions. compliance procedures: restricted lists, information barriers restrictions on personal trading using a combination of watch list and restricted list

ess the info. Is prepared in-line with mosaic theory

Compliance procedures limit number of people involved who are privy to recommendation change information shorten timeframe between dissimination and decision simultaneous dissemination maintain list of client and its holdings written and disclosed trade allocation procedures disclose levels of service

about the law

Annuity Due is greater than normal annuity whenever it gets complicated, draw timeline Calculating compounded annual growth rate: should consider only the final and initial revenue PV/FV calculations follow additivity principle i.e. PV of cashflows = sum of PV of individual cashflows

Financial Statements and analysis Direct-method questions at times provide information on depreciating expenses. Depreciation expenses being non-cash Non-cash transactions e.g. write-off, depreciation, amortization are not "classified" as cashflows as no cash transaction however, non-cash transactions must be added to Net Income while computing CFO as such get deducted in Income S PPE transactions are part of Investing Cashflow however in income statement any gain (loss) on sale of PPE is accoun While calculating CFO supplier, amort/depreciation doesn't need to be added to COGS While calculating CFF, be careful of adjusting dividends while calculating turnover ratios, remember averaging out the denominator

Economics elasticity uses average values

Fixed income semi-annual payments spot rate, YTM, BEY calcs

reciation expenses being non-cash charges are not considered in direct method cashflows as no cash transaction is involved. Such don't need to be added/subtracted unless calculation base is Net Income as such get deducted in Income Statement while arriving at Net Income in (loss) on sale of PPE is accounted for while computing Net Income hence such needs to be reduced (added) while computing CFO using

on base is Net Income (added) while computing CFO using Indirect method

contra account

contra account

contra account

contra account

ASSET = LIABILITIES + CONTRIBUTED CAPITAL + ADDNL. PAID IN CAPITAL + BEGINNING RTND EARNINGS + REVENUE - EARNINGS - DIVIDEND

diff in cash = total cashflow calc CFO, CFI, CFF both using direct indirect methods see how depreciation is ignored in direct methods also look at items considered in CFF, CFI dividends paid are part of CFF all others are CFO increase in asset = use of cash

irect indirect methods n direct methods

l others are CFO

GENERAL FUNDAMENTALS amount at which items are reported in financial statements historical cost - at which it was bought originally current cost - at which firm can buy now realizable value - at which firm can sell present value - discounted value of asset's future cashflows fair value - at which two firms can exchange Introduction Footnotes (audited) contain: accounting methods, estimations used addnl. Info. Like acquisitions, legal actions supplementary schedules (not audited) contain additional information like sales by BU, region hedging activities INCOME STATEMENT (47 - ) Gross reporting when firm is primary obligator, bears credit and inventory risk firm can choose supplier, can establish price

Going concern basis - firm will continue to exist Accrual basis - effect of transactions on financial conditio Matching principle - expesnes to generate revenue are r by the same principle, long-term assets are a No netting

MDA: assessment of perf. And condition of company from discussion over financial results, sales/expenses/cashflo general business perspective discussion over unusual/infrequent events In addition to MDA, firms release quarter/semi-annual re Unqualified opinion: statements are correct Qualified opinion: exceptions exist Adverse opionion: material non-conformance to standard

Unearned revenue when cash received and s

Revenue recognition - apart from accrual principle, when collection is reasonably sure and price is determinable Methods below used when contracts extend beyond one accounting periodgenerally construction projects % completion method: revenue, expenses, profit recognized as % completion w.r.t. costs. % completion= completed contract method: Used when outcome can't be reliably measured Under GAAP, revenue, expenses, profit recognized only when project is over Under IFRS, expenses, revenue to the extent of expenses recognised as incurred, profits at project completion under any of the above methods, loss must be recognized immedaitely % completion method is more aggressive as revenue recognized earlier Installment Sales - occurs when firm finances a sale and payments are expected over an extended period required when risks/rewards are not trasferred because seller remains in the property when collectibility is certain, revenue recognized at the time of sale when collectibility can't be reasonably estimated, Installment method: profit recognized = (cash collected / total sale) * total expected profit when collectibility is highly uncertain, Cost recovery method: cost is recovered first. Profit is recognised only when full cost has been recovered Transactions not affecting Net Income Issuing and reacquiring stocks affect Stockholder's equity not Net Income Dividends paid reduce stockholder's equity not net income Transactions included in Other Comprehensive Income affect equity but not net income unrealised forex currency translation gains/losses unrealised gains on derivatives for cashflow hedge unrealised gains on available-for-sale securities reported on balance sheet at fair value, reported directly adjustment for minimum pension liability change in accounting principle (e.g. LIFO to FIFO) requires retrospective application ie. restatements of prior statements change in accounting estimate is applied prospectively and doesn't require restatements of prior statmeentse.g. chang normally due to change in management's judgement, usually due to new information ???correction of an accounting error is reported as prior-period adjustment

Basic EPS Diluted EPS = (Net Income - preferred dividends) = [Net Income - preferred dividends] + [conv. Prefd. Shares Dividend Weighted Avg. comm. shares outstanding Weighted Avg. comm. shares outstanding + [conv. Prefd. Shares] + Effect of stock-split/ stock dividend Dilutive if: # of addnl. Shares get accounted from the beginning itself Pref. shares conv. Shares div / conv. Prefd. Shares < Bas Treasury stocks are deducted in denominator Conv. Debt conv. Debt interest (1 - tax rate) /shares from pref dividends are because of preferred stocks Stock options/Warrant (1- strike price/average share price) * N > 0 i average price and not year-end price taken in month averaging is done even with pref. shar BALANCE SHEET (83 Assets created by operating activities (e.g. generating net income), investing activities (purchasing mfg. equipment), financ Liabilities are created by operating actiivities and financing activities

Current assets and liabilities: likely to be converted to cash, obligations satisfied resp. within one year or one reporting c Operating cycle is the duration to produce, sell and collect cash Current assets - Current liabilities = Working Capital not enough WC indicates liquidity problems too much WC indicates inefficient assets usage Non-current assets indicate information about firm's investing activities Non-current liabilities indicate firm's long-term financing activities Inventory (incl. raw material, finished goods and WIP) - reported at lower of cost or net realizable value inventory costs exclude: wastage, storage, admin. overhead, selling costs Minority Interest: if firm has controlling interest in a subsidiary not fully owned calculated as pro-rata share of assets not owned by the firm reported on BS as liabilities or owner's equity Goodwill: excess of purchase price over fair value if identifiable assets and liabilities in the event of business acuisition trading secs Fair value yes yes (in income stmt) Held-to-maturity Historical/amort cost dividends no

BS Treatment realized gains unrealized gains

some financial assets are reported at fair value while others at present value fair value: tangible, intangible assets (amortized, depreciated, impaired value) present value: debt instruments like bonds, CASHFLOW STATEMENTS: 100reconciles beginning, end cash balance over an accounting period Non-cash investing/financing CFs: don't reslt in cash in/out e.g. acquiring real estate with financing from seller Operating Cashflow Direct method: coverts an accrual-basis income stmt. to cash-basis income stmt.

starts with cash received from customers and then deducts cashflow from purchases, operating expenses, interest and taxes Doesnt need adjustments for depriciation, write-offs, amortization etc. presents firm's operating cash inflow, outflow provides more information than indirect method Indirect method: net income converted to operating cashflow by making adjustments for transactions adding noncash expenses like depriciation, amortization deducting non-operating items' loss/gains (e.g. sale of land) (such are captured as part of CFI) adding any increase in operating liabs. And reducing any increase in operating assets focusses on difference between NI and CFO presents only net results of Cash-in and cash-out CF TIPS 1. mark activity including non-cash activities 2. strikeout summary items 3. keep striking out items already considered Investing Cashflow Calculated by examining changes to gross asset accounts that result from investing activities investing activities include property, plant, equipment, intangible assets and investment securities cashflows for capitalization i.e. creating asset that can provide economic benefits later related accumulated depriciation or amortization accounts are ignored as they don't represent cash expenses Financing cashflow measuring cashflows between firm and its suppliers of capital interest payments to creditors go under operating income Free Cashflow to the firm (FCFF) cash available to all the investors both equity owners and creditors = CFO + Interest(1-tax rate) - FC inv NCC non cash charges = NI + NCC + Interest(1-tax rate) - FCinv - WCinv WC inv working capital investment FC inv Fixed Capital investment Free cashflow to equity FCFE WC adjustments already get included in CFO cash available for disribution to shareholders by way of change in operating assets e.g inventory = CFO - FC inv + net borrowings Performance ratios cashflow to revenue = CFO/Revenue cashflow return-on-assets = CFO/total assets cash return-on-equity = CFO/average total equity cash-to-income = CFO/"Operating" income cashflow-per-share = (CFO-Dividends)/weigted # of common shares outstanding Coverage ratios Debt coverage = CFO/total debt Reinvestment ratio = CFO/(cash paid for long-term assets) Debt payment ratio = CFO/(cash long term debt repayment) Dividend payment ratio = CFO/dividend paid Investing and financing ratio = CFO/(Cash outflows from investing and financing

Common-size cashflow statement: everything expressed as a % of revenue alternatively (CF in) as % of total (CF in); and (CF out) as a % of total (CF out)

Problems to revise: page 121 onwards (all) FINANCIAL ANALYSIS TECHNIQUES (130 Vertical common-size statements Balance sheet expressed ad a % of total assets Income statement expressed as a % of revenue/netsales Horizontal common size statements Accounts expressed as a ratio of first year's values Limitations of financial ratios not useful when viewed in isolation different accounting treatment difficult to compare results across industries determining target value for a ratio is difficult

Review page 131, 132 - good summary of ba review current v/s non-current; lia

Valuation Ratios price-to-earnings ratio = Share's market price / EPS price-to-cashflow price-to-sales price-to-book Business Risk coefficient of variation used for this - CV sales, CV operating income, CV net income = standard deviation / expected value Credit risk analysis: company's ability to repay the debt interest coverage ratios, return on capital, debt-to-asset ratios Segment analysis when business units comprise of more than 10% revenue when business units are different in terms of geographies, operations etc. TIP: EBIT is used only for ROTC and cash-to-income ratio interest coverage also uses EBIT for obvious reasons rest all ratios use Net Income

INVENTORY ACCOUNTING (171 -

COGS = beginning inventory - ending inventory + purchases Under IFRS Inventory cost "capitalized" - called product costs: Inventory reported lower of cost or Net Realizable Value purchase cost Under GAAP conversion cost (includes labour costs) Inventory reported lower of cost or Market valuemarke allocation of fixed production overhead on nomal capacity level NRV - normal profit < Market Value < NRV other costs necessary to bring to present condition and location such costs are expensed when inventory is sold inventory is written down by (cost - inventory value) Other costs that are not capitalized - called " period costs" Inventory can be written up to the extent of previous writ unallocated portion of fixed production overhead review examples on 174 abnormal waste Inventory turnover = COGS / av. inventory storage costs No, of inventory days = 365/inventory turnover admin overhead High turnover, and lower revenue growth => insufficient i selling overhead Low turnover and lower revenue growth => obsolete inve Product costs can't be avoided even with 100% efficiency, and are directly linked to "creating product" whatever can be avoided and/or is indirect is covered under period costs LIFO confirmity rule: per GAAP, if LIFO is used for accounting, same should be used for tax purposes

LONG-LIVED ASSETS (196Assets whose economic benefits are expected beyond one accounting period. Cost of long-lived assets must be matched General rule is to recognize expense if future economic benefit is unlikely

Firm can either: 1 Capitalize the cost as an asset on balance sheet and as CFI out on Cashflow statement Interest that accrues during construction of asset is also capitalized as a part of asset's cost interest does get counted as CFIout due to change in asset value After capitalization, if asset is held for use, Cost is then allocated to: depreciation for tangible assets OR amortization expense for intangible assets having finite lives After capitalization, if asset is held for sale, cost is allocated to: COGS 2 Expense the cost in the income statement under operating expenses Tangible asset with finite life depreciated over finite life Sale/exchange of long-lived assets e.g. equipment gain/loss accounted as CF investing Intangible asset with finite life = sale price - carrying value (= original price Lack physical substance. Value based on rights granted e.g. patents, copyrights, brand names, license etc are amortized over its useful life Intangible asset with infinite life one that can't be purchased separately and may have an infinite life Can be created internally, purchased externally, or thru business acquisition ex. Goodwill, patent/licences that don't have finite life as those could be renewed w/o or at low cost Not amortized but tested for impairment annually

With some exceptions, costs incurred by the firm to create intangible assets are expensed as incurred Costs incurred to develop software for "others" are expensed as incurred until tech. feasibility has been establised after that, subsequent costs are capitalized Costs incurred to develop s/w for internal use are capitalized

Depreciation Amortization Impairment

Tangible/intangible asset Intangible assets Intangible assets finite life finite life infinite life (org decided to hold-for-sale) (patents, copyrights) goodwill, patents/copyrights that c e.g. equipment YES??? NO NO NO YES NO when carrying value may not be recovered with future usage Indication that firm hasnt recognised enough depr. Or amort. expense carrying val > fairvalue-sell cost

recoverability test

carrying val > Undisc. Future CFs current carrying value of reporting

Loss measurement carrying val - (fair val - sell cost) carrying val - Fair val or Disc. CFsgoodwill carrying value - goodwill

Impairment reduces carrying value, and is recognized as loss in Income statement. Reversing an impairment loss Impairment just like amortization, depreciation has no impact on CF. Under GAAP, recoveries are allow Additionally there are no tax savings from an impairment until asset is sold INCOME TAXES (228Taxable income and accounting income are different because of differences in tax laws and accounting principles Taxes payable "derived from" Taxable income "Tax Expense" recognized in Income Stmt. Using Matching principle - this isn't actual tax paid General rule: Taxable income is directly linked to cash-in and cash-out. Accounting income depends on "earning of revenue" and matching expenses Tax base of an asset = amount tax deductible or amount that will not be taxed in future (carrying value - tax base)*tax rate create DTL Calculate Carrying value - (amount of asset/liability that will be deducted from taxable income in future) e.g. tax base = depreciated value of the asset

Tax base of a liability = carrying amount - (amount tax deductible or amount that will not be taxed in future) (carrying value - tax base)*tax rate create DTA if tax base > carrying value DTL is created e.g. $10k advance pmt. Carryvalue of liability = 10k. Since amount collected is taxed when received, amount that won' as, that will be taxed now. => tax base = 10k-10k = 0. Therefore DTA = (10k-0)*t Deferred Tax Asset: Taxable income > Accounting income i.e revenue taxed before recognition Tax payable > Tax Expense

When revenue is taxable before it is recognized in income statement

Deferred Tax Liability: Taxable income < Accounting income i.e. revenue recognized before being taxed Tax payable < Tax Expense DTL that are not expected to reverse, typically because of expected continued growth in capital expenditures, should b

Above holds if DTL and DTA are expected to reverse in future If not for some reason, DTL is converted to equity and DTA is written-off Impact of tax rate changes: increase in tax rate will increase DTA and DTL and vice-versa => this will impact IT Expense as per above equation assuming taxes payable remain same Valuation allowance: (contra-account) DTA are assessed to determine likelihood of sufficient future income to recover tax assets DTA is reduced by "Valuation allowance" if it is more likely that some or all of DTA will not be realized increases tax expense and reduces Asset Under US GAAP, DTA and DTL are not netted Impact of tax rate change DTL/DTA adjusted accordingly and tax expense calculated accordingly

LONG-TERM LIABILITIES AND LEASES (253 Balanace sheet liability of a bond (book value) is the net present value of all the future cashflows (coupan pmts. + face Coupan payment is based on bond's interest rate called coupan rate. Calculated by multiplying face value with the coupan Interest expense is based on market rate This is the interest that investor wants based on the credit-worthiness of the issuer and a number of other parameters calculated by multiplying book value of the bond with the market rate of interest At par issuance: At discount Market rate = Coupan rate Market rate > Coupan rate Bond proceeds (liability) = Face value Bond proceeds (liability) < Face value Interest expense = Coupan rate Interest expense > Interest paid Difference added to liability Handling Cashflows Liability increase over time Issue proceeds as CFF On Maturity, liability = face value Interest paid as CFO Interest expense increase over time Repayment as CFF Think discount as cost of borrowing

BS Impact At issuance, both Asset and Liability increase by bond proceeds At any point in time, book value of bond liability will always equal present value of the remaining future cashfl Face: 1000; 10% coupon, 11% market; 5 years. PV = 963 Bond at discount Asset Liability Income Statement 1 bond sold 963 963 ref. ex. Spg259 2 a year later liability up by discount amort. interest expense =

5.9

963*.11 = interest paid + amort =

3 a year later

liability up by discount amort. 6.57

interest expensed = 968.9*.11 = interest paid + amort

Lessor view Sales-type lease (asset COGS = 8k) [Direct financing if COGS = Asset 1. asset removed Lease recievable 10k 2. lease payment received reduce lease receivable -1638 CFO =

Operating lease 1 Asset 10-2k

- firm will continue to exist of transactions on financial condition and income are recorded when they occur, not when they are settled in cash expesnes to generate revenue are recognized in the same period as the revenue me principle, long-term assets are amortized, depreciated over the period asset is supposed to generate economic benefits

perf. And condition of company from mgmt. perspective cial results, sales/expenses/cashflow trends

Proxy statements: issued to shareholders when vote is required

ual/infrequent events rms release quarter/semi-annual reports (not audited) statements are correct ceptions exist aterial non-conformance to standards revenue when cash received and services not delivered

Flow of accounting entries journal entires record every entry in order of dates general ledger sorts by accounts initial trial balance is created to show current balances

Inventory/COGS: LIFO, FIFO, Weighted average Under IFRS, LIFO not allowed

e and price is determinable rally construction projects .t. costs. % completion= (%cost incurred) / total project cost

Depreciation - for long-term assets straight-line = (cost-resid. Val./ useful life) declining balance = (cost - accumulated depr)/useful li double declining balance = 2 * (cost - accumulated de decl. bal. applies constant rate of depr. to assets curre

rred, profits at project completion

an extended period

Intangible assets: amortization is allocation of intang straight-line method used mostly goodwill - tested for impairment annually and the

Barter transactions: can be recognized at fair value only if firm h Income Statement Revenue/Net Sales COGS Gross Profit Selling, G&A costs R&D Costs Depriciation, amortization costs rental/lease Operating Profit = EBIT (earn sheet at fair value, reported directly in share-holder's equity as other comprehensive income Interest expense Investing gains ie. restatements of prior statements Unusual items (gains on sale of assets or ents of prior statmeentse.g. change in estimated life of an asset Infrequent Items (impairment, Income before Tax = EBT Tax Income from continuing oper

Earnings/losses from discontinued operatio nds] + [conv. Prefd. Shares Dividend] + [conv. Debt interest (1 - tax rate) ] Extraordinary items - material transaction t tstanding + [conv. Prefd. Shares] + [shares from conv. Debt] + [ NET ADDNL. stock options/warrant shares]Net Income - Dividends ares div / conv. Prefd. Shares < Basic EPS + other comprehensive income bt interest (1 - tax rate) /shares from conv. Debt < basic EPS price/average share price) * N > 0 i.e if the option is in-the-money price and not year-end price taken into account while evaluating anti-dilutive nature of options eraging is done even with pref. shares, conv. Shares, and warrants

purchasing mfg. equipment), financing activities (issuing debt, equity)

p. within one year or one reporting cycle whichever is greater

authorized shares: no. of shares that may be sold und issued shares: shares actually issued to shareholders outstanding shares: issued shares - shares acquired (

ACCOUNT FORMAT (in report format, asset, liabilities, owners' equity are all presented ASSET LIABILITIES CURRENT ASSET CURRENT LIABILITIES cash a/c payables inventory operating liabs. (taxes, wages) a/c receivables unearned revenue prepaid expenses accrued expenses trading securities notes, bonds payables current investments (trading securities) current portion of long term debt accrued revenue ARO liability NON CURRENT ASSET NON CURRENT LIABILITIES PPE long term debts Intangible assets pension liabilities

net realizable value

the event of business acuisition Available for sale Fair value yes (dividends) yes (other comp. income)

minority interest

Operating cf: inflows/outflows of cash resulting from transactions affecing net income (GAAP) Inflow Outflow cash collection from customers cash paid to employees and suppliers interest and dividends earned cash paid for other operating expenses (SG&A, selling sale proceeds from trading securities acquisition of trading securities

Sale of inventory

Interest, tax paid

investing cashflow: inflows/outflows of cash resulting from acquisition or disposal of long-term assets and certain in acquisition of fixed assets e.g. PPE, intangible assets sale proceeds from fixed assets e.g. PPE (including gains) sale proceeds from debt and equity investments (including gains) acquisition of debt and equity investments principal received on loans made to others Loans made to others r transactions cashflows for capitalization i.e. creating asset that c financing cashflow: inflows/outflows of cash resulting from transactions affecting a firm's capital structure principal amount of debt issued principal paid on debt proceeds from issuing stock payments to reacquire stock dividends paid to shareholders

Non-cash investing, financing, operating transactions (i.e. writeoff, amort, depriciation) are not reported in cashflow stateme

Total cashflow = CFO + CFI + CFF = Change in cash position between two balance sheets While calculating CFs, keep a track of items taken care of in Balance sheet and income statements. Best is to segregate opera Under indirect method: from Income statement start with Net Income +NI + NCC (non-cash charges) - (gains from Investing from Income statement reduce gains resulting from investing, financing cashflows e.g. gains on land sale from Income statement add amortization, depriciation as such are non-cash items from Balance sheet adjust changes to operating accounts e.g. from Balance sheet add increase in operating liabilities from Balance sheet add increase in accounts payables from Balance sheet similarly look for differences in others operating accounts. operating accounts include, receivables, inventory and payables Indirect to direct CFO conversion requires income statements and statements of cashflows under indirect method Cash collection from customers: + net sales Use + for net sales + increase in unearned revenue - increase in accounts receivables Cash payment to suppliers: - COGS (without depreciation, write-offs) Use - for COGS - increase in inventory + increase in accounts payables for the rest, follow simple rule: increase of assets => use of cash increase in liability => source of cash Cash Operating Expenses - SG&A + increase in accrued expenses - increase in prepaid expenses

from Income statement from balance sheet/indirect method from balance sheet/indirect method ssets e.g inventory from income statement from balance sheet/indirect method from balance sheet/indirect method

from income statement from balance sheet/indirect method from balance sheet/indirect method

Cash Wages from income statement - Wages from balance sheet/indirect method + increase in wages payable Cash interest from income statement - Interest

from balance sheet/indirect method + increase in interest payable Cash Tax - Tax + increase in Tax payable + increase in deferred tax liabilitiy - increase in deferred tax asset

from income statement from balance sheet/indirect method from balance sheet/indirect method from balance sheet/indirect method

age 131, 132 - good summary of balance sheet, income statement review current v/s non-current; liabilities v/s equity, current/long-term liabilities Look at performance ratios, coverage ratios as well Liquidity ratios (asset v/s liabilities) - liabilities in denominator measures of liquidity, ability to satisfy short-term obligations Current ratio = current assets/current liabilities C Q C (current quick cash) Quick ratio = (cash+marketable securities + receivables)/current liabilities Cash ratio = (cash+marketable securities)/current liabilities

If a ratio has balancesheet item and incom coverage, ratio, turnover item would always In most of the ratios, whenever a balances it is averaged instead of simply Activity ratios (w.r.t. respective account asset utilization or turnover ratios receivables turnover

inventory turnover = COGS / average inv

Payable turnover = purchases / average p asset turnover = revenue/total asset Be aware that averages need to be used

Solvency Ratios (w.r.t. total equity) (debt in nominator) measures financial risk and leverage Long term debt-to-equity = long-term debt/total equity Debt-to-capital = total debt / total debt + owner's equity debt ratio = total debt / total asset Debt to equity = total debt/total equity

Profitability ratios (w.r.t. revenues) how well mgmt. is converting effort into pro gross profit margin = Gross profit/revenu operating profit margin

Financial leverage ratio = total asset/total equity net profit margin = net income/revenue Interest coverage = earnings before interest and taxes(EBIT) / interest payments return on asset (ROA) return on total capital (ROTC) Dupont system of analysis return on equity (ROE) Return on Equity = Net Income/ Equity = (Net Income/Revenue)*(Revenue/Asset)*(Assets/Total Equity) = (net profit margin)*(asset turnover)*Leverage ratio return on common equity (ROCE) = (return on assets)*Leverage ratio review 147pg example = (net Income/EBT)*(EBT/EBIT)* (EBIT/revenue)*(revenue/asset)*(Assets/Total Equity) = (tax burden)*(interest burden)*(EBIT margin)*(asset turnover)*Leverage ratio growth rate g = RR * ROE net invome/EBT = 1 - tax rate RR = retention rate If ROE is low => either poor profit margin, poor asset turnover, or too little leverage = (net Income avl. To common

remember as equity -> asset -> turnover -> net income for 5 point, NI/Revenue is broken down further keeping NI < EBT < EBIT < Revenue in mind

= 1 - dividend payout ratio = 1 - Dividend/Earning

wer of cost or Net Realizable Value = estimated sale price - selling costs

remember: LIFO COGS, FIFO inventory i.e. LIFO CO FIFO low COGS, high inventory (than replaceme provides better Balance Sheet as inventory LIFO

wer of cost or Market valuemarket cost is the replacement cost mal profit < Market Value < NRV

high COGS, low inventory (than replaceme provides better income statement as COGS as LIFO inventory is likely to be lesser than

own by (cost - inventory value) ten up to the extent of previous write-down amples on 174 COGS / av. inventory = 365/inventory turnover wer revenue growth => insufficient inventory wer revenue growth => obsolete inventory reating product"

Converting LIFO to FIFO FIFO Inventory = LIFO Inventory + LIFO Reserve Adjust RHS by increase tax liability = LIFO Reserve*tax rate Increase Owner's equity by LIFO Reserve(1-tax rate) FIFO COGS = LIFO COGS - increase in LIFO Reserve

for tax purposes

LIFO Liquidation occurs when LIFO firm's inventory quantities decline. In this situation this implies higher profit margins and higher income ta Obviously, firms can increase earnings, profits by liqui however, this can't continue forever

ong-lived assets must be matched with the revenues it generates over a period of time. Such allocation of cost is called

Capitalization delays expensing. Its effect on: Net Income Cashflows Higher during capitalization period During capitalization period Lower after capitalization period as cost is reported as CFI out, Investing cashflow is lower Shareholder's equity at the same time, since expenses are not repoted, CFO is higher Higher during capitalization period After capitalization period Lower after capitalization period CFI and CFO remain same as depreciation or amortization are non-cashflow items review example on 200 as interest is expensed, there won't be $5 depreciation ng-lived assets accounted as CF investing ce - carrying value (= original price - acc. Depreciation)

/o or at low cost

sed as incurred

Intangible assets goodwill, patents/copyrights that can be renewed at little/no costs

Asset Retirement Obligations Assets that cause environmental damage e.g. nuclear Treatment asset START WITH Disc. PV ADJUST EVERY YR - depr. For analytical purposes, treat ARO same as debt this will increase solvency ratios like debt r In addition, accretion expenses are treated as interest

current carrying value of reporting unit > current fair value of reporting unit goodwill carrying value - goodwill implied value

g an impairment loss Under GAAP, recoveries are allowed for assets held for sale but not for assets held for use or goodwill

and accounting principles

ctual tax paid

ble income in future)

not be taxed in future)

Difference in Taxable and Accounted Income is caused by: timing differences of revenue and expense recognition in income statement and tax r certain revenue and expenses are recognized in incomes stmt. But never on tax or vi different carrying values and tax bases of assets/liabilities. Generally because of diffe gain/loss recognition differences tax losses from previous periods may offset future taxable income financial statement adjustments impairment is recognized as an expense however tax isn't deductible till asset is sold Permanet difference - difference between taxable income and income statement that these don't create DTA or DTL caused by revenue/expenses that aren't taxable/deductible effective tax rate = tax expense/EBT statutory tax rate - tax rate of jurisdiction above two could be different when firm operates in more than one geographies

ed when received, amount that won't be taxed in future Temporary = 10k difference - diff. between tax base and carrying value leading to either tax in general caused because different depreciation methods are used for tax return and either results in future taxable income or expected future tax deductions

wth in capital expenditures, should be treated as equity

will not be realized

ture cashflows (coupan pmts. + face value at maturity) discounted at market rate ultiplying face value with the coupan rate

and a number of other parameters

ue of the remaining future cashflows discounted at market rate of interest Income Statement

ref. ex. Spg259 interest expense =

Handling zero coupon bonds 0

963*.11 = interest paid + amort = 105.9

interest expensed = 968.9*.11 = interest paid + amort = 106.57

105.9 no interest expense only amort. Expense hence CFO is higher 0 106.57

= 8k) [Direct financing if COGS = 10k and no gross profit] Liability Expense/Revenue Recognition revenue recognized = 10k COGS -> -8k

Lessee view Finacing lease (10k worth of equipment fo 1 asset and liability increased by 10k

2 @1 yr end asset depreciated by 10/5 = 2k, interest rcvd. = 1k =>

ase receivable

CFO = -1000 on account of interest CFF = -1638 on account of reduction in liab EBIT = -2k; Net Income = -3k Operating lease calculations

Expense/Revenue recognition Depr = -2k rental income = 2638

=>

CFO = -2638; EBIT = -2638; Net Income =

At the end of the day, total interest paid + t

conomic benefits

rs when vote is required

every entry in order of dates

created to show current balances which are then adjusted

ng-term assets esid. Val./ useful life) cost - accumulated depr)/useful life nce = 2 * (cost - accumulated depr)/useful life stant rate of depr. to assets current book value

mortization is allocation of intangible assets like patents, trademarks, licenses over useful life hod used mostly d for impairment annually and the impairment amount is recognized in income statement

cognized at fair value only if firm has rcvd. payments historically and firm can establish a fair value based on that experience

Gross Profit period costs like G&A costs are accounted for in the period incurred and are not tied to revenue recognition e.g. rentals

on, amortization costs Operating Profit = EBIT (earnings before interest, tax)

ems (gains on sale of assets or part of business) t Items (impairment, write-offs, restructuring costs) Income before Tax = EBT Income from continuing operations

osses from discontinued operation (net of tax) nary items - material transaction that is both unusual and infrequent (net of tax) e.g. uninsured lossed, early long-term debt retirement Net Income indicator of organisations' future earnings - Dividends + other comprehensive income unrealised gains/losses unrealized hedging, forex gains pension liabilit gains

o. of shares that may be sold under firm's article of incorporation (.e.g. BSNL decided to give away 10% equity) s actually issued to shareholders ssued shares - shares acquired (treasury stock)

s, owners' equity are all presented in one column) OWNER'S EQUITY CONTRIBUTED CAPITAL OR CAPITAL STOCK ++++ ADDITIONAL PAID-IN CAPITAL (in excess of par) ++++ RETAINED EARNINGS ===== BEGINNNING RETAINED EARNINGS + REVENUE - EXPENSES - DIVIDENDS ++++ OTHER COMPREHENSIVE INCOME ===== unrealised gains ------ TREASURY STOCK no voting rights, no dividends

ong term debt

minority interest

captured either as liability or mezzannine section

Statement of change in owner's equity Endign balance = beginning balance + retained earnings (Net Income - dividends) + other comprehensive invome issuance/repurchage of common stocks

es and suppliers perating expenses (SG&A, selling etc.)

ong-term assets and certain investments ssets e.g. PPE, intangible assets d equity investments

alization i.e. creating asset that can provide economic benefits later m's capital structure

e not reported in cashflow statement since they don't involve in/outflow of cash e.g. exchange of debt with equity

ments. Best is to segregate operating, financing, investing activities first

h charges) - (gains from Investing) - increase in assets + increase in liabilities ows e.g. gains on land sale as non cash items don't lead to cash outflow and it does get subtracted while computing NI, this needs to be added back to ge Amortization: for intangible assets like licenses, patents, trademarks etc. Asset increase => use of cash Liability increase => source of cash

ws under indirect method

st, follow simple rule: of assets => use of cash n liability => source of cash

as balancesheet item and income stmt. Item, balance sheet item will be in denominator ratio, turnover item would always be in denominator e.g. interest coverage ratio = EBIT/interest paid the ratios, whenever a balancesheet item is compared against income statement item it is averaged instead of simply year-end balance atios (w.r.t. respective accounts revenue) If turnover ratios are for a quarter, instead of 365 use 91.25 zation or turnover ratios es turnover = annual sales / average receivables days sales outstanding = 365 / receivables turnover days of inventory on hand = 365 / inventory turnover no. of days payable = 365 / payable turnover cash conversion cycle = DSO + Days of inventory on hold - No. of days of payables

y turnover = COGS / average inventory

urnover = purchases / average payable

nover = revenue/total asset that averages need to be used

ity ratios (w.r.t. revenues) mgmt. is converting effort into profits ofit margin = Gross profit/revenue

margins relative to revenue

g profit margin = operating profit(EBIT) / revenue (before tax and interest) margin = net income/revenue asset (ROA) = net income / average total assets total capital (ROTC) = EBIT / total average capital equity (ROE) = net income / total average equity common equity (ROCE) = net income -dividend / total average "common" equity

7pg example

ate g = RR * ROE RR = retention rate = (net Income avl. To common - dividend declared) / net Income avl. To common

= 1 - dividend payout ratio = 1 - Dividend/Earning

OGS, FIFO inventory i.e. LIFO COGS are higher when prices are on the up S, high inventory (than replacement cost), high income, low cashflow better Balance Sheet as inventory is based on recent costs

S, low inventory (than replacement cost), low income, high cashflows better income statement as COGS are based on recent costs nventory is likely to be lesser than market value, inventory write-downs are less likely in LIFO LIFO results in higher CFO because of lesser taxes. Higher COGS get balanced out by lower inventory. lesser taxes therefore increase CFO since inventory and COGS both are part of CFO, net gains would be because of tax savings

quantities decline. In this situation, older inventory i.e. lower costs form part of COGS ofit margins and higher income taxes increase earnings, profits by liquidating older inventory ontinue forever

cost is called amortization, depreciation Depreciation carrying (book) value = historical cost - accumulated depr. historical cost = purchase price + installation + transportation costs straight line method Depr expense = (original cost - salvage value) / useful life Accelerated depreciation method higher depreciation initially, lesser later on => lower net income in early years Double-declining balance method = 2 * carrying (book) value/ useful life salvage value isn't taken into account Units of production method: based on usage = (cost - salvage value) / units produced GAAP allows usage of different methods for financial reporting and tax reporting straight-life for financial reporting, accelerated depr. for tax reporting Difference in taxes captured as deffered tax liability in later years, when depr. Is less, excess tax paid is reduced from deferred tax liability Fixed Asset age helps analyst identify older, less efficient assets helps analyst forecast significant financing requirements

average age = accumulated depriciation / annual depr. Expense av. Depriciable life = original cost / annual depr. Expenses

remaining useful life = ending net investment / annual depr. Expenses ending net investment = original cost - accumulated depreciation review example on 211, 212 vironmental damage e.g. nuclear power plants, plants generating toxic waste etc. liability expenses Disc. PV + accretion interest - depr - accretion interest es, treat ARO same as debt crease solvency ratios like debt ratio, debt-to-equity ratio etc. expenses are treated as interest while calculating interest coverate ratio

on in income statement and tax return omes stmt. But never on tax or vice-versa bilities. Generally because of difference in depreciation methods

axable income

ax isn't deductible till asset is sold ome and income statement that will not reverese in future

more than one geographies

arrying value leading to either taxable or deductible amounts in future ethods are used for tax return and income statement uture tax deductions

lease (10k worth of equipment for 5 years @ 10% interest => 2638 EMI) Assets Liability Expense Recognition liability increased by 10k 10k 10k asset depreciated by 10/5 = 2k, liability reduced by principal amount 10-2 = 8k 10k-1638 = 8362 depreciation = 2k interest part of EMI = 1000 000 on account of interest 638 on account of reduction in liability k; Net Income = -3k g lease calculations rental = 2638 (PMT over 5 yrs corresponding to PV = 10k, 10% IR) 638; EBIT = -2638; Net Income = -2638

d of the day, total interest paid + total principal paid will be equal to rental paid

erm debt retirement

ds to be added back to get CFO

ays of payables

GAAP by FASB (rules based) Regulatory body is SEC 10-K: annual financial statements filing, 10-Q: quarterly filing DEF 14-A: proxy statements to shareholders prior to AGM 144: firm issues certain securities to qualified buyers w/o registering securities with SEC Qualities: relevance and reliability Different objectives for business and non-business stmts.

FASB defines asset as a future economic benefit. Doesn't allow upward adjustment of assets Uses revenue, expenses, loss, gain and comprehensive income as performance elements rule-based Income statement related differences: revenue recognized when (a) realized or realizable and (b) earned As per GAAP (in addition): revenue recognized when: (a) evidence of sale between buyer and seller (b) product delivered, services rendered (c) price determined/determinable (d) seller reasonably sure of collecting money Extraordinary items reported separately (net of tax) after net income from continuing operations In completed contract method, costs, revenue, profit not recognized till completion Balance sheet related differences:

all allowed. LIFO preferred by most US companies Inventory reported lower of cost or market value. No write-up allowed. Only when asset is held-for-sale, write-up is allowed (e.g. if inventory is held for use, write-up isn't allowed) Minority Interest can be reported under liabilities, equity or mezannine section Cashflow related differences: Interest earned/paid reported as operating activity Dividend earned reported as operating activity Dividend paid reported as financing activity Tax paid for all operating, investing, financing activities reported as operating activity If firm uses direct method, adjustments necessary to reconcile net income to cash flow must be disclosed Other differences: R&D costs are generally expensed as incurred GAAP allows different depriciation methods for tax and financial reporting dealing with a certain situation, political pressures that regulatory bodies face from business groups company can't be appropriately quantified

IFRS by IASB (principles based) Regulatory body: FSA for UK, many national regulatory auths. Belong to IOSCO Objectives: 1. protect investors 2. ensure fairness, efficiency and transparency of markets 3. reduce systemic risk Qualities: understandability, relevance, reliability, comparability same objectives for business/non-biz. Entities Principles: fair presentation, going concern basis, accrual basis, consistency between periods, materiality, aggregation and no offsetting Places more emphasis on going-concern assumption Asset as a resource from which a future economic benefit is expected. Upward adjustmet allowed to the extent of depreciation accounted for previously income and expenses as elements of performance principles-based

uses accrual basis Doesn't allow reporting extraordinary items separately from income statement net of tax, after income from continued operations revenue recognized upfront upto costs, profit recognized only at completion

IFRS requires current/non-current format unless liquidity -based presentation is more relevant (e.g. banking industry) LIFO not allowed Inventory reported lower of cost or Net Realizable Value = estimated sales price - selling costs write-up allowed only to the extent of write-downs Minority interest reported under Equity section

interest or dividend earned can be reported as operating or investing activity interest or dividend paid can be reported as operating or financing activity

Tax paid reported separately for operating, investing, financing activities ow must be disclosed

Research costs are expensed as incurred. Development costs are capitalized during development phase

business groups

Demand Elasticity/Curve Must read: pg 21 keeping other things in the system constant, what additional price reduction will push customer(s) to consume one more it also called marginal benefit curve therefore. Actually, it is "worth" or "value" curve demand curve indicates decreasing "value" to consumers of additional goods or services consumer surplus = sum of value consumer got with every item consumed (i.e. sum of marginal benefit he derived) MINU Perfectly Elastic Demand: two identical products available in market. Any change in one's price will lead to infinite demand inc Perfectly Inelastic Demand: insulin, a necessity, Demand Elasticity depends upon: closeness of substitute: more substitutes => high elasticity, less substitutes => low elasticity. proportion of income spent - lesser income spent => inelastic demand as consumed quantity wouldn't change much time elapsed since last price hike: more time => more time for people to decide upon changinghence more elasticity as

Cross Elasticity: change in price of one leading to change in consumption of the other Income Elasticity: less % of income going into product => product demand is inelastic as one wouldn't mind paying that little extra e.g. chang high % of income going into product => product demand is elastic as people would like to switch to something cheapere Necessities are income inelastic An inferior good shows negative elasticity

Supply Elasticity/Curve price at which supplier is willing to supply Nth item supply curve illustrates opportunity cost of additional units of goods or services that must be foregone opportunity cost of producing additional units of goods increase as more and more resources are bid away from alternativ supply elasticity depends upon available resource substitutes: more substitutes mean higher elasticity as input items are not constrained to produce more supply decision time frame

Equillibrium point till price bid by customer != price offered by supplier, marginal value is more than the marginal cost (before equill pt.) and beyond equill. Pt., the value that consumer places on the "other" good (good corresponding to the opportunity cost) is mo before equill. Pt, value that consumer places on the good is more than the value it places on other services/goods forgone demand curve shows marginal benefit to the society and supply curve shows marginal cost to society at equill. Pt., marginal benefit for society (i.e. benefit to both consumers as well as suppliers) is maximised

to understand supply and demand curves from society's marginal benefit and marginal costassume two parties a consu When markets are functioning well, competition and allocation of price lead to an efficient allocation of resources, where Under prerfect-market conditions, industry supply curve is also marginal societal (opportunity) cost curve In capitalist economy, each consumer tries to consume the combination of goods that he values most and each producer Allocative efficiency is attaned when allocation of economy's productive resources leads to production of quantities of va Deadweight loss - loss to society because of difference in marginal benefit and cost Obstacles to efficient allocation to productive resources: results in whenever supply/demand curves don't take into a Price controls such as Price floor or ceiling Taxes and trade r maximum rental or minimum wages are the examples

Statutory tax on s Actual Incidence Pws = max. black market rent Pws-Pc = creates loss because of house search Qd-Qs = housing supply shortfall Price ceiling leads to supply shorffall and results in: black market or first-come first serve discrimination from supplier reduction in quality of goods and other inefficiencies because of supply shortfall

labour market: minimum wages Qs = available labour Qd =producer's demand of labour at that wage Qs-Qd = excess labourers Relative elasticities Deadweight loss resulting in: whoever is less ela producers looking for efficient alternatives Less elastic supply resulting in unemployment reduction in pleasant/safe working conditions reduction of non-monetary benefits to labourers

External costs costs imposed on others that are not taken into account in production decision e.g. costs imposed on fishermen by a firm that pollutes the ocean as part of production process supply curve doesn't reflect "all the costs" incurred by the "society" this results in overallocation of resources by the suppliers Public goods and common resources Monopoly common resources get inefficiently used (overused) single seller. Chooses profit-maximizing quantity as there isn't cost involved. less than efficient results in overproduction External benefits when demand curve doesn't reflect "total benefit" to society consumption benefits enjoyed by other people in addition to buyers results in equillibrium quantity being lesser than efficient quantity e.g. development of a tropical garden in an industrial complex UTILITARIAN AND SYMMETRY PRINCLE FOCUS ON: Fairness principle whether rules of allocation of resources are fair whether results of allocation of resources are fair Short-run capacity can't be adjusted production volume can be controlled by labour adjustment Long-run all can be modified/leveraged to increase quantity

Utilitarianism: (result-based) value maximised when each person owns equa wealth should be transferred from rich to poor (res 1 everyone's wants and needs are same 2 marginal benefit of a dollar is greater for a poo benefit to poor being more than loss to rich => this implies that the total marginal benefit is g problems: lesser labour and capital trade-off between fairness and efficiency resu 1 transfer by way of higher taxes will cause them 2 higher taxes will reduce savings. 3 there is admin cost involved in ensuring the tr

ORGANIZING PRODUCTION (PG-50)

Opportunity Costs: return that could have been earned elsewhere Profit maximisation Constrained by Explicit Costs 1 technology constraints production cost technology defined as means of prod interest cost additional technology resources mea Implicit Costs 2 information constraints implicit rental (opportunity costs to a firm for using its own capital) lack of information on which to base economic depreciation: decrease in a firm's asset coz of TVM information has cost associated with foregone interest: interest that firm could have earned 3 market constraints normal profit (opportunity costs of owner's entrepreneurship expertise) how much customers are willing to p Economic rent = revenue - [total opportunity costs = area below Supply curve] price and marketing activities of com Accounting profit > Economic profit as it accounts only for explicit costs

Economic activity can be produced by: Market concentration measurements Herfindahl- Hirshman index 1 market co-ordination (Do-it-yourself ap sigma (% market share) square each ingredient picked from individua <1000 => competitive 2 firm co-ordination 1000-1800 => moderately competitive lower transaction costs - negotiations >1800 => not competitive economies of scale - av. Unit cost de Four-firm concentration ratio: economies of scope - when same re % revenue of top 4 firms w.r.t. industry economies of team production - as re <40% => competitive markets All above lead to firm co-ordination being mor >60% => oligopoly Usefulness of these measures is limited because: 1 problems defining geographical scope of markets 2 barriers to entry and firm turnover in markets (no barrier means higher competitiveness) 3 weak relationship between market and industry OUTPUT AND COSTS (PG-63)

Economic profit is maximised when MR = PERFECT COMPETITION (PG 75)

Price-takers are firms that can't decide price on their own therefore, FIRM's demand curve* is perfectly elastic price-taker market is an example of perfect competition producer firms in such markets don't have any influence on market prices * Market demand curve may not be a straight line though Perfect competition when entry barrier doesn't exist economic profit = 0

P > ATC Short-run profit maximization for a firm can't c Economic profit (P-ATC) is maximised Long-run equilibrium output level for perfectly when MR = MC = ATC which is where ATC is minimum

In short-run, to meet increase/decrease in demand firms adjust quantities by increasing/decreasing labour Assuming MC = ATC in the beginning firms earn economic profit if demand increases Normal profit reduces if demand decreases MONOPOLY (pg 88) Monopoly when barriers to entry are high Legal barrier patents, licenses, govt. approved franchisees etc. Natural barrier (natural monopoly) when large economies of scale when economies of scope exist

For a price taker, Marginal Revenue = Price (as deman For producers facing downward-facing demand curves

As compared to perfect competition, Monopoly produces Qmon < Qpc to claim consumer surplus Qmon maximises profit as MR = MC @price Pmon creates deadweight loss w.r.t. perfect comp. (MC = MB further loss of efficiency seeking/establishing Pmon

Natural monopoly when: economies of scale are so pronounced that ATC is min fixed costs are high and marginal costs are low without regulation, monopolist will maximize profits by Economies of scope can also lead to a monopoly

MONOPOLISTIC COMPETITION AND OLIGOPOLY (pg 99) Monopolistic competition: 1 large number of independent sellers each firm having small market share so none can drive price firms need to pay attention only to average price not to individual competitors too many firms in industry for collusion (price fixing) to be possible 2 differentiated products each product slightly different

Firms in monopolistic compet face downward-sloping dem demand curves are highly e

close substitute to others 3 firms compete on price, quality and marketing quality is a significant product-differentiating characteristic strong correlation between quality and price that firm can charge marketing is a must to inform customers about product's (differentiating) attribs. 4 low barriers to entry firms can enter and exit

Oligopoly is a form of monopolistic competition small # of sellers interedependence (decision made by 1 firm affects demand, price and profit of others significant barrier to entry coz of large economies of scale products may be similar or differentiated e.g. Auto industry or Airplane mfg. industry

Firm produces Q such that MR = Because of economic profit = P* this leads to downward shift of d P* = ATC* such that EP = 0

Traditional model of oligopoly more elastic demand curve beyond certain price point Pk - price above which competitors will remain at Pk Oligopoly firms are in this leads to consumers switching to alternatives they can earn great pro causing relatively more elastic demand but only if neither of the Below Pk, competitors will match price-cut Oligopolists maximise their Qk is therefore Profit Maximising output level

Dominant firm oligopoly Model one firm has significant cost advantage this firm has large market share it produces quantity such that MR = MC this maximises its economic profits rest of the firms are price-takers they produce quantity where MC = P Consider this: S1 reduces price in order to increase "his revenue" he can do that as this price isn't related to MC=MR eqn. and is driven by an agreement with other company such that at industry level MC = MR other firm will also reduce price impacting both

MARKETS FOR FACTORS OF PRODUCTION (pg 111) marginal revenue product Factors influencing additional rev. gained by employing one more unit of a productive resource holding other inputs constant Downward sloping similar to MR curve for a downward sloping demand MRP curve is firm's short-run demand curve for that productive resource e.g. labour, Elasticity of dema So long as MRP > Price there is opp. to gain, hence for maximum profits, MRPlabour = PRICElabour MRP defined Wage Rate - highest a firm will pay for an additional labour 1

Effect of labour unions on wages

2 3

Monospony when buyers decide the price e.g. single emp

Labour unions do "Collective bargaining" Simply restrict supply (strikes) untill employer agrees for higher wage Wage increase reduces demanded quantity from Qc -> Qu Unions manage this decline in overall demand by: a demanding for more "unionized" workers b increase demand for products in outside world by advertising e.g. products marketed as being made by "unionised labour" c increasing price of substitutes (ie. unskilled labour) e.g. unions forcing politicians to increase minimum wages d increasing marginal product by unionised workers by trainings

For the employer, maximum profit will be when MC i.e. addnl. revenue by employing addnl. labour = Monosponic employer will employ lesser labour (Q this leads to deadweight loss of underemployment as MRPadditional worker > Wage If workers are unionised and employer is monopso actual wage is decided by bargaining

Renewable and non-renewable resources supply water is renewable, hence its supply is fixed hence it is perfectly inelastic and price is determined by the demand curve alone oil is non-renewable and though known stock at any given point is fixed it tends to increase over time with tech. advancements Rate at which oil is supplied (flow supply) is perfectly elastic at a price that equals expected next-period value If oil price is expected to increase at a rate higher than Rf interest rate suppliers will curtail production and wait for oil price to increase similarly, if ate of Rf interest rate increase is lower than oil price increase suppliers will supply more and invest earned revenue to earn more interest This is called "Hotelling principle"

Finer points Except for price, if anything else changes demand/sup price will function to equalise quantity demanded by co al benefit he derived) MINUS price he paid for it Determinants of supply and demand other than the pri lead to infinite demand increase of the other and infinite decrease in demand of onemarginal cost = d(TR)/dQ Under the assumption of perfect competition, supply is any cost changes will shift supply curve, any benefit ch when consumers increase the quantity demanded "AT wouldn't change much similarly when supplier price changes because of inpu hence more elasticity as time progresses supply or demand increase will lead to outwards move

r(s) to consume one more item

ng that little extra e.g. change in chewing gum price ch to something cheapere.g. luxury products

are bid away from alternative productive uses

onstrained to produce more or with higher efficiencies

cost (before equill pt.) and marginal value less than the marginal cost (after equill. Pt.) the opportunity cost) is more than the value they place on the good. ther services/goods forgone to produce those goods.

assume two parties a consumer having infinite power to consume various goods, and a supplier having infinite capability to produce any goo ation of resources, where marginal benefit to society just equals marginal cost for the last unit of each good and service produced

es most and each producer tries to maximize profits from production. Resulting in Allocative Efficiency roduction of quantities of various goods that have total maximum benefit to customers

d curves don't take into account total benefit or total costs to society Taxes and trade restrictions (equill. does reach)

Subsidies/quotas

Statutory tax on supplier (cost increases) statutory tax on buyer (benefit decreases) Actual Incidence of tax = tax allocation between buyer and seller Ptax-Pe = burden shared by buyer Pe-Ps = actual tax felt by the seller (Ptax-Ps)* Qtax = tax revenue Relative elasticities of demand/supply curves determine actual incidence of tax between buyer/seller whoever is less elastic will bear more Less elastic supply/demand will also mean lesser deadweight loss illegal goods: penalties involved increase cost and has same effect as tax

deadweight loss fro

Similarly productio Quotas lead to hig

zing quantity

If EP(s) = EP(d), equill. price would remain same

Symmetry principle (rule-based) en each person owns equal amount of resources people in similar situation should be treated similarly (rule-base ferred from rich to poor (result based) treat others in the same way as you like them to treat you and needs are same equality of opportunities a dollar is greater for a poor than the rich fairness must be on the basis of fairness of rules. ng more than loss to rich => more is gained than lost If rules are fair, results will automatically be fair e total marginal benefit is greater 2 rules: our and capital 1 govt. must recognize and protect private property fairness and efficiency resulting from cost of executing wealth transfer i.e. everything valuable must be held by people higher taxes will cause them to work less, resulting in less than efficient quantity 2 private of property labour must be transferred when it is voluntarily done educe savings. property acquisition through an exchange of something els t involved in ensuring the transfer

on Constrained by

gy defined as means of production l technology resources means additional costs

ormation on which to base decisions on has cost associated with it

h customers are willing to pay marketing activities of competitors

y can be produced by: dination (Do-it-yourself approach) edient picked from individual markets

Efficiency is evaluated based on labour and capital imployed Production organ Technology efficiency Command systems output with least amount of specific inputs Economic efficiency output at lowest cost Incentive systems: Something which is technically inefficient can't be economically efficient Principal-agent pr Types of biz. orgs: Proprietership Solved by: single owner, decision not by group, unlimited liability 1 Partnership 2 multiple owners, unlimited liability, 3 Corporation limited liability, large capital availability

nsaction costs - negotiations costs es of scale - av. Unit cost decreases as volume increases es of scope - when same resources could be used to produce a range of services/goods es of team production - as resources become specialized leading to efficiencies rm co-ordination being more efficient than market-coord

s maximised when MR = MC

Equillibrium in a perfect competition market

aximization for a firm can't continue for long P-ATC) is maximised when MR = MC um output level for perfectly competitive firm is:

e ATC is minimum

P = ATC Firm experiences econ As shown above, in perfect competition: when AVC < P < ATC more firms will enter to earn profit firm continues ope this will increase supply and reduce price till P = ATC as long as firm rec no firms will earn economic profit (EP) as When P = AVC, TC=TR; When P < AVC, firm do MC = ATC = MR = P Firms will only earn Normal Profit i.e opportunity cost of owner's entrepreneu

In long-run, increase in demand: leads to higher equill. price and Assuming MC = ATC in the beginnin firms start earning EP this will make other firms en Or existing firms increase lo this will reduce equill. p i.e. EP comes back to z Similarly, reduction in demand in l makes firms to either downsize o such that EP is again zero

Long-run equillibrium price could be higher/lower depending this depends upon firm's LR

Revenue = Price (as demand curve is flat) ward-facing demand curves, MR < P since price must be reduced in order to sell additional units

Technology advancements generally helps firms earn Economic Profi reduces market price in long term existing firms using older techs.

Monopoly price-setting strategies For price discrmination to wor Single-price face a downward sloping de To maximise profits, monopolists will expand Quantity till MR = MC have at least two identifiable To ensure profit, Demand curve must lie above ATC for Q* so that P* > ATC be able to prevent custome Price discrimination different consumers different price attempt to claim consumer surplus when different consumers classes can't sell Monopolists are price searchers they experiment with different prices to find out one that maximises profit Natural monopoly: average cost and marginal cost pricing

etition, Monopoly laim consumer surplus MR = MC @price Pmon r.t. perfect comp. (MC = MB) eking/establishing Pmon

Regulations to improve resou Average cost pricing: forces monopolist to pr this ensures monopolis Increased output, and s

pronounced that ATC is minimized when there is 1 firm arginal costs are low list will maximize profits by producing where MR = MC ad to a monopoly

Marginal cost pricing: referred to forces monopolist to re this results in a loss to

Difficulties to regulators in co Lack of information on firm's Cost shifting: firm has no in Quality regulations: difficult Special interest effect: firm

MC assumed constant for simplicity

s in monopolistic competition ace downward-sloping demand curve demand curves gain elasticity from demand curves are highly elastic monopoly -> oligopoly -> monopolistic comp. -> perfect competition

Though Monopolistic competition leads to Perfect competition is characterised by n

produces Q such that MR = MC and charges P* In Long-run in monopolistic competition use of economic profit = P*- ATC*, more firms enter P > MC => inefficient allocation of resources eads to downward shift of demand curve till ATC isn't minimum => inefficient production ATC* such that EP = 0 in Long run Price slightly higher than perfect competition

Oligopoly firms are in a Prisoner's Dilemma type of situation they can earn great profits if they agree to share a restricted output quantity but only if neither of them do not cheat Oligopolists maximise their total profits by joining together (colluding) and operating as single seller (monopolist)

Importance of innovation, pro Innvoation firms that bring new and inn enabling them to increa but because of low barrier t Advertising inform customer of different create perception of differen It can actually bring down a Brand name

Successful collution happens when: cheating is easy to detect threat of new entrants in market is less enforcement of anti-collusion laws, and penal

Factors influencing supply of Factors influencing firm's demand for labour Increase (decrease) in price of firm's output increases (decreases) demand for labour people prefer leisure, wage Effect of factors other than price depends upon complement (substitute) nature wages, are opportunity cost e.g. decrease in computer price decreased demand for Customer Services professional as wages increase, value o demand for IT professionals increased however as they are complementary size of adult population also Elasticity of demand of labour capital accumulation of item more elastic in long run as in long run more things can be changed e.g. automated machinery more for labour-intensive production processes Physical and Financial Capita

more where labour represents significant portion of costs degree to which labour and capital (machines) could be substituted e.g. warehouse operations for filling/shipping orders has more elastic demand of labour airlines' demand for pilots is less elastic however de the price e.g. single employer in the region

two primary factors of produ physical assets of firm (plan greater the demand of phys For profit maximisation: a MRPlabour = Wage Ra

A firm will employ additional physical capital untill its MRP = Cost of Capital i.e. interest rat Difference between MRPlabour and MRPcapital is that returns on labour happen immediately while returns on physical capital happens over a period of time Demand for financial capital is derived from present value of MRP of physical capital downward sloping curve Supply of financial capital is driven by: influenced by consumption now or later a interest rates b current incomes c expected future incomes

imum profit will be when MCL=MRP employing addnl. labour = marginal cost of labour will employ lesser labour (Qm) at Wm ht loss of underemployment worker > Wage d and employer is monopsonist ided by bargaining Economic Rent and opportunity costs

Opportunity cost of an employee is what he could earn For low skill jobs, as there are many opps , opp. Cost i e.g. wage rate at a car wash For high-skills jobs, Opp. Cost and Wage Rate have si e.g. a highly successful actor Economic rent = Earnings - Opportunity Costs Similar to producer's surplus this implies that a highly skilled professional will make high economic rent at it is difficult to replace him

else changes demand/supply. It would shift demand, supply curves as appropriate e quantity demanded by consumers and produced by producers demand other than the price of the good in question, such as consumers' income, input prices and so on, are not explicitly represented in

erfect competition, supply is determined by marginal cost. Firms will produce additional output as long as the cost of producing an extra unit supply curve, any benefit changes will shift demand curve he quantity demanded "AT A GIVEN PRICE", it would lead to demand curve shift e changes because of input costs or otherwise, that would shift supplier curve will lead to outwards movement of respective curve. Decrease will lead to invwards movement of respective curve

apability to produce any good. If you have an objective to maximize benefits to both....it will lead to equilibrium position across all nd service produced

Subsidies/quotas

deadweight loss from overproduction - MB < MC to society

Similarly production quota limits lead to underproduction loss Quotas lead to higher market price and increase profits for suppliers

reated similarly (rule-based) them to treat you

vate property held by people when it is voluntarily done exchange of something else he owns

Production organisation Command systems: chain of command followed e.g. army where its easy to monitor/measure performance Incentive systems: incentive based to motivate workers for performance Principal-agent problem incentive/motivations of managers(agent) different from principal ( owners) Solved by: ownership in firm incentive pay long-term contract: to encourage CEOs develop strategies for long-term profit

Law of diminishing returns: as more and more of one resource is added, output keeps increasing but at decreased

In short-run, only labour and raw-material costs can be altered In long-run, all including plant size, equipment, technology can be altered Long-run cost curves are called planning curves. Economies of scale because: 1 savings due to mass production 2 specialization of labour and machinery 3 experience Diseconomies of scale because of: 1 increasing bureaucracy 2 motivating large workforce 3 great barrier to innovation and entrepreneurial activity 4 increased principal-agent problem

Firm experiences economic losses when P < ATC when AVC < P < ATC firm continues operations and tries to minimize losses as long as firm recovers AVC, its loss will be less than Fixed Costs When P = AVC, firm is at Shutdown point When P < AVC, firm doesn't recover even Running Cost, and it considers SHUTDOWN

cost of owner's entrepreneurial expertise

un, increase in demand: s to higher equill. price and supply g MC = ATC in the beginning start earning EP his will make other firms enter market Or existing firms increase long-term capacity, leading to rightward shift of Supply curve this will reduce equill. price and increase equil. quantity till MC = ATC i.e. EP comes back to zero , reduction in demand in long-term es firms to either downsize or leave industry shifting supply curve such that EP is again zero

n equillibrium price d be higher/lower depending upon economies/diseconomies of scale his depends upon firm's LRATC curve (refer LONG RUN AV. TOTAL COST Curve)

gy advancements generally reduce input costs s firms earn Economic Profit till others adopt the change too ces market price in long term ng firms using older techs. Will experience economic losses and will be forced out

price discrmination to work, seller must: ace a downward sloping demand curve have at least two identifiable groups of customers having different demand elasticities be able to prevent customers from reselling

ulations to improve resource allocation Average cost pricing: forces monopolist to price corresponding to ATC = Demand this ensures monopolist end up getting only Normal Profit Increased output, and social welfare (allocative efficiency)

Marginal cost pricing: referred to efficient regulation forces monopolist to reduce price such that Demand = MC this results in a loss to the firm therefore subsidy = ATC - MC is required

culties to regulators in controlling prices in case of high barriers: Lack of information on firm's ATC, MC or demand schedule Cost shifting: firm has no incentive to reduce costs as that will cause regulators to reduce prices Quality regulations: difficult to measure. Firm can reduce quality to maintain profits Special interest effect: firm may influence regulations by political connections

polistic competition leads to inefficient production/higher price etition is characterised by no product differentiation

ortance of innovation, product development, advertising and branding

irms that bring new and innovative products face less elastic curves enabling them to increase price and earn EP but because of low barrier to entry, they need to continually innovate

nform customer of differentiators create perception of differences between products that are actually similar t can actually bring down average costs (if advertising results in larger sales)

ppens when:

ants in market is less ti-collusion laws, and penalties of collusion are weak

ors influencing supply of labour people prefer leisure, wage rates must be high enough for them to give up leisure wages, are opportunity cost of leisure as wages increase, value of leisure for ind. increase, and so does marginal wages size of adult population also affect supply of labour capital accumulation of items that increase efficiency at home also increases supply

sical and Financial Capital

wo primary factors of production - labour (people), physical capital (machines) physical assets of firm (plant, property, equipment - PPE) greater the demand of physical capital, greater the demand for financial capital For profit maximisation: MRPlabour = Wage Rate b MRPcapital = Cost of Capital MRPcapital present value of future returns st of Capital i.e. interest rate

loyee is what he could earn in next highest-paying job are many opps , opp. Cost is very close to wage rate

ost and Wage Rate have significant difference

portunity Costs

lled professional

ot explicitly represented in the supply-demand diagram. Changes in the values of these variables are represented by shifts in the supply an

t of producing an extra unit of output is less than the price they will receive.

osition across all

ncreasing but at decreased rate

resented by shifts in the supply and demand curves. By contrast, responses to changes in the price of the good are represented as movem

e represented as movements along unchanged supply and demand curves.

MONITORING JOBS AND PRICE LEVEL (PG 126) POPULATION WORKING AGE POPULATION young and institutionalized LABOR FORCE not in labour force EMPLOYED unemployed Unemployment rate = (employed / labour force ) *100 Labour force participation = (labour force / working age popluation) * 100 employment to population = (employed / working age population) * 100 = unemployment rate * labour force participation

Sources of Unemployment frictional: normal labor turnover, people enteri or ongoing creation/destruction of jobs Structural: coz of change in technology, skills

Cyclical: coz of economic recession/expansion

Full Employment: when no cyclical unemploym Natural unemployment rate = unemplyment r

PRODUCTION AND PRICES (PG 137)

bor turnover, people entering/leaving labor force on/destruction of jobs ange in technology, skills

Aggregate hours total labor used to produce real GDP Real wage rates quantity of good/services an hour's work can buy combines wages with price-levels Potential GDP: when full employment real GDP fluctuates around potential GDP

CPI = cost of CPI baske cost of CPI baske Inflation rate

nomic recession/expansion

when no cyclical unemployment ent rate = unemplyment rate at full employment

CPI is baised new goods quality changes Bias is as much as 1% h

CPI = cost of CPI basket at current prices X 100 cost of CPI basket at base period prices

CPI > 100 mostly

Inflation rate = (CPIcurent year - CPI last year) * 100/ CPIlast year CPI is baised because it doesn't take into account: new goods substitution quality changes outlet substitution Bias is as much as 1% hiher

Asset allocation decision (pg. 104) Four steps in portfolio mgmt. process: write a policy statement develop an investment strategy implement the plan monitor and update investor's needs and Investment objectives must be described in terms of both risk and return 1 return 2 risk Specifying investment goals in terms of just returns exposes investor to: in-appropriate, risky investment strategies 90% of the portfolio return differences can be explained by difference in portfolio allocations

Return objectives: Capital preservation objective of earning at least the infla with less or no chance of loss appropriate when time horizon is les Capital appreciation (most risky) objective of earning at least the infla over some period of time appropriate when funds needed in th Current Income (income objective) when primary purpose is to produce total return (long term, risk averse) objective of having portfolio grow in v through capital gains as well as r In terms of risk: capital appreciation

Portfolio Management (pg. 111)

Markowitz model - assumptions on investor's behavior investment opp. is looked at as probability dist. of E(R) over in risk is measured as variance of E(r ) all decisions are made considering only Risk and E(R) investors prefer lesser risk for same E(R) investors maximise their expected utility over investment horiz

Co-variance On an indifference curves, all investments are equally preferred A curve towards NW is more preferred

Risk Or Std. deviation of a portfolio having 3 assets

The risk of a portfolio depends on: asset weights, std. dev. of Portfolio theory: only for risky assets Asset Pricing Model (pg. 130) Capital market theory Extension of Portfolio theory by addition of a risk-free asset Assumptions: markowitz investors: portfolio selection along efficient frontier unlimited risk free lending and borrowing

Introduction of a risk-free asset converts efficient frontier into CML (capital market line)

all investors see same E(r ) v/s risk all investors have same period horizon all investments are infinitely divisible frictionless markets: no taxes or transaction costs no inflation or interest rate changes markets in equilibrium As per the theory, stock having more unsystematic risk will actually have lesser equilibrium returns as compared to a stock having more systematic risk (ie. more sensitivity to market risk factors) CAPM, SML, Beta Given that only relevant risk for an individual asset i is the covariance with market returns, relationship is straight line

this holds coz correlation coeff. = 0

X, Y risky portfolios on Efficient Frontier a portfolio along RFR-Y is preferred to RFR-X coz of more returns for a given risk This can go on till we reach M. At M 100% is invested in p

SML uses beta on x-axis, hence all stocks, portfolio of stocks in equilibrium wil plot on SML Beta as risk contribution of a security to a well-diversified portfolio CML plots against total risk (sigma P), hence only efficient portfolios plot on CML Identifying under/overvalued As all portfolios under equilibrium are on SML, a portfolio is: undervalued if its estimated returns are above SML i.e estimated returns > expected (or required) returns overvalued if estimated returns are below SML i.e estimated returns < expected (or required) returns Zero-beta model Instead of RFR, a zero beta portfolio can be used as a risk-free asset

Assumption: Differential borrowing and lending rates as borrowing and lending rates are different in real-world CML has some curvature on Efficient frontier which implie that beyond M, returns would be lesser because of higher

Assumption: transaction costs No transaction costs assumtion guarantees that all stocks SML at equilibrium. In case there are transaction costs inv slightly-mispriced stocks won't be brought back to SML. This will allow a band of E(r ) around SML whose width wi transaction costs

SML CML differences

Investment constraints: constraints that impact po Liquidity: potential need of ready cash

e of earning at least the inflation rate or no chance of loss ate when time horizon is less and fund needed in near future reciation (most risky) e of earning at least the inflation rate exceeding inflation me period of time ate when funds needed in the future e.g. retirement ome (income objective) mary purpose is to produce income instead of appreciation (long term, risk averse) e of having portfolio grow in value to meet future needs gh capital gains as well as re-investment of income of risk: capital appreciation > total return > income objective

Time horizon; refers to time between making an in

Tax concern: after tax returns are what investors a

Legal and regulatory factors: constraints that impact investment decision of in e.g. penalty for early withdrawals Unique needs and preferences

n investor's behavior obability dist. of E(R) over investment horizon

g only Risk and E(R)

d utility over investment horizon

Correlation

between -1 and +1

=> higher negative correlation leads to: lesser portfolio risk higher diversification gains Efficient frontier: a portfolio is efficient when no other portfolio: can give better E(r ) for a given risk can be less risky for a given E(r ) represents a set of portfolios that will give highest returns at each risk level

Optimal portfolio

folio having 3 assets

: asset weights, std. dev. of assets, and correlation of asset returns

nto CML (capital market line)

Unsystematic risk that disappears during portfolio construc unique, firm specific

Market portfolio M best that can be achieve

s coz correlation coeff. = 0

on risk diversification Systematic risk can't be diversified Risk that remains in portfolio 'M' beyond diversification is called Systematic risk

ferred to RFR-X coz of more

securities sensitive to market movements have high Systematic Risk Total risk = systematic + unsystematic risk

. At M 100% is invested in portfolio M M represents market portfolio all investors have to do to get the risk/return combination that suits them the most is to simply vary proportion between M and RFR

Comparison between CML and SML

Since one shouldn't be comp at equilibrium security returns this also implies that the ris Adding more assets to portfol

wing and lending rates s are different in real-world Efficient frontier which implies be lesser because of higher rates

CML plots returns v/s total risk SML plots all portfolios against B Portfolios that are not efficient plot under Efficient Frontier As per CAPM, in equilibrium, pric Compare C and D between two graphs A low-beta stock/portfolio like C m Even though D has higher systemic risk, C's total risk is higher total risk n guarantees that all stocks move to Assumption: heterogenous expectations and planning periods Assumption: no taxes, ere are transaction costs involved, homogenous expectations and single holding period is individual investors pa be brought back to SML. necessary to bring multitude of CML, SML into one. so their CML, SML ba around SML whose width will depend upon If these assumptions are not valid, there will be multiple Investors pay capital g CML and SML leading to a band of lines with width dependent E(r after tax) = [(Pe-Pb on divergence on E(Rm ) and holding periods

constraints that impact portfolio construction ed of ready cash

o time between making an investment and needing the funds returns are what investors are concerned with

pact investment decision of individuals as well as FII y withdrawals

Optimal portfolio for each investor is one where investo's highest indifference curve is tangent to efficient frontier

ars during portfolio construction

M best that can be achieved

k can't be diversified ns in portfolio 'M' beyond called Systematic risk

sitive to market ve high Systematic Risk ematic + unsystematic risk

ince one shouldn't be compensated for bearing risk that could have been diversified, t equilibrium security returns depend only upon Systemic Risk his also implies that the riskiest stock may not provide greatest returns dding more assets to portfolio will bring down UNSYSTEMATIC risk with decreasing rate, however Systematic risk can increase or decreas

plots all portfolios against Beta. Hence, whether efficient or not, they will be on SML on equilibrium er CAPM, in equilibrium, prices are direct function of systemic risk w-beta stock/portfolio like C may not necessarily be less risky when considering Assumption: no taxes, CML, SML is arrived at on an assumption of no taxes. individual investors pay different marginal taxes depending upon their slabs so their CML, SML based on post-tax income will be different Investors pay capital gain tax on securities and ordinary income tax on dividend E(r after tax) = [(Pe-Pb)(1 - Tcapitalgain) + Div * (1 - Tordinary)] / Pb

risk can increase or decrease depending upon additional assets beta

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question

differentiation between gains/losses under revenue v/s other comprehensive income espwcially w.r.t. investments and assets minimum pension liability how is "completed contract" handled under IFRS discontinued operations handling. Post measurement date and during phaseout period how is prior-period adjusment reported? CFI calculation, problem D. inventory write up example tax calculation in double-depr and per-unit methods impact of accretion expense on interest coverage ratio - why is accretion expense added to EBIT? relationship between netincome and CFoperations how does LIFO COGS impact CFO? Long-lived asset - Q No. 2

nvestments and assets