CFA Level I flashcards

Ability to take risk reflects financial capacity (time horizon, income, wealth), while willingness reflects psychological risk tolerance; when they conflict, the more conservative measure typically governs.

• Ability is objective; willingness is subjective/psychological
• When they conflict, advisors generally follow the more conservative constraint
• Client education can help align willingness with ability over time

Memory trick: When head and heart disagree, let the cautious one lead

IFRS requires that significant parts of an asset with materially different useful lives be depreciated separately, rather than as a single unit, to better reflect the pattern of economic benefit consumption.

• Each component's depreciable base is divided by its own useful life
• US GAAP permits but does not require component depreciation
• Common in aircraft, buildings, and machinery with distinct parts

Memory trick: Split the plane, depreciate each lane.

A distribution is negatively skewed when it has a long tail on the left side, causing the mean to be less than the median, which is less than the mode.

• Negative skew: mean < median < mode
• Positive skew: mean > median > mode
• Skewness measures asymmetry, not tail thickness (that's kurtosis)

Memory trick: The tail points where skew's sign lies — left tail, negative sign.

A model that calculates the expected/required return on an asset based on its systematic risk (beta) relative to the market.

• Formula: E(R) = Rf + β[E(Rm) − Rf]
• Beta measures sensitivity to market movements
• Assumes investors are compensated only for systematic risk

Memory trick: Risk-free base plus beta times the market's extra kick

The level of EBIT at which two alternative financing plans produce identical earnings per share, used to evaluate the impact of financial leverage on EPS.

• Above the indifference EBIT, more leveraged plans produce higher EPS
• Below it, the less leveraged (equity-heavy) plan produces higher EPS
• Formula: (EBIT)(1-t)/N1 = (EBIT-I)(1-t)/N2

Memory trick: Find the tipping point where debt's extra risk finally pays off in EPS.

Analysts may combine public information with non-material nonpublic information and use professional judgment to reach investment conclusions, even if those conclusions would be material if based on a single MNPI source.

• Distinguishes legitimate analysis from insider trading
• Each individual piece of information used must not itself be both material and nonpublic
• Widely used defense in II(A) analysis of research-based conclusions

Memory trick: Small tiles, big picture, no insider info needed.

The full price is the amount a buyer actually pays, equal to the clean (quoted) price plus accrued interest since the last coupon date.

• Full price = Clean price + Accrued Interest
• Accrued Interest = Coupon × (days since last coupon/days in period)
• Bond quotes in the market are typically clean prices

Memory trick: Clean is quoted, dirty is what you pay.

The effective cost to a firm of borrowing after accounting for the tax deductibility of interest payments.

• Formula: rd × (1 − tax rate)
• Interest expense reduces taxable income, creating a tax shield
• Always lower than the pretax cost of debt when tax rate > 0

Memory trick: Taxes take a bite out of the cost of debt

Spreading false or misleading information, or information known to be false, with the intent to mislead market participants and distort security prices for personal gain.

• II(B) covers both transaction-based (e.g., wash trades) and information-based manipulation
• Intent to distort price or mislead is the key element
• Applies regardless of anonymity or medium used

Memory trick: Lies that move the price are manipulation in disguise.

Under GIPS, net-of-fees returns must reflect the actual deduction of investment management fees from portfolio value, typically calculated by dividing (1 + gross return) by (1 + fee) and subtracting 1, rather than simple subtraction.

• Net return = (1+gross)/(1+fee) − 1 for a lump-sum year-end fee
• Simple subtraction understates true fee impact due to compounding
• GIPS firms must present at least one of gross- or net-of-fees returns per firm policy

Memory trick: Fees compound, don't just subtract — divide and conquer the return.

Standard IV(A), Loyalty, requires employees to obtain consent from their employer before engaging in independent, compensated practice that could compete with the employer's business, even if minimal resources are used.

• Consent must be obtained before beginning independent practice for compensation
• Applies even without direct client overlap or resource use
• Failure to disclose/obtain consent is itself the violation, regardless of intent

Memory trick: Ask before you moonlight in the same field.

A real estate metric that measures the annual return on the initial cash invested, before any debt financing.

• Calculated as Net Operating Income (NOI) divided by the initial equity investment (purchase price if unlevered).
• Focuses solely on the cash flow generated by the property, not capital appreciation.
• Provides a snapshot of the property's income-generating ability relative to its cost.

Memory trick: Cash-on-Cash: How much cash income from your initial cash payment.

Measures a hedge fund's sensitivity to overall market movements, often assessed through net exposure and beta.

• Net Exposure = Long Positions - Short Positions.
• Gross Exposure = Long Positions + Short Positions.
• Beta indicates the fund's systematic risk relative to the market.

Memory trick: Net Exposure times Beta feels the Market's tremor.

Private equity funds charge management fees, typically 1.5% to 2.5% annually, to cover operational expenses.

• Calculated on committed capital during the investment period.
• Calculated on net asset value (NAV) during the post-investment period.
• Reduces the limited partners' (LPs) net returns.

Memory trick: Committed Capital for Investment, NAV for Post-Investment, then Sum.

A model used to determine the theoretical futures price of a commodity, based on its spot price and the costs of holding it.

• Theoretical Futures Price = Spot Price * (1 + Risk-Free Rate) + Storage Costs.
• Excludes convenience yield in its basic form.
• If actual futures price > theoretical, it's overvalued; if actual < theoretical, it's undervalued.

Memory trick: Spot grows by risk-free, then add storage, that's fair.

A hedge fund strategy that profits from mispricings between convertible bonds and their underlying common stock.

• Typically involves buying the convertible bond and shorting the underlying equity.
• Aims to be market neutral by hedging equity price risk.
• Profits from volatility, credit spread changes, and bond-equity conversion features.

Memory trick: Arbitrage seeks mispricing, Converts link Bond & Stock.

Net income is the final profit remaining after all expenses, including costs of goods sold, operating expenses, interest, and taxes, have been deducted from revenue.

• Represents the 'bottom line' of the income statement.
• Crucial for assessing a company's profitability and financial health.
• Calculated as Revenue - COGS - Operating Expenses - Interest Expense - Tax Expense.

Memory trick: Revenue's journey down, past costs and taxes, to find the final gain.

The future value of an ordinary annuity is the total accumulated amount of a series of equal payments made at the end of each period, earning compound interest.

• Payments occur at the end of each period.
• Used to calculate the future worth of a stream of regular savings or investments.
• Formula: FV = PMT * [((1 + r)^n - 1) / r].

Memory trick: End-of-period payments grow to Future Value, like a 'house' built with 'monthly' 'bricks'.

A depreciation method that allocates an equal amount of an asset's depreciable cost to each year of its useful life.

• Simplest and most common depreciation method.
• Depreciable cost = Asset Cost - Salvage Value.
• Annual Depreciation = (Cost - Salvage Value) / Useful Life.

Memory trick: Straight-line means a steady, even reduction over time, like drawing a line.

COGS represents the direct costs attributable to the production of the goods sold by a company during a period, calculated using the inventory equation.

• Key component of the income statement.
• Directly affects gross profit and net income.
• Formula: Beginning Inventory + Purchases - Ending Inventory.

Memory trick: Start with what you HAD, add what you BOUGHT, subtract what's LEFT, to find what you SOLD.

Book value per share (BVPS) represents the amount of equity attributable to each share of common stock, based on accounting records.

• Reflects the historical cost of assets less liabilities.
• Calculated as (Total Assets - Total Liabilities) / Common Shares Outstanding.
• Often compared to market value per share to assess valuation.

Memory trick: Assets minus debts, then split among the common shares.

The expected value of a random variable is the weighted average of all possible values, where the weights are the probabilities of each value occurring.

• Represents the average outcome if an experiment is repeated many times.
• Calculated as Σ(x_i * P(x_i)).
• Can be used for discrete or continuous random variables.

Memory trick: Probability's Product Sums to Expectation's Outcome.

The profit for a short put option is the premium received minus the payoff to the buyer (Strike Price - Spot Price, if positive).

• Payoff to buyer = max(0, Strike Price - Spot Price)
• Profit for seller = Premium - Payoff to buyer
• Seller's maximum profit is the premium received if the option expires out-of-the-money
• Seller's maximum loss is limited but can be substantial as the underlying price approaches zero

Memory trick: Short put: Collect first, then pay if put to the test!

The profit for a long call option is the payoff (Spot Price - Strike Price, if positive) minus the premium paid.

• Payoff = max(0, Spot Price - Strike Price)
• Profit = Payoff - Premium
• Loss is limited to the premium paid if the option expires out-of-the-money

Memory trick: Call to action: Buy low, sell high, but remember the cost!