CFA Revision

1. Tips to crack CFA-1 syllabus in 6 days
Equity & Fixed Income
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2. Tips-n-Tricks : Equity Revision
• One-Period Valuation Mode
 V0=(D1 + P1) / (1+K0) ; be sure to use expected Dividend D1 in calculation
• Infinite Period Dividend Discount Models
 Critical relationship between ke & gc
 Critical assumption of infinite period DDM
• Price Multiples
 P/E multiple
 P/BV multiple
 P/Sales multiple
 P/CF multiple
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3. Tips-n-Tricks : Equity Revision Contd …
• Earnings Multiplier Model:
 P0/E1= (D1/E1)/ (k-g) = Payout ratio /(k-g)
• Price Indexes & Bias
 Price weighted
 Equal weighted
 Market Cap Weighted
• Estimating EPS
 EPS1 = [sales (EBITDA %) – int - depn] (1 - t); Where sales, interest & depreciation are all per share
amounts
• Concentration Ratios
 N-firm concentration ratio is sum of the market shares of the N largest firms.
 Herfindahl index (N-firm or industry)
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4. Tips-n-Tricks : Equity: Do Not Forget
• Remember that technical analysis is a direct violation of weak-form EMH and Fundamental
analysis is a direct violation of semi-strong from EMH
• Concepts that need to be crystal clear before entering the exam hall: The difference in FCFE and
FCFF and which discount rate is applicable under both of them is of utmost importance.
• Don’t forget to discount the terminal value while calculating the intrinsic value of a stock in the
exam. This is a general mistake which students do.
• Never confuse between the required rate of return and the growth rate in the Gordon Growth
Model Equation.
• The top-down approach is a method of valuation that begins with first analyzing the overall
economy and then continuing to drill down to the specific analysis.
• Enterprise Value (EV) = Market Cap (of Equity) + Market Value of Debt - Cash and Cash
Equivalents (including marketable securities)
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5. Tips-n-Tricks : Fixed Income Revision
• Basics of Bond:
 Basic Features of Bond Structures
 Repayment /Pre-payment Provisions
 Bullet Bonds:
 Serial Bonds
 Amortizing Securities:
 Sinking Fund
 Call Provisions:
 Non-refundable Bonds
 Basics of Floating Rate Bonds
• Bonds & Risk Management
 Interest Rate Risk
 Reinvestment Risk
 Credit Risk
 Sovereign Risk
 Event Risk
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6. Tips-n-Tricks : Fixed Income Revision Contd…
•
Bond Pricing
 Basic Bond Pricing
Market price
CF1
Y
TM
1
Market price
1
CF1
1 S
1
CF2
Y
TM
CF2
1 S
2
2
CF3
Y
TM
1
CF3
1 S
3
3
..
...
 Accrued Interest & Clean Prices
 Nominal:
Nominal Spread
 Z-Spread: Price =
YTM Bond
YTM Treasury
Coupon
1 1yr Spot rat e ZS
Coupon
1
1
2 yr Spot rate
ZS
2
 Options Adjusted: Option Adjusted Spread = Z-Spread – Option Cost
•
Yield Calculation
 Current yield = Annual coupon payment / Bond price
 Bond equivalent yield(BEY):
2 * 1 YTM AnnualPay
1/2
1
 Annual equivalent Yield(AEY)= (1+(BEY/2))2 -1
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7. Tips-n-Tricks : Fixed Income Revision Contd…
• Advanced Features of Bonds
 Duration & Convexity
 Effective duration (D) = (V--V+)/(2V0(Δy))
 Modified Duration = Macaulay Duration /(1+ YTM)
% P
[ Duration * y Convexity * ( y ) 2 ] *100
 Other Duration Measures
 PVBP=Duration*0.01%*Bond Value
 Term Structure Theories
 Pure Expectations Hypothesis
 Liquidity Preference Theory
 Market Segmentation Theory
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8. Tips-n-Tricks : Fixed Income Revision Contd…
Fundamentals of Credit Risk
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9. Tips-n-Tricks : Fixed Income: Do not Forget
•
The Current Yield of a bond DOES NOT CHANGE with frequency of coupon payments. It is same for
annual pay, semi-annual pay, quarterly pay or any other frequency coupon payments.
•
While calculating Forward Rates from Spot Rates or Spot Rates from Forward Rates always draw the
timeline with the cash flows for valuing fixed income securities. There is less scope of error when you
visually understand what needs to be calculated.
•
While asked to find the YTM of a bond, don't forget to adjust the outcome of I/Y on calculator with
frequency of coupon payments. If you are calculating YTM using semi-annual coupon payments,
multiply the outcome of I/Y * 2.
•
PMT=0 always for Zero coupon bonds. If you don’t explicitly press PMT=0, then the calculator will take
the PMT value of your previous TVM calculation.
•
While calculating the Yield to Call (YTC) or Yield to Put (YTP), FV changes to the Call Price or Put Price
and not PV, and N changes to the Time till the call date.
•
Effective Duration calculations explicitly take into account the a bond’s option provisions such as
embedded options. Only Callable bonds exhibit negative effective convexity and it is more prominent at
lower interest rates. The other methods (Macaulay & Modified) ignore the option provision completely.
The Macaulay and Modified Duration of a Callable Bond are always positive since they do not factor in
the option.
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